ServiceNow Inc. (NOW, Financial) is a software as a service company that originally provided a platform for IT service management. The beauty of its solution is it’s immensely scalable and therefore can serve thousands of customers, with high operating leverage. In the second quarter of 2023, the company reported strong financial results as it beat both revenue and earnings growth forecasts. In addition, its board of directors implemented its first ever share buyback program, purchasing a staggering $1.5 billion worth of stock. In this post I am going to break down its business model and financials, let’s dive in.
Software Business Model
ServiceNow is most famous for its IT help desk platform, which benefited from the increasing digital transformation of enterprises and the bottle neck in IT support. From that point, ServiceNow expanded into various other areas from HR and Legal delivery to customer service and financial operations management. This is a brilliant strategy as once inside an organization the company can cross sell its various product offerings.
During its earlier growth phase the business was also headed up by Frank Slootman (now CEO of Snowflake), who wrote the book “Amp it up” and is known for his high performance style of management.
ServiceNow also offers a “creator workflow” solution which enables teams to build digital workflow apps with its low code solution. This can automate processes, improving business efficiency.
Surprisingly the business also offers a solution for highly technical areas such as telecommunications network tracking and “Cloud Observability”. The latter space is particularly interesting as there are many huge market capitalization companies in this industry such as DataDog (DDOG) ($31.4 billion) and Dynatrace (DT), $14 billion.
More recently ServiceNow has introduced a number of Generative AI features. This includes “Now Assist” which offers a personalized chatbot service which can be used to enhance the customer service experience. Customers benefit from the software knowing which product they ordered, while agents get a summary of a customer's prior actions with possible solutions. Other applications include content creation for emails and helping employees find out how to do an action easily. The “text to code” offering is a similar solution to Github co-pilot as it increases developer productivity.
The company has also recently scored partnerships with large technology consulting firms Accenture and Cognizant to help accelerate the use of AI inside large organizations. I believe this is a positive sign as given the tough economic climate, sales through partner channels tends to be lower friction.
ServiceNow also scored a partnership with the leading AI chip provider Nvidia. This looks to be deeper than surface level corporation, as the CEO of NVIDIA Jensen Huang joined a ServiceNow event on stage. This should give the business a competitive advantage as the two giants aim to implement AI offerings into enterprises.
Growing Financials
ServiceNow reported solid financial results for the second quarter of 2023. Its revenue was $2.15 billion, which beat analyst forecasts by $20.99 million and rose by 22.72% year over year.
The vast majority of this revenue ($2.08 billion) is subscription revenue which rose by 25% year over year, on a constant currency basis.
Remaining Performance Obligations (RPO) reached $14.2 billion, up a staggering 22.5% year over year.
Breaking down by industry, transportation and logistics led the way with over 80% growth in the second quarter.
In terms of customers 1,724 customers paid the business $1 million in Annual Contract Value, which included 45 customers paying over $20 million each up a solid 55% year over year. This is a huge benefit to the company as larger customers tend to have higher retention rates and even more upsell opportunities.
The renewal rate for ServiceNow was 99% in 2023. This means customers see the product as highly “sticky” as it is deeply embedded into their business functions.
ServiceNow has been pushing its “Better together” storyline with C level executives in order to position its offering as the ideal solution for vendor consolidation.
In the second quarter 19 out of the top 20 customer purchase orders included five or more products.
Its IT service management (ITSM) platform is still driving the majority of the growth contributing to 16 of the top 20 deals, which included seven deals valued at over $7 million. However, its Customer workflows also produced strong results with eight deals over $1 million.
Margins and Balance Sheet
Moving onto profitability, ServiceNow reported operating income of $1.679 billion in the second quarter, which was up from the $1.363 billion reported in the prior year. Its non GAAP operating margin was 25%, which was 200 basis points higher than management's guidance. This was driven by a disciplined cost management process.
The business benefited from an income tax benefit which reflected a $965 million valuation allowance for deferred tax assets.
Overall the business has a strong balance sheet with $7.5 billion in cash and short term investments. The business does have around $1.5 billion in debt, but this is well covered and long term.
Valuation?
ServiceNow trades at a price-sales ratio of 15, which is 13% cheaper than its five-year average.
The GF Value Line indicates a fair value of $789 per share and thus the stock is “modestly undervalued” at the time of writing.
Final Thoughts
ServiceNow is an incredible company which is truly in a strong position when it comes to leveraging its many software solutions. Its recent partnerships with Accenture and Nvidia offer huge potential, as the business should be able to short circuit the current macro environment which is tough. Its valuation is reasonable and the business is surprisingly profitable, therefore this could be a great long term investment.
