Four Reasons ServiceNow Could Grow Faster Than Its 22% Target
ServiceNow — a 13,000 employee Santa Clara, Calif.-based provider of business workflow software — leads the pack of 36 publicly-traded technology companies I am researching.
How so? In the decade from 2010 to 2020, its revenues top the list — having grown at a 59.2% average annual rate while its stock rose at 44% a year.
Sadly for investors, that upward trajectory has been interrupted — as of June 2, its shares had fallen 22% from their all-time high of $598 reached this February.
Does this represent a buying opportunity?
I see four reasons that ServiceNow revenue could beat expectations:
It creates compelling value for customers
It grows organically — rather than by acquisition
Its culture attracts and inspires great talent
It empowers people and holds the accountable
(I have no financial interest in the securities mentioned in this post).
ServiceNow’s Confusing First Quarter Results
ServiceNow’s first quarter reports confused investors. The good news was that its $1.36 billion in first quarter revenue was 30% more than the year before and $20 million above the Wall Street consensus, according to Barron’s. Meanwhile, subscription revenue was ahead of guidance and non-GAAP earnings per share of $1.52 was 18 cents above the Street.
The problem — which seemed to drive its stock down 7.3% the day after its report — was guidance for the second quarter and the year. ServiceNow projected second-quarter subscription revenue in the range of $1.29 billion to $1.295 billion, “up 27%-28%, and below the $1.305 billion Wall Street consensus,” noted Barron’s
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The middle of the range of ServiceNow’s full year 2021 revenue forecast is $5.463 billion — up 21% from 2020 — and slightly below its previous 2021 forecast of $5.49 billion.
Investors may also have been disappointed in the first quarter ServiceNow added 53 new customers with a net annual contract value of more than $1 million — down 40% from the previous quarter, according to SiliconAngle.
On May 10, ServiceNow guided growth expectations well-below its longer-term growth rate. After posting 33% average revenue growth for the last three years, ServiceNow CEO Bill McDermott told analysts on May 10 that its revenues would reach $10 billion by 2024 — growing at a 22% compound annual rate from 2020’s $4.5 billion.
He also extolled ServiceNow’s total addressable market. As he told investors in ServiceNow’s Q1 2021 earnings conference call, “In the past year, the transformation of work has accelerated the adoption of digital products, services, and experiences. As a result, digital investments are at an all-time high and will total more than $7.8 trillion by 2024, according to IDC.”
How ServiceNow Creates Value For Customers
ServiceNow’s software helps companies get work done more effectively and efficiently. The company’s software makes business process reengineering — a concept introduced in the 1990s — within reach for processes that cut across departments.
A case in point is ServiceNow’s work for Lloyds Banking Group which dramatically improved its payment operations.
As John Ball, Senior Vice President-Customer Workflows, ServiceNow, told analysts on May 10, in 12 weeks ServiceNow enabled the bank to reduce its payment operations process from 16 steps across six different systems to two steps and one system.
The new process increased customer satisfaction, enabled the bank to resolve problems 70% faster, and slashed errors and mundane tasks for agents.
Creating value for customers is vital to ServiceNow’s success. As McDermott told analysts on May 10, “ServiceNow is actually building products faster than ever from ideas to customer-ready in days. We know the customer is the only boss. This is why we have a 98% renewal rate, very strong Net Promoter Score, and an ever increasing base of successful customer references.”
A favorable review noted that “deployment can be done in 5 to 7 weeks for standalone ITSM if there is minimal customization. We have integrated with our monitoring tools, ERP – Finance/Procurement system, CRM tool and various other systems/tools.”
A critical review noted that ServiceNow’s product is “flexible to configure request and automate integration processes, but still falls short [because it] tries [too] hard to be everything.”
Despite this mixed customer feedback, in 2020, Gartner dubbed ServiceNow an ITSM Magic Quadrant leader for the seventh year in a row.
ServiceNow Grows Organically
If a company is lucky and very clever, it can keep building new products that generate considerable revenue that spring from its first one. ServiceNow prides itself on having made acquisitions that add new skills, rather than depending on acquisitions for new revenue.
