NOW

Publicly traded companies mentioned herein: Apple Inc (AAPL), Facebook Inc (FB), Alphabet Inc (GOOG; GOOGL), Netflix Inc (NFLX), ServiceNow Inc (NOW)

Highlights

The presenter is long shares of ServiceNow (NOW), and believes that further growth can be driven by some underappreciated aspects of the story. NOW is a SaaS company, providing workflow automation services to a global customer base. It has benefited from the digital transformation/ shift to the cloud, and there is “virtually no competition” for NOW as it attacks a $60B TAM. Despite the stock appreciating 100%+ over the past two years, and ~50% YTD, the presenter feels the Street forecasts for revenue growth are too conservative, and fail to reflect the potential benefits of up- and cross-selling to a very stable, and growing, customer base. The enterprise opportunity is underappreciated as well, given only 16% of sales are attributable to large enterprises today. Setting a price target for a stock that trades at 10x forward sales is a challenge, but he sees substantial upside potential for patient shareholders if the company can compound revenue and reach $10B in total sales over the investment horizon. He arrives at this target by grossing up each cohort of customers using a growth track that is based on NOW’s 2010 cohort. This estimate could prove to be conservative, as it does not include the potential for many “new logos” to sign up, or new products to contribute to growth, both of which could provide optionality.

Data from recent filed statements, estimates from S&P Capital IQ

• Looking at Street growth estimates, the presenter finds it hard to believe that growth will decelerate to just over ~20% in the out years. Based on an intensive cohort analysis complemented by survey work, he believes that NOW can easily upsell its customers. The oldest cohort of customers the company talks about (2010) is still increasing spending by +30% annually, and many of those customers are still doubling spend YoY.

  • The presenter explained how a company will implement NOW’s service in a regional office for a function that could benefit from automation, and after seeing the ROI, it will deploy the service across the entire organization.

  • With 98% gross renewal rates, the company has the opportunity to grow revenue rapidly via upselling its current base, without adding new customers. A DCF of this base scenario results in a fair value that’s roughly in line with today’s valuation. As such, the presenter believes there is “free” optionality on NOW’s ability to add new logos over time.

    • With enterprise accounts representing just ~16% of NOW’s revenue, there could be substantial room for growth above upselling core customers.

• With the huge run up in FANG stocks seemingly winding down, the presenter believes there could be a secular shift toward cloud and SaaS providers. Investments in this realm typically do not face regulatory risk, there are no fears about trade wars, etc.; and, recurring revenue is typically high. These attributes should be appealing to TMT investors.

• If an investor is thinking, “I missed it, and I'll just wait for a better price”, the presenter thinks it is worth noting that NOW has rewarded patient investors, regardless of prior peaks/troughs. Looking back to the peak levels seen in 2014 and 2015, when the multiples were actually higher than today, a buyer of the stock would have seen a near 30% CAGR. Obviously, it would have been a better CAGR buying the troughs, but timing is always difficult with expensive stocks.

• For upside, since the presenter doesn’t have a precise target, he looks at the ease with which a higher multiple to sales can be justified. Projecting growth of the 2011 - 2017 cohorts out, using 2010 as a guide, suggests $10B in revenue should be achievable in the out years.

  • Given the unit economics of the business, NOW could “easily” run with 50% margins if it stopped investing in growth (i.e., reduced sales and marketing expenses). The presenter would not want to see the company do this, as investing in sales and marketing should help earnings compound at a high 20s(%) rate, ahead of Street expectations.

  • Taking the 2010 cohort as the example, and assuming spending is $80k per customer, the presenter grosses up sales each year for the later cohorts in line with the experience of the oldest clients. This results in $10B of revenue, without adding any new logos. He strongly suggested that interested investors check with customers that are willing/able to speak about NOW’s services to get a feel for the ROI and level of loyalty, as this is key to understanding the upsell/ growth opportunity.

    • For example, the launch of a finance product in 2019 could be an incremental catalyst.

• When asked what investors could worry about, a participant mentioned hearing that some customers are frustrated by NOW’s customer service, as there isn’t a lot of competition. The company can also be tough with negotiations/price increases, and larger deals can cause volatility in quarterly results; however, he agreed that the ROI is there and the TAM is huge. Additionally, there is the potential for M&A to further increase NOW’s workflow management offerings. All-in, growth could continue at 30% annually for years to come.