Up 6%, NowX can justify ServiceNow’s 18 times forward revenue valuation

ServiceNow, a workflow process management service provider headquartered in Santa Clara, California, has been performing strongly since its IPO.

Thanks to my interview with Chief Product Officer CJ Desai on June 29, I can understand why. This is good news for ServiceNow investors, but bad news for companies that think they can get rid of slowing growth.

Should you invest? According to its investor presentation in the first quarter of 2021, although ServiceNow’s revenue growth rate has slowed from a staggering 59% average growth rate in the ten years ending in 2020, it expects subscription revenue to grow by approximately 28% in 2021 , Reaching approximately US$5.4 billion.

If ServiceNow can exceed this growth rate every quarter, then its stock price-which has risen by only 6% so far in 2021 (versus the S&P 500 index has risen by 16%)-may climb.

(I have no financial interest in the aforementioned securities).

ServiceNow: A 16-year growth story

I appreciate ServiceNow’s efforts to stimulate its growth through internally developed products. This is because research shows that most acquisitions fail to generate returns for the price paid to complete them.

ServiceNow’s organic growth story began with its founder’s extraordinary vision in 2005 to develop product architecture to improve business process efficiency. Sadly, it took years to figure out how to communicate this value to customers.

In 2009, ServiceNow developed an IT Service Management (ITSM) application, which drove very rapid growth. At a relatively modest additional cost, ServiceNow can apply the ITSM application to other company processes, such as customer service, human resources, legal, and procurement.

In 2018, ServiceNow institutionalized the idea of ​​launching one or two new revenue-generating products every year through the so-called NowX. This year, ServiceNow expects to launch two to three new products, with revenues of approximately US$100 million.

Let customers buy

ServiceNow takes time to win customers. “ServiceNow founder and chairman Fred Luddy was only 5 years old when he founded the company. He was assaulted at his previous company [Peregrine Systems some of whose other executives went to jail in the wake of a 2002 bankruptcy, according to Forbes]In 2004, he created a platform as a service. At the time, the company was still in the early stages of building a cloud-based service architecture. It is difficult for ordinary people to understand its value. We visited banks, governments, and healthcare providers, and they asked,’What should we do? ‘” Desai said.

Finally, a demo made the customer purchase the concept. As he said, “From 2005 to 2009, we worked hard to convince customers. We gave a demonstration in which an employee asked to use a computer or try to reset the password, but the IT staff could not be contacted. Fred and the team developed ITSM A platform. The company likes its flexibility and scalability. They ask “Can it be used with other systems?” “We provide a scalable ITSM platform for sales staff. It provides us with a better growth trajectory.”

ITSM can manage customer service. “It works. An employee of a large bank needs a laptop. What happened? The employee wants to add a monitor; will the manager approve the purchase? Will our department allow it? IT must provide security credentials; the computer is shipped to confirm receipt but Employees who can’t get the computer to run,” Desai pointed out.

How ServiceNow surpassed its original market

After ServiceNow went public, investors questioned whether its market opportunity was large enough. As he told me, “We launched ITSM as our product in 2012. The unanswered question is:’Is this a large enough market? Will it grow or is it just a small TAM niche market? We are aware Our ITSM platform can be extended using the same architecture to solve other business issues, such as customer service, legal, and procurement.”

ServiceNow is able to extend its good reputation to new business functions while rapidly adjusting its products to solve these new problems. “We have established a good relationship with the CIO and asked the CIO to recommend us to the head of human resources and customer support. We can expand to different procurement centers. The economics of the unit that creates new products are very favorable. Use 24 engineers to build a customer service platform within the month,” Desai explained.

What’s on the platform? As he said, “The platform provides all the core services that support operations-including user experience, data models, and application programming interfaces (APIs) needed to integrate with other systems. We have all the building blocks, and it’s 100 % Cloud-based. From the customer’s point of view, we provide the ability to integrate with other systems without them having to spend millions of dollars.”

ServiceNow’s new product introduction with the help of NowX

In 2018, ServiceNow launched NowX, aiming to launch one or two new revenue-generating products every year. “Beginning in 2016, we launched customer service; in 2017, we added human resources and software asset management; in 2020, we added industry-specific solutions to telecommunications and banking. By 2021, we will Increase healthcare and manufacturing, and will introduce the insurance industry in 2022,” Desai said.

ServiceNow prides itself on its ability to grow without revenue. As he told me, “We are the only company in the SaaS industry that expands by organically building products. We will get a small team with technical skills. We can create a new software-as-a-service in six months to a year, Used by 10 to 24 people. Our products are divided into four categories, with a total target market of US$175 billion. We create products that create value for our customers and cooperate with system integrators such as Accenture and Deloitte.”

ServiceNow’s customer-centric culture and NowX product development methodology

In theory, the work done by ServiceNow is based on the culture and organizational mechanisms that other companies can adapt to.

One of them is a culture of speaking and acting on the premise of being customer-centric-the difficult part is acting.

As Desai described, “Why do we win? Unlike other companies I have worked for, ServiceNow is truly customer-centric. Fred focuses on customers. We have a culture of humility and hunger. The company has 16 years of history. , And did not lose this aspect. We talked to customers and asked how we can make them successful. We have a large customer that will launch the customer service application on July 4. On July 1, our engineering, sales and The leaders of the service department are working hard. We were on standby until midnight the night before. This service is always well received. If our customers have speed bumps, we will figure it out. Our renewal rate is very high. There is no finish line. “

NowX also protects its product development focus from pressure to meet quarterly investor expectations. As he said, “Through NowX, we limit our investment to protect it from short-term pressure to meet quarterly forecasts. We increase R&D investment at a rate of revenue growth plus 4%.”

In my opinion, ServiceNow is not standing still. “We have a healthy paranoia, constantly innovating and expanding our way of execution. 60% of our employees are developing today’s products; 30% are developing products that will generate a return on investment within 12 to 36 months; 10% We are studying future products. In 2019, we launched two new products; in 2020, 5 new products; in 2021, we will launch new products; by 2021, we will launch two or three new products with revenue of 100 million US dollars ,” he concluded.

Can ServiceNow grow to a high valuation?

Sadly for ServiceNow, it has not escaped the attention of investors, that is, the company’s revenue growth rate is not as fast as in the past.

SeekingAlpha pointed out that after rising about 20% as of June 22, ServiceNow stock is expensive. The argument is that ServiceNow has a market value of more than 100 billion U.S. dollars and a growth rate of about 20%. Compared with Workday, Atlassian and Snowflake, the valuation of its forward revenue of about 18 times is expensive.

If ServiceNow’s growth rate can exceed investor expectations (approximately 27%), or its valuation drops to about 14 times its forward income, its stock may be bought. “Key takeaways: Despite the declining growth rate and disappointing progress in profitability, the transaction price of forward income is still more than 18 times. I think the risk of ServiceNow is far greater than the return. Stay on the sidelines until this stock drops to a more buyable level Level,” SeekingAlpha pointed out.

Not all analysts agree-Goldman Sachs believes that the stock will rise to $695. “In our opinion, the scale and product range of ServiceNow covers [IT service management, IT operations management, customer service management]The unique advantages of HR, human resources, and workflow engines have increased the company’s revenue in 2020 by more than three times, reaching 4.5 billion U.S. dollars. Driven by multiple long-term themes such as digital transformation, workflow automation, and low-code, no-code, 2026 The revenue may reach 15 billion U.S. dollars. Code,” analyst Kash Rangan wrote.

If he is right, ServiceNow’s stock has 25% upside potential.