This is what ServiceNow has done. In a May 26 interview, chief innovation officer, Dave Wright told me, “I have worked at ServiceNow for 10 years. Before that I worked at Peregrine Systems with Fred Luddy who cofounded [and is Chairman of] ServiceNow. He developed a platform to get work done across the enterprise. We could not get [potential customers] to understand it. Peregrine used it for ITSM [tracking corporate IT service requests] on top of the platform. IT Service Managers noticed how flexible it was — as a cloud-based ITSM platform.”
ServiceNow extended its expertise in corporate workflows to corporate functions beyond ITSM. “Between 2005 and 2011, we moved beyond ITSM to IT operations management and business management. We made it a single source of truth so that different departments would not need to copy the data. [Our core competency] is creating workflows for the enterprise.”
ServiceNow can help other departments reengineer processes and it has added technical functions that enhance its platform. “We allow enterprises to break down tasks. We could do the same for human resources, marketing, or finance — every corporate departments. Then we looked at how to enhance the product. We acquired technology to make it better. We can perform analytics, we can add artificial intelligences to process data,” Wright told me.
ServiceNow has been able to fend off competitors that excel in automating the work of individual corporate departments. As he said, “No-one else needs to lose for us to win. There are best of breed companies — such as SAP (Enterprise Resource Planning), Salesforce (Customer Relationship Management), and Workday (Human Resources) that enterprises will buy. They focus on one department and are really good at one thing.”
The key to ServiceNow’s success is that it helps companies make cross-functional processes more effective. “Our service does multiple things in multiple systems. For example, when you join a company, HR sets you up for payroll, benefits, and orientation training, IT gives you a laptop and connects you to the network; facilities gives you an office. There is onboarding workflow and our service creates the tasks that need to be done across those departments. Nobody else plays in that space,” Wright explained.
ServiceNow’s culture focuses employees on giving customers what they need. As McDermott told investors in April, “Our culture was born for this moment. Our team of 14,000 colleagues are exponential thinkers. This is how we continuously bring innovation to everything we do. In just the past 18 months, we have more than doubled the features and functionality of our platform for our customers.”
ServiceNow will broaden its geographic, customer, and vertical scope to achieve its growth goals. “Future growth will come from additional geographies; moving from our current enterprise customers to smaller companies; and product discovery. We can move from IT service to operational technology such as Development Operations (DevOps),” Wright said.
ServiceNow also depends on partnering with large consulting firm. As CFO Gina Mastantuono, told me in a May 28 interview, “Our partner ecosystem helps ensure that our 6900 global customers — 80% of the Fortune 500 — get value from our technology. At $1.5 billion, the partner ecosystem represents a good chunk of revenue. Eight partners have $1 billion business consulting on the application of our product.”
ServiceNow has created an organization that focuses on creating the future — not solely extending its current strengths. “We have a unit called NowX which comes up with brand new products such as connecting the Internet of Things and robotic process optimization. We can also make applications for specific vertical markets such as telecommunications, finance, healthcare, and manufacturing.”
NowX has generated new products — though I don’t know how much they contribute to ServiceNow’s revenue. As Chirantan C. J. Desai, Chief Product and Engineering Officer, told investors on May 10, in 2019 NowX introduced two new products. That figure increased to five in 2020 that are being used by 50 large customers.
In 2021, Desai expects NowX to “introduce two or three additional products that will result in over $100 million ACV and act as a growth driver for years to come.”
ServiceNow Attracts And Motivates Talent
ServiceNow did not layoff employees during the pandemic. It has been hiring. As McDermott told investors, “We made 3,000 new hires, and we are now 14,000 ServiceNow strong. Our team has a deep passion for diversity, inclusion and belonging. Our employee engagement scores are soaring. Our people are really happy and…fired up to be the fastest growing SaaS company at scale in the world.”
Glassdoor gives ServiceNow decent ratings. Based on 1,409 reviews the company has 4.3/5 stars; with 87% recommending the company to a friend and 97% approving of McDermott. Employees like the work-life balance and 40% annual growth. Strangely, they also complain about work-life balance and say that middle management needs more training.
