Software Sector Sees M&A Hopes and Cheap Valuations
The software sector is seeing a mix of optimism and caution, driven by potential mergers and acquisitions (M&A) and attractive valuations. While deal talk has provided a valuation floor, fundamental factors and AI disruption sentiment will ultimately determine the sector's trajectory. The sector remains cheap on forward earnings but has seen significant declines over the past year.
Truist highlighted that 2026 software M&A activity has been 'quite sleepy,' but talks by Silver Lake to take a company private at about 15x free cash flow (FCF) could set a benchmark. European peers rallied in sympathy on August 14. Truist’s target list includes 'A list' companies like Commvault, Elastic, Five9, GitLab, HubSpot, UiPath, Varonis, and Zeta Global, and 'B list' companies like Dynatrace, Intapp, JFrog, Klaviyo, Paylocity, Qualys, and Tenable.
Strategic buyers are active, with reports of talks for Listen Labs at about $2 billion following a $3.6 billion deal for Fin in June. Software stocks rallied on September 14, aided by easing AI-disruption fears and takeover premiums. Workday’s $4 billion buyback and upcoming analyst day on October 13 suggest management is pushing for independence.
However, the bear case remains that press reports do not guarantee deals, and if talks fade, the premium could be at risk. Fundamentally, the sector shows low multiples, double-digit growth, and large one-year drawdowns. Investors priced in AI disruption, making cash-generative businesses attractive targets for private equity.
The pick to watch is Workday, trading at $188.27 as of October 5, 2026, with a market cap of $44.86 billion and a forward P/E of 16.4x. Revenue and levered FCF have shown strong growth, but the risk is that part of the price already reflects a takeover premium. Salesforce, trading at $229.22, is seen as a lower-risk alternative, not a takeover play, but its own deal spree could pressure shares.
In summary, M&A is a catalyst, not a thesis. The more durable support comes from cheap valuations and rising free cash flow. Workday’s October 13 analyst day will be the next test for the sector.