I have been negative on ServiceNow (NYSE:NOW) for going on a year and a half now, with core unprofitability and high stock-based compensation as my driving thesis, but with patent infringement lawsuits as a final kicker.
For example, in an article written in Nov 2014, I mentioned both the patent infringement case levied by HP (NYSE:HPQ), and more importantly that brought by BMC. The tenor of the pleadings in the BMC case in particular made me believe that "BMC appears to be taking NOW's potential infringement "personally" which could be very costly for NOW." I provided several details from the cases, including that NOW didn't have a single patent to its name and that BMC had made the following accusation:
18. ServiceNow has made it clear that the ultimate goal of its infringing activities is to destroy BMC's reputation and business. Among other things, ServiceNow's Chief Executive Officer Frank Slootman has gone on record with statements about BMC such as:
(i) "We have been dismantling [BMC's] business left, right, and center."
(ii) "We have taken the whole company down."
(iii) "I fear for their future because we're going to drive a truck right through it . . . ."
In December of 2015, I followed up on my thesis, including highlighting a third party appraisal of the suits, which included this conclusion regarding the initial Markman hearing in the BMC case:
In this instance, the ruling was almost entirely in BMC's favor, which suggests that ServiceNow's position may be untenable and/or its litigation team is overmatched. Given the history with HP, both have a relatively high probability of being true and, in fact, the harder it is to win a case the more competent the legal team has to be to prevail. This ruling suggests that BMC's team is adequately provisioned, while ServiceNow's is not.
While this doesn't assure BMC will win, it gives it a significant advantage going into the trial because the battle has been defined in accordance with BMC's wishes. This would be like a duel where one side can pick both the location and weapons before going into the battle and, as you would expect, is particularly proficient with the choices it made.
Today, NOW filed an 8-K announcing that it is taking a whopping $270M charge for litigation settlement expenses. Here's the relevant text:
On April 8, 2016, ServiceNow, Inc. (the "Company") and BMC Software, Inc. ("BMC") entered into a confidential settlement agreement (the "BMC Settlement") to resolve all patent-related litigation between the Company and BMC. Under the BMC Settlement, the Company and BMC each provided a general release from all past claims, including claims related to infringement of all patents in dispute, and entered into a covenant not to sue for patent infringement for a specified term of years.
As previously announced on March 9, 2016, the Company and Hewlett Packard Enterprise ("HPE") entered into a confidential settlement agreement (the "HPE Settlement") to resolve all patent-related litigation between the Company and HPE.
The Company took total aggregate charges of $270 million for litigation settlement expenses in the quarter ended March 31, 2016. The charges cover the fulfillment by the Company of all financial obligations under both the BMC and HPE Settlements with no remaining financial obligations under either settlement.
Because the settlement is sealed and confidential, we're not privy to any restrictions that NOW (or the other parties) may have agreed to. But given the seemingly unilateral victories by the plaintiffs, it wouldn't be a stretch to think NOW may be operating under new rules in developing its software. Moreover, it's also interesting to note that the settlement with BMC leaves open the possibility of future patent infringement suits after "a specified term of years."
To put the cost number in perspective, consider that as of its latest 10-K, NOW reported $285M in revenues for its most recent quarter and listed about $947M in net current assets (crediting back deferred revenue).
I still believe that the single most fundamental reason to be short the stock is the company's core unprofitability. However, the cost of today's settlement and the implications about a management team that generated this situation is also a strong corroborating factor. As a result, I remain short the stock.
Disclosure: I am/we are short NOW.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I actively trade around core positions.