Third Bridge webinar: AI “starts and ends with fundamentals”

Third Bridge Co-Founder, Joshua Maxey, along with Scott Kessler, TMT Sector Lead at Third Bridge, and Harriet Matthews, Funds Editor at Mergermarket, recently delved into some of the insights from our 2023 PE forecast during a webinar hosted by Third Bridge and moderated by Dan Thomas, VP at Third Bridge. The panellists discussed the PE outlook and then focused on one of our report’s main findings – that AI has overtaken cloud services as TMT’s most prized asset. Here are the key takeaways from the AI insights shared.

Our 2023 PE forecast found that AI is attracting a high level of interest despite 39% of respondents saying technology has the widest bid-ask spread (see chart below). Would-be buyers and sellers are valuing their assets divergently, but an overwhelming 90% still expect to see greater PE activity in the technology sector over the next 12 months. So, how should investors think about sizing the AI opportunity, and what are the issues to be mindful of?

Scott Kessler said the market is awash with estimates of “multi-trillion-dollar market opportunities”, with PwC describing AI as a “game changer” that could potentially contribute up to USD 15.7trn to the global economy by 2030.1

However, many have questioned whether what we are seeing today could morph into a sequel of the DotCom Bubble era – a period in which swathes of companies announced plans to invest in the internet with the sole purpose of boosting their valuations. Although seemingly effective at first, this was ultimately not sustainable. 

A key difference between then and today is that 25 years ago the “whole market got caught up in it,” Scott Kessler said, suggesting the scope and scale of any bubble we’re seeing is not yet comparable. “Today it’s a lot more concentrated in software and services… as opposed to across industries and sectors.” 

Nevertheless, to seize opportunities in this burgeoning field, Scott suggested that managers should stick to their core competencies. “AI should fit within the mantra or investment thesis rather than the other way around.” In our report, we found that managers are developing specialist expertise to create value through hold periods and differentiate themselves amid fierce competition.

“Everyone likes to say it’s different this time. It isn’t. It starts and ends with fundamentals, and the way that you understand those is through sticking to your knitting and due diligence.” – Scott Kessler, TMT Sector Lead, Third Bridge

Due diligence is absolutely critical. When considering an opportunity in AI, investors must consider critical factors including whether or not the technology is proprietary, what the competitive landscape looks like, and how these and other dynamics could shift in both the near and long term. In particular, companies that are making acquisitions to jump-start an AI practice should demonstrate how they plan to “keep the pedal to the metal” and sustain longer-term advantages.

Productivity could be the near-term opportunity

Investors can see the AI opportunity through many different lenses – but the most common is productivity and cost savings. In the near term, “the cost and expense side of the discussion probably takes priority” rather than revenue and growth, Scott said. As an example, he noted how a former ad-agency executive told Third Bridge Forum he could see AI enabling around a 30% reduction in headcount-related costs and expenses. 

And what about revenue opportunities? Many large software companies including Microsoft and Adobe have been busy rolling out AI-enabled products. But what happens next with regards to pricing remains to be seen. Another expert interviewed by Forum believes AI could add USD 10-12bn in TAM for Adobe, and might also enable the company to charge up to 50% more for its AI-driven products.

However, it might not be as simple as that. Dan Thomas raised the important question of whether companies that are facilitating operational enhancements through AI will be able to bolster their bottom line, or whether there will be an expectation among clients for more competitive pricing. 

Replying, Scott pointed to a recent Forum Interview in which a call centre executive said AI already handles about a third of enquiries. “That number is going to go to about 75%. So, as a customer, are you going to pay the same rate knowing they are reducing their headcount and OPEX? There will be a lot more pressure on those types of companies in terms of pricing.” 

AI’s impact on PE workflow

AI is making its mark at the workflow level too. Joshua Maxey said most PE firms are looking at AI across their entire portfolio, particularly given their sharp focus on value creation today. “If you think of PE as a three-pronged approach: sourcing, due diligence and portfolio management, the applicability of AI spans all three.” 

Our 2023 PE forecast certainly echoes this. Specifically, 73% of respondents consider deal sourcing the area where advanced technology has had the greatest impact at their firm, followed by due dilience (68%) and valuation (67%) (see chart below). 

Additionally, over half (58%) of GPs surveyed believe advanced technologies such as AI have the greatest potential to improve ESG reporting in the next three years, followed by regulatory reporting (39%).

However, our panellists also noted that many questions remain about the legal and regulatory ramifications of AI. At the portfolio level, it will depend on how AI is being used – making decisions vs reducing costs, for example. Ultimately, there needs to be a high level of transparency and trust, Harriet Matthews said. 

There is also a whole host of data privacy and ethical aspects to consider. For example, if a company decides to use AI to prepare its corporate tax filing and an error is identified, who is culpable for that error – the person who chose the software, how the software was implemented, or the software itself? 

“A lot of companies see massive opportunity, but the path to realising that opportunity is going to have more pitfalls than people recognise at this point,” Scott said. Our panellists agreed that investors should expect more guidance and even regulatory moves by governments in the months and years ahead. 

AI is certainly making inroads in the PE world, but as Harriet noted, the industry remains highly human relationship driven, and that is unlikely to change anytime soon. 

The information used in compiling this document has been obtained by Third Bridge from experts participating in Forum Interviews. Third Bridge does not warrant the accuracy of the information and has not independently verified it. It should not be regarded as a trade recommendation or form the basis of any investment decision.

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