Another Wall Street investment bank lowers its rating for China’s software industry: AI disruption, valuation overhaul!

In the past decade, the most captivating narrative in the capital markets for the software industry has been "SaaS-ization"—as long as subscription revenue grows, current losses are not only tolerated, but even seen as a necessary cost for grabbing market share.

The market has paid a hefty valuation premium for this, betting on high future profits brought by scale effects. But the explosion of generative AI is dismantling the foundation of this logic: AI has not made software more standardized or more profitable; instead, it has forced software firms to revert to being customized service providers—essentially "selling labor."

On February 10th, according to Wind Trader news, UBS pointed out in its latest report that the rapid iteration of large language models (LLMs) is triggering a fundamental re-evaluation of the "standardized SaaS" model. The SaaS halo, which once enjoyed premium valuation, is fading; the market is no longer buying into long-term growth stories, but demands to see present cash flow and profit.

Historically, software firms commanded high valuations because scalable subscription revenue could deliver operating leverage and high profits. However, as LLM-native agents may commoditize standard SaaS workflows, standardization may cease to be an asset, and instead become a liability.

According to UBS analyst Sara Wang, revenue growth without profit protection is no longer a sustainable investment thesis. The market is shifting from a sales-based valuation model to a framework based on price-to-earnings (P/E) or free cash flow (EV/FCF).

The report says this shift in valuation paradigm has directly led to a downgrading of the whole sector's rating. Since AI is forcing software companies to offer more customized services to meet customers’ vague demands, their business models are aligning with low-margin "IT services."

Coincidentally, Morgan Stanley noted in a report on February 4th that this marks the start of a long-term narrative transformation, ending the irrational rally in the sector as of January 2026. Although seat-based SaaS charging models are not common in China, traditional software (especially tools) faces the same disruption risk in the long run.

Nevertheless, the report notes that existing software vendors still have a window to embrace new technologies and can use their large installed customer base to resist disruptors, but overall risks remain tilted to the downside.

The "Curse" of Standardization: The SaaS Premium Is Vanishing

According to the report, in the past, the valuation logic for leading Chinese software firms relied on "convergence premium"—investors bet they would eventually achieve high-profit, standardized subscription models like Salesforce or Adobe. Therefore, despite their profitability lagging far behind their U.S. counterparts, the EV/Sales ratios for Chinese software stocks long matched those of U.S. stocks.

However, UBS believes this logic has been utterly dismantled by AI. Since the beginning of the year, despite no evidence that SaaS profitability has been disrupted by AI, the stock prices of leading U.S. software companies have dropped by 10%-40% amid the fading SaaS subscription premium.

When AI large models (LLMs) can replace standardized workflows, software firms are forced to retreat to the old path of customization. If the end value of a standard SaaS product faces the threat of being replaced by AI, and delivery requires more custom development, the logic behind high SaaS valuations no longer holds.

UBS stated that the Chinese software sector's valuation system is being forced to decouple from SaaS and return to traditional IT service valuation—which means that price-to-earnings (P/E) or free cash flow (EV/FCF) will replace sales multiples as the new anchor for pricing.

The "AI Trap" of Revenue Growth Without Profit Growth

UBS cited data from the Ministry of Industry and Information Technology (MIIT) in its report, showing that since the "DeepSeek Moment" at the start of 2025, revenue growth in China's software sector has indeed accelerated, but profit margins have been declining.

The bank believes this reveals a harsh reality: although AI has driven increased enterprise IT spending, this demand is not directed toward standardized software products.

To bridge the gap between customers' unclear needs and the rapidly iterating large models, software companies are forced to invest heavily in manpower to provide customized services. In this model, revenue growth no longer leads to margin expansion; on the contrary, heavy custom development may drag down profitability.

This is an "awkward" combination: enterprises are willing to spend on AI, but more money flows to delivery and transformation, not toward high-profit incremental gains of standardized subscriptions. In terms of valuation, revenue growth is no longer automatically equated with margin expansion.

In its report, UBS breaks down the bottlenecks in software firms’ AI monetization into three:

1) Insufficient AI capabilities—the current product quality is not yet enough for customers to keep paying;

2) Immature digital ecosystems—fragmented data and old hardware dragging out implementation cycles;

3) Trust issues with AI expertise—traditional software providers may be compared by clients to AI startups and cloud vendors for AI abilities.

But UBS also leaves room for opportunity: the very challenges will offer chances for vendors who can deliver end-to-end solutions, understand vertical industries, and cross-sell traditional digital products.

The price is that, as models see new versions every 2–3 months and more large models claim to cut into vertical scenarios, software companies must iterate and deliver faster. However, "more customization" usually means less standardization and more difficulty expanding margins.

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The above content is from Wind Trader.

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