Citigroup: North American software sector stable growth, next leader emerges driven by AI

Citi believes that the latest North American software sector report for the third quarter of 2025 has provided market with a peace of mind: from the revenue perspective, more than twenty SaaS (Software as a Service) and infrastructure software companies covered by Citi are expected to have a stable median compound annual growth rate (CAGR) of 15% during the period from 2024 to 2026, consistent with previous figures. The average has slightly increased from 15% to 16%, and for two consecutive quarters, no major downward adjustments in revenue expectations have occurred. More importantly, the net revenue retention rate (NRR) that reflects customer cross-selling intentions has remained stable. Among the companies providing quarterly updated data, Cloudflare (NET.US) has shown outstanding performance with a significant increase of 5 percentage points in the NRR, achieving the highest sequential growth rate among the sample companies. Despite already having a high NRR of over 120%, Rubrik (RBRK.US) has successfully maintained this excellent level this quarter. Citi's analysis believes that when "stable growth becomes the mainstream trend" in the industry, and by 2026, generative AI and Agentic AI evolve from mere "concept speculation" to becoming strategic necessities for enterprises, the entire software industry will have a credible foundation to achieve a second acceleration in development. On the profit front, the performance continues to maintain a stable and restrained trend. During the period from 2024 to 2026, the expansion of operating profit margins (OPM) shows a mild upward trend, with the median increasing from 1.0 percentage points to 1.2 percentage points, and the average increasing from 2.3 percentage points to 2.6 percentage points. In the sample cohort, over half of the companies have not experienced any changes in operating profit margins quarterly. Citi's analysis points out that after the "drastic cost reduction" actions from 2022 to 2023, most corporate management is now hesitant to further cut costs. They are more inclined to reinvest the efficiency gains brought about by artificial intelligence (AI) into sales and research and development, to secure a position in the market competition by 2026, that is, to secure a "seat at the table". One data point that supports this view is that the median sales efficiency (measured by new revenue divided by lagged sales expenses) in 2025 is 0.43, almost the same as the forecasted 0.44 three months ago; although the average has increased from 0.51 to 0.54, this growth is mainly due to some companies raising revenue guidance, rather than further cost reductions. In summary, the industry is currently pursuing growth in a "respectable" manner, abandoning the previous "sacrifice profits for market share" approach. Individual Stocks Analysis In terms of individual stock performance, Rubrik, DigitalOcean (DOCN.US), and the recently recovering Fastly (FSLY.US) continue to lead the industry. Rubrik has shown strong growth momentum this quarter, raising the compound annual growth rate (CAGR) for revenue from 2024 to 2026 by another 2 percentage points to 34%, maintaining its position at the top of the industry. At the same time, the expansion of its operating profit margin has also been raised by about 2 percentage points, and its free cash flow rate (FCFM) guidance has increased by 3 percentage points, with all indicators performing very well. DigitalOcean is outstanding in terms of sales efficiency. In 2025, its sales efficiency indicator increased significantly by 0.23, rising to 1.95; by 2026, this indicator further increased by 0.38 to 2.37. These two increases are the largest among the companies covered by Citi. Moreover, the company has advanced its growth target of 18-20% set for 2027 by a whole year. Fastly's "comeback" performance is particularly notable. In the first full quarter after the CEO and CFO took office, the company demonstrated strong recovery momentum. The revenue growth guidance was raised by about 3 percentage points, leading to an increase of over 2 percentage points in the three-year revenue CAGR, the net revenue retention rate (NRR) also increased by about 2 percentage points, reaching 106%. In addition, the expansion rate of the operating profit margin increased by over 2 percentage points, the free cash flow rate rose by over 3 percentage points, and the sales efficiency in 2025 increased by 0.09, with multiple indicators among the top three for improvement. In stark contrast, Varonis (VRNS.US) and Rapid7 (RPD.US) are the only two companies in this report where growth expectations have been lowered. Due to poor renewal of on-premise subscriptions and delays in federal projects, Varonis has had its CAGR for revenue from 2024 to 2026 reduced by about 2 percentage points to 14%. Furthermore, the company announced that it will discontinue its self-hosted version of services in December 2026, which has further intensified the market's conservative expectations for its short-term development. In addition, Varonis also saw a decline in sales efficiency in 2025, with a decline of 0.02-0.03 compared to the previous quarter. Rapid7 is facing unique challenges in terms of execution, with quarterly revenue falling below expectations, forcing the company to slightly adjust its growth guidance. Looking at the "better than expected" performance, the industry as a whole is showing positive trends. The average revenue exceeding expectations has increased from 1.6% in the previous quarter to 2.3%; the profit exceeding expectations has increased from 2.3 percentage points to 2.8 percentage points, both of which are slightly higher than the average levels of the past two years. In terms of individual stocks, Check Point (CHKP.US) stands out, with a bill exceeding expectations by 11%, marking the fastest year-on-year growth rate since 2012. Fastly also performed well, with revenue exceeding expectations by 4.8%, operating profit margin by 6.6 percentage points, significantly outperforming its average performance in the past two years. Although Rubrik's revenue exceeded expectations by only 2.2%, its operating profit margin exceeded expectations by a high 17 percentage points, ranking first among the sample companies, and the company saw its first profitable quarter. Conclusion Taking into consideration various factors, Citi maintains its preference for platforms that are "large-scale, stable growth, and high efficiency": Datadog, CrowdStrike, and Zscaler continue to solidify their positions as leaders in growth; although Atlassian's growth rate is slightly lower, its operational efficiency is outstanding; Rubrik and Cloudflare, with their excellent execution capabilities and advantages that align with the current market trends, have received additional praise from Citi. The underlying message in this research report is clear - in the upcoming year of 2026, the competitive landscape in the AI field will undergo a major transformation, moving away from the previous "incremental exploration" model to a "platform-led, all-encompassing" pattern. Only companies that hold the key "cards" of customer resources, technological reserves, and ample cash flow are qualified to take the initiative in the upcoming budget allocation battle of generative AI (GenAI) and Agentic AI, and secure a favorable position. For investors, instead of betting on stocks that may have enticing stories but uncertain fundamentals, it is advisable to focus on industry "leaders" that have already stabilized their growth momentum and are ready to take advantage of the AI trend when it arrives.