- ServiceNow reaffirmed its place as one of the greatest SaaS businesses with its Q1'20 performance.
- Given the recent guidance, I perform a series of valuation tests that show the business as slightly undervalued.
- It is a good time to start a position in these uncertain times given the highly recurring revenue nature, scale, and experienced management team.
- The team is also adapting to the new covid reality.
ServiceNow (NYSE:NOW) is one of the greatest SaaS companies of all time. It reaffirmed its position with its recent Q1'20 performance, where it lowered overall guidance only 1% due to covid. Given the highly recurring nature of the business (>90% is recurring), scale ($4 billion this year in top-line), and experienced management team, this company remains one of my top picks for a long-term oriented SaaS investor.
I valued the business, incorporating the new financial results and outlook, on a variety of comparable and intrinsic methodologies. My conclusion after this valuation is that the business is slightly undervalued. Given the uncertain times we are in, if we see overall market drops it is a great time to start building a position. I would keep this on my watch list.
The output of my valuation shows a price target of $375, about 16% above current level (as of this writing).
Source: Valuation output
Let us dive into each of these approaches. First, let's start with comparables. We can see the business is still driven on an EV/S basis, and on an earnings is relatively expensive. It is one of the few SaaS plays that has shown consistent profitability, and that deserves a premium.
Source: Comparables and management estimates
Looking now at the DCF, we can see stable cash flows into the FCF model. Management provided guidance at 29% of revenue, which we flatlined across the period. It resulted in a significant undervaluation. Take this with a grain of salt as the inputs are highly sensitive. That is one reason I average all my approaches in the valuation model.
Source: DCF model
Management breaks out recurring and non-recurring revenue. It is striking to see that this is a pure SaaS business operating at scale. The real only other one at this type of scale is Salesforce (CRM).
This predictability allows the company to accurately forecast its revenue into the future. Management guided down just 1% on the recent earnings call.
This business model does well in uncertain times, and I could see technical fund flows moving into ServiceNow due its recurring nature. I could also see short-sellers come to the name as it heats up while other parts of the economy stay muted. This eventually will drive up the price when they cover, if you are a long-term holder and believer as I am.
Looking beyond the business statistics, I think looking at management is critical for any long-term holding. ServiceNow has had turnover in its senior staff, so this is an especially important point to focus on. Can the existing team manage through the crisis and at scale? After doing an analysis, my answer is yes.
Bill McDermott recently joined the company. He was former CEO of SAP, a diversified $150 billion company, where he was the boss from 2010 to 2019. I believe he brings knowledge about scaling to ServiceNow that will help it weather this storm (he saw 2008 at SAP) and also achieve new heights. ServiceNow is at half the value of SAP today (roughly $60 billion).
Source: ServiceNow website
Chris Bedi (CIO), CJ Desai (CPO), and other notable senior members have been in their post for some time, which allows the new management team to learn. I think this mix of experience is important for a business that already has a track record of extraordinary performance and wants to grow to the next scale without losing what works.
Adapting to coronavirus
Beyond these fundamental attributes, I believe the current virus reality presents an opportunity for the team to show how they react in a tough environment. I am impressed by their recent product moves.
The company has launched emergency response apps on its platform as shown below, and built upon its existing ecosystem. These four apps are offered at no charge (taking advantage of low marginal software costs). The goal is to keep customer priorities in mind.
Source: ServiceNow website
Further, the business announced that 70 global and regional partners are helping customers through the covid crisis. I believe this customer-centric view bodes well for long-term shareholder growth.
Valuation is a risk in the short term. After recent earnings, I would not be surprised if the stock ran up to or past its fair value. For long-term investors, it is an opportunity to hold and sit tight. For those trading shorter-term, you can play both sides of the coin.
Great performance also brings competition. Given that ServiceNow has a significant pipeline of international and large deals, some may take longer to close. We will not see the impact of these indicators for a few quarters, but it something to keep in mind.
This article was written by
Analyst’s Disclosure: I am/we are long 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.
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