Back in July, I previewed ServiceNow (NYSE:NOW) earnings and said that the company was likely due to post some exceptional results given its lofty valuation. The stock has fallen approximately -10% since this appreciation. Let’s catch up on the name.
As a reminder, NOW is a Software-as-a-Service (SaaS) company that manages workflows across systems by connecting and unifying siled systems on a single platform. The company’s product began as an IT service management (ITSM) solution to help IT departments better manage their networks, optimize costs, and quickly identify and remediate security vulnerabilities. It has since expanded its use cases to other departments as well.
The offering now includes solutions for customer service, human resources as well as the areas of automation, procurement and low code. The platform also offers solutions for legal services and health and safety. Its offerings are sold by subscription primarily through direct sales.
Strong Q2 results don’t move the needle
In my earnings preview, I noted that history and analyst channel review suggested that NOW was likely to beat analyst expectations, and in this regard, the company has indeed delivered. However, as expected, this wasn’t enough to boost the stock, causing it to fall -3.9% in the next session following its report.
During the quarter, the company increased revenue by 23% (and also by 23% excluding foreign exchange) to $2.15 billion. That narrowly beat the consensus of $2.13 billion. Subscription revenue rose 25% to $2.075 billion. Professional services revenue fell -20% to $75 million.
Adjusted earnings per share of $2.37 were well above analyst estimates of $2.02.
The company recorded 70 transactions with new net ACV of over $1 million during the quarter, representing growth of 30%.
One area I think investors should pay attention to this quarter was RPO (Deferred Revenue + Backlog) growth. In this context, NOW recorded a 24% increase in RPO to $14.2 billion, and current RPO (cRPO) increased by 25% to $7.2 billion, or 24% on a constant currency basis.
While these numbers were solid, you really needed to see an acceleration in growth on these numbers to get the stock going. While cRPO accelerated on an absolute basis, growth slowed slightly on a constant currency basis. That’s very good growth, but NOW’s stock valuation is quite high, so it really needed a big number to get investors excited.
Looking ahead, the company forecast third-quarter revenue growth of 25.5% to 26.0% to $2.185 billion to $2.195 billion. Based on constant exchange rates, growth of 23.0% to 23.5% was expected.
Additionally, cRPO was forecast to increase by 25%, or 21.5% on a constant currency basis. This would continue the trend of a slight slowdown in cRPO growth on a constant exchange rate basis.
Overall, NOW once again presented very strong quarterly results. As I stated in my original article, NOW is a great company, and I think it has continued to prove that every single earnings report does. While some SaaS companies complained about a difficult macroeconomic environment and corporate budget issues, the company still continued to experience solid growth, indicating the power of its solutions.
After the earnings results, management headed to the investment conference, with a focus on generative AI. Management noted that it has made many acquisitions in this space over the past six years to add technology in machine learning, automation and other areas. The company also noted that generative AI is a topic of discussion in every customer conversation.
At a Deutsche Bank conference in late August, Pable Stern, SVP and GM of Technology Workflows, said:
“All of these conversations we have with customers always start with the voice of the customer telling us where they are, what their top priorities are and what they need to solve. And then we’ll have a conversation based on what they want to talk about. And generative AI is a topic in every one of these discussions. So the demand is there, the interest, the potential. And we don’t just see this among managers. So when I talk to a CIO or CTO, we hear it. But also from a practitioner perspective, and we have over 100 customers who have already signed up with us for design partner programs for our generative AI solutions, customer-focused use cases, employee-focused use cases, this kind of demand is really unforeseen in terms of how We quickly saw that there was demand on the market for a new product. Now you asked about some risks. Well, one of the things that we’re really proud of is if you think about a lot of the acquisitions that we’ve made in the past, so companies in the AI space like Element AI. Not only have we focused on gaining intellectual property rights in the technology and advancing machine learning, but we also value trustworthiness. And what can happen to this AI? And how can you trust that Gen AI will not only deliver insights, but also ensure that your data is your data and things are protected? And so I think one of the things that comes up in a lot of conversations with our customers is that they trust ServiceNow.”
Meanwhile, at a Goldman Sachs conference earlier this month, CEO William McDermott noted that the Pro version of his solution, launched a few years ago, comes with a 25% price increase. Given the amount of attention surrounding AI, this should be a nice boost for NOW in the future. There’s probably still some hesitancy towards AI and companies want to be cautious about it, but as it becomes more common there should be some good upsell opportunities for NOW.
SaaS companies are generally valued using a revenue multiple because they have high gross margins and the companies want to pump money back into sales and marketing to grow.
In this regard, NOW is valued at a P/E ratio of approximately 12.6x based on consensus for 2023 revenue of $8.91 billion. Based on 2024 revenue consensus of $10.86 billion, it trades at a P/S multiple of 10.3x and an EV/S multiple of 9.9x.
In the past, the company has often traded at over 13x LTM sales, sometimes even over 20x. However, growth is slowing from over 30% to the low 20% range. It is expected to be 23% this year and 21.8% next year.
For a SaaS company with a gross margin greater than 75%, no debt, and growing revenues in the low to mid 20% range, spending a fair share on sales and marketing, I generally consider a valuation of 10x P/S rather high. End of an appropriate assessment. Based on estimates for 2024, this value is approximately the current level of NOW. The industry has a multiple of around 8x with a similar growth of 20%. I don’t think the huge multiples seen between 2020 and 2022 make sense.
NOW continues to prove that it is a great company and continues to produce solid results. The company is now well ahead of the AI curve, having built and acquired its technology over the past few years. Additionally, the company has partnered with chip leader NVIDIA (NVDA) to help develop generative AI solutions for enterprises. Given the price increase the company is seeing on its already established Pro product with AI features, the future is likely to remain bright for NOW, especially when it comes to leading with AI.
However, NOW shares are still not cheap. Given his growth, I think it’s pretty appropriate that there are several. If you own the stock, I would continue to do so, but I’m not a new money buyer at current levels. Therefore, I rate the stock as “Hold”.
Source : seekingalpha.com