Another Wall Street investment bank downgrades China's software industry: AI disruption, valuation restructuring!

Over the past decade, the most compelling narrative in the capital markets for the software industry has been “SaaSification”—as long as subscription revenue grows, current losses are not only tolerated but even seen as a necessary cost to capture market share.

The market has paid a high valuation premium for this, betting on the future high profits driven by scale effects. However, the explosion of generative AI is dismantling this logic: AI has not made software more standardized or more profitable; instead, it is forcing software companies back into customized services that “sell human heads.”

On February 10, according to ChaseWind Trading Platform, UBS stated in a recent research report that the rapid iteration of large language models (LLMs) is triggering a fundamental reassessment of the “standardized SaaS” model. The high premium once enjoyed by SaaS is fading, and investors are no longer willing to pay for long-term growth stories but instead want to see immediate cash flow and profits.

Historically, high valuations for software companies were justified by scalable subscription revenues that provided operating leverage and high margins. However, as native LLM agents (intelligent agents) potentially commoditize standard SaaS workflows, standardization may no longer be an asset but rather a burden.

According to UBS analyst Sara Wang, growth in revenue without profitability protection is no longer a sustainable investment logic. The market is shifting from valuation frameworks based on sales (Sales) to those based on P/E ratios or free cash flow (EV/FCF).

The report states that this shift in valuation paradigm has directly led to downgrades across the sector. Since AI forces software companies to provide more customized services to meet vague customer needs, their business models are beginning to resemble low-margin “IT services.”

Coincidentally, on February 4, Morgan Stanley also pointed out in a research report that this marks the beginning of a long-term narrative shift, ending the unreasonable rally in this sector that lasted until January 2026. Although SaaS models based on seat-based pricing are not widespread in China, traditional software (especially tool-type software) also faces disruption risks in the long run.

However, the report also notes that existing software vendors still have a time window to embrace new technologies and leverage their large existing customer base to resist disruption, though overall risks remain tilted downward.

The “Curse” of Standardization: SaaS Premium Is Disappearing

According to the report, in the past, the valuation logic for leading Chinese software companies was based on “convergence premiums”—investors betting that they could eventually achieve high-margin standardized subscription models like Salesforce or Adobe. Therefore, despite their profitability being much lower than their US counterparts, Chinese software stocks’ EV/Sales ratios have long been aligned with US stocks.

However, UBS believes this logic has been thoroughly shattered by AI. Since the beginning of the year, although there is no evidence that SaaS profitability has been fundamentally overturned by AI, the stock prices of leading US software companies have already fallen by 10%-40% amid the fading SaaS subscription premium.

When LLMs can replace standardized workflows, software companies are forced to revert to the “customization” old path. If the ultimate value of a standard SaaS product faces AI substitution threats and delivery requires more tailored development, the high valuation logic of SaaS no longer holds.

UBS states that the valuation system for China’s software industry is being forced to decouple from SaaS and revert to traditional IT services valuation—meaning P/E or EV/FCF ratios will replace EV/Sales as the new pricing anchors.

“Revenue growth without profit growth” AI Trap

UBS cites data from the Ministry of Industry and Information Technology showing that since the “DeepSeek moment” in early 2025, the growth rate of revenue in China’s software industry has indeed accelerated, but profit margins have declined.

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 vague customer needs and rapid iteration of large models, software companies have to invest heavily in providing customized services. Under this model, revenue growth no longer translates into margin expansion and may even drag down profitability due to heavy customization.

This creates an awkward combination: companies are willing to spend money on AI, but more of that money flows into delivery and transformation rather than high-margin incremental subscription revenue. For valuation, revenue growth no longer automatically equates to margin expansion.

In the report, UBS breaks down the bottlenecks of AI monetization for software companies into three parts:

1. Insufficient AI capabilities—current product quality not enough to keep customers paying;

2. Immature digital ecosystems—data fragmentation, outdated hardware, extended implementation cycles;

3. Trust issues around AI expertise—traditional software vendors may be compared unfavorably to AI startups and cloud providers in AI capabilities.

But UBS also leaves an opening: The challenges themselves create opportunities for vendors capable of delivering end-to-end solutions, understanding vertical industries, and cross-selling traditional digital products.

The cost is that as models are updated every 2-3 months and more large models claim to penetrate vertical scenarios, software companies must iterate and deliver faster; however, “more customization” usually means harder standardization and more difficulty expanding profit margins.

This insightful content is from ChaseWind Trading Platform.

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