Is Enterprise Software Immune to Macro Challenges? - 7investing

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Is Enterprise Software Immune to Macro Challenges?

June 16, 2022

Everyone is talking about inflation and the overall macroeconomic situation. 

Some retailers are out right-sizing their inventories. 

eCommerce businesses have experienced softening demand following two years of crazy growth during the pandemic.

Overall, if one reads the conference calls, we get a sense of caution in the wind.

But the music from the enterprise software industry seems to have a different beat. The general vibe is upbeat, with the move to the cloud, more digitization, and overall solid demand for at least the class-leading software businesses. 

Microsoft (NASDAQ: MSFT) CEO Satya Nadella, for example, opened their Q3 2022 earnings call with the following commentary:

“It was a record third quarter, driven by the continued strength of the Microsoft Cloud, which surpassed $23 billion in revenue, up 32% year-over-year. Going forward, digital technology will be the key input that powers the world’s economic output. Across the tech stack, we are expanding our opportunity and taking share as we help customers differentiate, build resilience and do more with less.”

And Nadella went on to conclude his remarks with the following:

“In closing, we are entering a new era where every company will become a digital company. Our portfolio of durable digital businesses and diverse business models built on a common tech stack position us well to capture the massive opportunities ahead.”

It is a familiar tone to those of us tuning into technology companies’ earnings. 

Salesforce.com (NYSE: CRM) co-CEO Marc Benioff during their recent Q1 2023 call, seemed to suggest that the tumultuous ongoings of the world had, thus far, little impact on their business:

“And so far, we’re just not seeing any material impact from the broader economic world that all of you are in. Our demand environment where demand is very strong, and if you look over the last 23 years, Salesforce has proven to be incredibly resilient based on this incredible business model.”

And this isn’t just the enterprise software behemoths that are exhibiting confidence. I have previously discussed how the cybersecurity sector appears to be growing gangbusters through the thick and thin of the economy.

There’s no doubt software is eating the world. Companies today have no choice but to adopt the best software practices, or else they face the possibility of extinction. Software is no longer a choice, an afterthought, or an option; it is a necessity.

But does that mean the software industry is 100% immune to the economy? 

That would be asking for too much. And I think we have seen the first-level impact of this starting to show in some shape or form. So just a month after those effusive words from Satya Nadella, Microsoft issued a slide deck downgrading their previously published sales guidance by around $400 million. The culprit was the rising US dollar!

And in the same earnings call where Marc Benioff was beating the drum on software demand, Salesforce too tweaked their sales guidance for fiscal 2023 downwards by $300 million. And again, you guessed it, citing foreign exchange impact.

Salesforce CFO Amy Weaver noted that “the change in currencies represents an incremental $300 million year-over-year headwind on top of the $300 million we provided last quarter, bringing the total year-over-year FX headwind to $600 million.

Most class-leading software companies are still seeing strong growth. And there’s no reason to believe that demand will materially change pace anytime soon. And foreign exchange movements do tend to net out over time. Companies love calling them out when they act as headwinds but don’t publicize their benefit when it works as a tailwind. And as Amy Weaver noted in her commentary to analysts, there is some degree of natural hedge in these businesses as far as currency is concerned. Why? Because many companies have regional revenue and expenses in the same currency, and thus there shouldn’t be much impact from an operating margin standpoint.

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