ServiceNow’s Differentiated Software Drives Multiple Organic Growth Vectors in Expanding TAM

Business Strategy & Outlook:

ServiceNow has been successful thus far in executing on a classic land and expand strategy. First, it built a best-of-breed SaaS solution for IT Service Management (ITSM) based on being modular and flexible, having a superior familiar user interface, offering a way to automate a wide variety of workflow processes, and becoming a platform to serve as a single system of record for the IT function within the enterprise. Having established itself in ITSM and then the much larger IT operations management, or ITOM, market, the firm moved beyond the IT function. The same set of product design features and technologies has allowed ServiceNow to bring its process automation approach to HR service delivery, customer service, and finance. More recently, ServiceNow has been offering higher pricing tiers with an increasing array of features, along with industry specific solutions, which have higher ASPs and help drive revenue growth.

ServiceNow’s success has been rapid and notably organic. The company already offers high-end enterprise-grade solutions and boasts elite level customer retention of 97% to 98%. ServiceNow focuses on the largest 2,000 (G2K) enterprises in the world and these customers continue to renew for larger contracts, with the average annual contract value doubling in the last three years. Further, the company has no small business exposure. Additionally, customers overall are re-upping for more than one solution, as more than 75% of customers are multi-product purchasers, which is driving deal sizes higher. Having the IT function within an enterprise as the initial landing pad is fortunate, as it provides a built-in advocate for software (an IT responsibility) for other functional areas of the enterprise. ServiceNow will continue to use its position to land new IT-driven customers and upsell ITOM features on the platform, but the company will increasingly cross-sell emerging products in HR and customer service, along with the platform as a service (PaaS) offering. The product strength, market presence, and a strong sales push into areas outside of IT, will continue to drive robust growth.

Financial Strengths:

ServiceNow is a financially sound company. Revenue is growing rapidly, while non-GAAP margins are positive and expanding. The continued traction in ITSM and ITOM, along with adoption of new use cases in customer service and HR service delivery, and the PaaS solution will continue to drive revenue growth in excess of 20% for at least the next five years. As of Dec. 31, 2021, ServiceNow had $3.3 billion in cash, offset by approximately $1.6 billion in debt, resulting in a net cash position of $1.6 billion. Gross leverage sits at 2.1 times trailing EBITDA, which allows for flexibility should the environment worsen. Operating margins are increasing as ServiceNow continues to scale, with 2019 the first year of profitability on a GAAP basis. ServiceNow should be able to drive in excess of 100 basis points of margin expansion annually. Free cash flow margin was 31% in 2021, providing a preview of what will be strengthening margins over the next decade. In terms of capital deployment, ServiceNow does not pay a dividend, does not regularly repurchase shares, and makes only small acquisitions. In fact, ServiceNow has spent only a few hundred million dollars on acquisitions in aggregate since 2011. The company made a variety of tuck-in acquisitions in 2019 and 2020–all for undisclosed amounts. Small, feature-driven acquisitions are expected to continue but have not explicitly modeled any such deals. The company might not initiate a dividend in the foreseeable future, nor regular share repurchases.

Bulls Say:

ServiceNow’s superior product has led to rapid share gains and exceptional retention within the ITSM market. Now the company is using this strength to expand into other areas of ITOM.
The company has added additional growth drivers, including customer service and HR service delivery, which should help propel robust growth over the next five years.
GAAP operating margin was break-even for the first time in 2019 and see a decade-long runway for expansion.

Company Description:

ServiceNow Inc provides software solutions to structure and automate various business processes via a SaaS delivery model. The company primarily focuses on the IT function for enterprise customers. ServiceNow began with IT service management (ITSM), expanded within the IT function, and more recently directed its workflow automation logic to functional areas beyond IT, notably customer service, HR service delivery, and security operations. ServiceNow also offers an application development platform as a service (PaaS).

(Source: Morningstar)

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