ServiceNow cares about how people feel and their intellectual strength. As Mastantuono said, “We were hiring 25% more people in total and 30% more engineers. We needed people with IQ and EQ — the future of work is empathy and compassion. This is the dream job purpose built. We make work work better for people. Leaders must be aligned with the purpose of putting customers first and being hungry and humble.”
ServiceNow is adding talent with new skills globally. As Wright told me, “To attract talent we go for diversity. We are adding design skills and user experience and customer experience designers. We made an acquisition to add to our design skills. We are more data and analytically focused. We have AI people. We want people who are not worrying about the negative consequences of doing something different; who are ambitious (hungry) and humble; and who enjoy the ride because social interaction drives loyalty.”
The challenge of competing for talent in Silicon Valley has sent ServiceNow to other geographies. “We seen geographic expansion from Silicon Valley, to India, UK, Seattle, and the Netherlands. We are Saas-based — we don’t need to be tied to a specific location.”
ServiceNow Empowers People and Holds Them Accountable
ServiceNow has a rigorous process for delivering on the results its promises to achieve. Generally, it empowers people closest to its markets to take ownership of the outcomes they can control and holds them accountable for achieving results.
As Mastantuono explained, “We have a talented leadership team; a three to five year plan; an annual strategic planning process that includes financial goals, key performance indicators (KPIs), and Dream Big Priorities — such as cross-functional initiatives. Team work makes the dream work.”
ServiceNow sees itself a data driven company. “We automate our KPIs and have a revenue dashboard. We have a global leaders meeting with the top 200 leaders to make sure they understand the strategy and our priorities. It cascades to workers — each employee’s work ties to the strategy and priorities needed to get to $10 billion and $15 billion in revenue. Every single person has three to five goals relating what they do to corporate priorities,” she said.
ServiceNow makes sure it communicates its goals and strategies. “If it’s important enough to be communicated it’s never communicated enough. We had monthly all hands meetings during the pandemic and now it’s every two months. We want empowerment and accountability. We want in-market people to drive the results. We hold them accountable and measure with KPIs,” concluded Mastantuono.
Analysts: ServiceNow’s Growth Could Hinge On Go-To-Market Pivot
Analysts have a wide range of target prices for ServiceNow. Were those targets achieved, investors could enjoy returns between 24% and 35%.
Morningstar’s price target of $587 would yield a 24% return; Needham sees the stock rising to $591; and Citi set his price target at $639 — for a 35% return.
Needham analyst Jack Andrews was looking for upside from the May 10 analyst day. Sadly the stock has increased only about 2% since then. Andrews told Barron’s that the first quarter had a lot of moving pieces that likely left investors wanting more.”
Needham is bullish on ServiceNow’s “ability to capitalize on digital transformation initiatives is unchanged” and should view its lower price as a buying opportunity.
Citi analyst Tyler Radke described ServiceNow’s missing its second quarter and full year forecast as “mainly noise” which could hurt the company in the short term.
He sees the stock as outperforming significantly in the longer term.
Wright told me that ServiceNow’s competitive advantage is that it never had to pivot from Luddy’s original technology vision.
But ServiceNow is pivoting its go-to-market in a significant way. In a June 2 interview, Phil Carter, Group Vice President, European Chief Analyst and WW C-Suite Tech Research Lead at IDC. told me, “The $7.4 trillion digital transformation opportunity that ServiceNow is targeting represents cumulative 2021 to 2024 spending on key technologies such as cloud, AI, and IoT. To capture that opportunity, ServiceNow must open up c-suite conversations.”
Doing that represents a new challenge for ServiceNow. “There will be high growth at ServiceNow as well as a focus on profitability, platform investment, and customer satisfaction. ServiceNow is hiring and training existing team so it can engage the C-Suite — which includes the CEO as well as chiefs of operations, customer, human resources, information security and risk, finance, and IT.”
If ServiceNow can excel at building these C-Suite relationships, it may be able to win a significant share of the Digital Transformation opportunity and exceed its 22% growth guidance. Were that to happen, its stock could retrace the ground it has lost since February.