Concluding my analysis on ServiceNow
On Monday, I analyzed software maker ServiceNow (NOW) through my "first look" lens.
Then I did a deeper dive yesterday, focusing on the "SaaSpocalypse" that's crushing the sector – and why ServiceNow won't be displaced by AI. I also noted that "the stock today is the cheapest it has ever been."
Today, I'd like to finish my analysis of ServiceNow by elaborating on these points...
My team and I did a full write-up on the company in last month's issue of Stansberry's Investment Advisory (subscribers can access it here), in which we detailed ServiceNow's expertise:
ServiceNow sells workflow-management and AI-orchestration software. This software sits above a company's existing enterprise systems...
This ServiceNow software coordinates and manages AI workflows across customers' software systems through a centralized oversight layer. ServiceNow calls this the "AI Control Tower."
This isn't just another agentic AI tool. It's the governance and orchestration layer for all AI agents and workflows.
This is the type of software companies need to take full advantage of agentic AI.
We highlighted how CEO Bill McDermott began moving the company toward becoming a broad workflow-based platform long before the term "agentic AI" was commonplace:
McDermott has a history as a visionary leader. He was previously CEO of SAP – the German software giant that sells every type of corporate software you can think of. He oversaw SAP's transition to the [Software as a Service ("SaaS")] model, doubling its revenue and tripling its market cap from 2010 to 2019.
He's doing similar things at ServiceNow. Under his leadership, ServiceNow has quadrupled its revenues and doubled its market cap.
As McDermott pointed out on the company's [fourth-quarter] earnings call, ServiceNow has reached $1 billion, $5 billion, and $10 billion in revenue faster than any other enterprise-software company (not counting acquisitions). And it will hit $15 billion this year.
Investors worry whether this organic growth will continue, as fewer software licenses will be bought by humans when AI agents take over their work. But as we explained, ServiceNow can simply switch to "usage-based" licenses:
ServiceNow began doing this in 2023 with the launch of its generative AI software suite, Now Assist. It charges customers based on the amount of work completed by AI agents rather than the number of humans using its software.
In its latest quarter, bookings of its Now Assist software more than doubled to $600 million in annual contract value. We'll be keeping an eye on this performance, but we're optimistic that ServiceNow's usage-based AI revenue will keep growing faster than any loss of legacy [human]-based revenue.
We're also bullish on the company's biggest competitor, Salesforce (CRM). But we highlighted several reasons why we like ServiceNow better:
ServiceNow is growing sales twice as fast (about 20% per year versus 10%).
About 5% of ServiceNow's sales come from Now Assist, while Salesforce's Agentforce generates just 2% of the company's sales.
Also, ServiceNow has historically focused on "back office" software (IT, security, human resources, legal, supply chains), while the more narrow "front office" uses (sales and marketing) have been Salesforce's specialty.
That gives ServiceNow a technological advantage. It built its software from the ground up to work across departments using a single data model. Salesforce did not. Its software often requires custom development for workflows outside of its core sales and marketing software.
In summary, ServiceNow is well positioned to continue growing at a high rate and maintain its mouth-watering margins and free cash flows.
Yet amid the SaaSpocalypse, the stock is priced at its lowest valuation ever... as if it's never going to grow again.
For nearly all of its existence as a public company, investors (rightly) valued ServiceNow at an extremely high earnings multiple. And they were richly rewarded for it, as the stock rose nearly 50 times from its 2012 IPO through mid-December 2024.
The stock has traded at an average 71 times forward price-to-earnings (P/E) multiple over the past decade, peaking at 111 times, as you can see in the chart below:
Yet after the stock's precipitous decline, it now trades close to its all-time low of just 21.3 times consensus analysts' estimates for this year and 17.5 times next year's, based on this morning's price around $88.
Those are downright cheap multiples for a business as fantastic as ServiceNow.
Over time, ServiceNow's usage-based license fees should exceed what it would have earned under its previous model. The company should be able to continue growing revenue at 20% a year, conservatively.
Meanwhile, AI will help the company cut costs on research, development, and customer service. So its earnings should grow even faster than revenue – 25% per year, easily.
Averaging 20% revenue growth and 25% earnings growth over the next five years translates into earnings of around $11 per share.
If we assume that the current panic subsides and investors award the stock a multiple of 30 times earnings – less than half its historical range – that would make the stock worth $330.
That's almost four times today's price. And ServiceNow could easily beat those projections and rise even faster.
My team and I have only one complaint: ServiceNow – like many software companies – relies heavily on stock-based compensation to reward employees.
As a result, the company's shares outstanding have increased by 54% since 2013, as you can see in this chart:
That share-count growth, however, has slowed in recent years thanks to well-timed share repurchases. And last year, with the stock price falling, the company massively ramped it up, as you can see here:
Earlier this year, ServiceNow's board authorized $5 billion more for share repurchases, on top of $1.4 billion it had already reserved for buybacks. And the CEO also thinks the stock is a bargain, as he bought $3 million worth of stock with his own money in February.
I agree with him that this is a "once-in-a-generation moment." And it helps reinforce why my team and I at Investment Advisory recommended the stock...
As I've said previously, the sell-off in software stocks has created wonderful investment opportunities. With ServiceNow, the SaaSpocalypse has given us a bargain on a fantastic business that's poised to profit further.
Again, Investment Advisory subscribers can see the full write-up on ServiceNow right here.
If you aren't a subscriber, you can become one – and gain access to our specific "buy up to" price for the stock and recommended way to protect your capital, as well as our full portfolio of other open recommendations – by clicking here.
Best regards,
Whitney
P.S. I welcome your feedback – send me an e-mail by clicking here.