How AI Is Creating Net New Markets, Especially for Cybersecurity

On the March 19 bonus episode of The Morning Filter, co-host Dave Sekera talked with Morningstar senior analyst Malik Ahmed Khan about the case for cybersecurity stocks, how artificial intelligence is influencing the industry, and which cyber stocks may benefit. Here is an excerpt from the show.

How AI Is Changing Cybersecurity

David Sekera: You mentioned a little bit and touched on your artificial intelligence and the longer-term impact there. And what I’ve seen across the market in general and the software space in particular is a lot of those software stocks really have been under intense pressure over the past year, if not longer. Some of those stocks falling 20%, 30%, even 40%, just because so many investors are concerned that artificial intelligence either could disrupt or in some cases even completely displace the businesses and products of these software companies. As an investor, how would you recommend, how should they think about the difference between investing in more of those software-as-a-service stocks versus cybersecurity stocks?

Ahmed Khan: First of all, it’s important to understand that cyber has never been purely software. And at the top, I mentioned services and hardware, which are not really impacted or are not clear, they’re not software-driven per se. The second thing I would mention is that, especially when we’re thinking about the effect or the impact of AI on cyber, and then juxtaposing that or comparing that with software, one key differentiator is that there is an adversarial dynamic when we’re thinking about AI and cybersecurity. So a good example of this would be, let’s say you have a large language model that makes detection of threats 5X better. Now that, by definition, also means that an attacker can use the same model and actually detect vulnerabilities 5X faster or 5X in a more efficient way. So I guess what I’m trying to say is that since AI is dual-use for both the adversaries and the defenders, it actually means that the overall cyberspending has to elevate, which is not a dynamic that you see in other parts of software.

So this is unique to cybersecurity. Second thing I would say is that AI is creating net new markets. So AI runtime security, there’s securing actual AI use cases or actual AI deployments. Then there’s new firewall spending that’s going to happen in data centers. So there’s a lot of net new spending in cybersecurity that companies under our coverage are going to benefit from. And that may be harder to pin down when it comes to the broader software universe, where you see more headwinds than tailwinds, which is not the case when we’re thinking specifically about cybersecurity.

Which Companies Could Rise to the Top of the AI Evolution?

Sekera: Yeah. And so with artificial intelligence, as an investor looking in the cybersecurity space and investing here, just thinking about maybe even like the next 12, 18, 24 months, are there certain things that you’re watching that you think that they’re going to evolve in a certain direction? And if so, do you think that there’s going to be certain cybersecurity companies that are going to be better positioned for those evolving needs here in the medium term?

Khan: For sure. No. So Dave, what we have is we have essentially an AI quality scale, which sort of ranks cybersecurity companies on a variety of different factors related to AI. That could be product monetization, the number of enterprise customers they have, the kind and richness of data the companies actually aggregating and then running their AI models on. So it has a bunch of different factors, and that sort of like AI quality scale, if once we apply that to our coverage, the larger players, so that would be CrowdStrike CRWD, Palo PANW, Fortinet FTNT, and Zscaler ZS, really come to the fore or really rise to the top. And I think that’s the story that we see formulating when it comes to AI. So I mentioned earlier, we’ve seen vendor consolidation, people want to spend more with less. We think AI is going to come and turbocharge that dynamic. So if you’re Palo and historically you’ve gone on acquisition sprees to buy specific modules, well, now AI actually increases your product velocity.

So you can actually see a product and say, “Hey, this is a good product that a competitor may have.” And you can build that in-house and in a much faster pace than you were able to in the past, which lets you gain market share much faster. So when it comes to AI in particular, we expect that there is going to be a tale of two cities here. So one city is going to be the platform vendors, which is going to be beneficiaries of AI. But even in our coverage, we have companies that we think are going to be laggards or companies that we think are going to lose market share. So these are the smaller players like Rapid7 RPD, Tenable TENB, etc.

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