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Is ServiceNow the Best Big SaaS Stock?

Regular readers of Nanalyze know that we have a soft spot in our hearts for software-as-aservice (SaaS) stocks. There’s a number of reasons behind our love affair. Firstly, SaaS businesses provide a steady stream of predictable, recurring revenue through subscriptions. Secondly, these companies generally enjoy high-gross margins, enabling them to generate significant revenue to grow rapidly, grab market share, and absorb downturns. Thirdly, customer stickiness. Once hooked on a SaaS platform, customers are loath to abandon ship, leading to high customer retention rates and opportunities for upselling.

One SaaS stock we’ve been hooked on for a while is Snowflake (SNOW), a cloud-based data warehousing and analytics platform that meets and exceeds all key SaaS metrics. After all, if Snowflake is good enough for Warren Buffett, then it’s good enough for Nanalyze. One drawback of SaaS stocks is that they often command a premium due to their growth potential. However, that also means that any results deemed less than perfect can rock the stock, so it’s important to figure out a fair valuation for stocks like Snowflake and stick to your convictions. We have done just that, adding Snowflake stock to both the Nanalyze Disruptive Tech Portfolio and the Nanalyze New Money Portfolio when the simple valuation ratio (market cap/annualized revenue) drops below our threshold.

Top 10 SaaS stocks.
Top 10 SaaS stocks by market cap. Credit: Mike Sonders

Snowflake is among the top ten biggest SaaS stocks traded on U.S. exchanges at No. 10. At the top of the list are the usual suspects like Adobe (ADBE), Salesforce (CRM), and Intuit (INTU). We didn’t find Salesforce to be overly compelling, and it’s hard to see Adobe or Intuit as disruptive companies, though they’re still above our growth rate threshold of “double digits” having grown revenues last year by 10% and 13% respectively.

Click for ServiceNow company website

At No. 4, is ServiceNow, which is not exactly a household name but may be one of the most underrated SaaS stocks on the list. In 2023, the Silicon Valley firm had nearly $9 billion in revenue, with about 97% coming from subscriptions for its cloud-based software platform that helps companies automate and manage various workflows and processes across their organization. Year-over-year subscription revenue growth was 26% and gross margin was 82%. Unsurprisingly, ServiceNow is now profitable.

Chart of tech stock performance since 2012.
Yup, there’s a lot of squiggly lines up there but the takeaway is that ServiceNow has blown away other top SaaS stock (and the tech-heavy Nasdaq) since the company IPO’d in June 2012. Credit: Yahoo Finance

Let’s see if we’re ready to fall in love again.

About ServiceNow Stock

Our story begins with a guy named Fred Luddy. In the early aughts, he served as the chief technology officer for a company called Peregrine Systems, an enterprise software company that focused on IT service management (ITSM) solutions. He had amassed a tidy little nest egg of $35 million, which vanished overnight amidst a multibillion-dollar securities fraud scandal that sent Peregrine into bankruptcy. Hewlett-Packard later acquired Peregrine. 

ServiceNow 2023 snapshot
Credit: ServiceNow

Unemployed but undeterred, Luddy started ServiceNow in 2003 just before his 50th birthday with a similar business focus as Peregrine on software to support a company’s internal ITSM needs. ServiceNow grew from the proverbial garage startup, which eventually IPO’d in 2012, to a company with a nearly $150 billion market cap today. Fun fact: Original investors have enjoyed a +2,850% return on their money compared to about +500% on the Nasdaq. Naturally, past performance is no guarantee of future results.

ServiceNow platform
Credit: ServiceNow

The business has also grown beyond ITSM to power four different workflows across one interconnected platform, with a number of different products within each category. 

  • Technology: Capabilities cover not just ITSM but also IT operations and security. Key products include incident management, change management, asset management, performance monitoring, event management, and vulnerability response.
  • Customer and Industry: These workflows connect customer service processes across the organization. This includes tools for case management, field service management, and customer engagement through portals and virtual agents.
  • Employee: A consumer-like self-service experience enables employees to access services like HR, legal, workplace resources, etc., simplifying and automating processes like employee onboarding.
  • Creator: This area provides low-code/no-code tools that allow organizations to build custom apps and workflows on the ServiceNow platform.

Much like Salesforce provides software to companies for external customer relationship management (CRM), ServiceNow offers enterprise software for internal relationship management. The platform automates routine, repetitive tasks and workflows by setting up rules and processes, such as automatically assigning incoming requests to the right team or individual based on their skills and workload. It also acts as a centralized database to store and track all assets, resources, and service data across the company, including things like employee records and where the bodies are buried.

ServiceNow and the Generative AI Opportunity

And, like Snowflake, ServiceNow has gone all-in on machine learning and generative AI. Unlike Snowflake, ServiceNow appears to have been spending some time putting the pieces into place rather than suddenly pivoting into large language model (LLM) territory. At least that’s how ServiceNow CEO Bill McDermott spinned it during the company’s Q4-2023 earnings call earlier this year.

“[W]hen you drill deeper into the Gartner forecast between 2023 and 2027, $3 trillion will be spent on AI. What we have here is a strong, durable market being supercharged by a once-in-a-generation secular trend. ServiceNow has been investing, innovating, and preparing for this wave for years, which is why we’re catching it so early.”

ServiceNow CEO Bill McDermott

We could not track down the specific data cited by McDermott from Gartner, a global research and marketing firm known for its magic quadrants (ServiceNow has long dominated ITSM) and hype cycle diagrams like this one:

Gartner Generative AI hype cycle.
Credit: Gartner

However, we probably don’t need Gartner to tell us we’re in the midst of a massive hype cycle over generative AI (GenAI). The firm does note that by 2026, more than 80% of enterprises will have used some type of GenAI application in production environments, up from less than 5% in 2023. Analysts at McKinsey and Company only add to the hype by claiming that GenAI will add the equivalent of $2.6 trillion to $4.4 trillion annually to the global economy.

McKinsey impact of generative AI on global economy.
Credit: McKinsey

Among the top use cases per McKinsey? Software engineering and customer operations. These are exactly some of the areas where ServiceNow is baking LLM capabilities into its platform. For example, the company recently unveiled a capability called Now Assist – AI-powered chatbots for different workflows like IT and customer service management – that can understand natural language queries, provide summarized responses, and automate ticket resolutions. One customer, Hitachi Energy, is using case summarization with Now Assist for ITSM to “resolve cases faster, saving millions.” Text-to-Code is another GenAI function that generates snippets of code from text. 

McDermott says ServiceNow is eating its own dog food: Text-to-Code has increased the company’s developer innovation speed by more than 50%. A separate report noted that after just four months since deployment, generative AI was doing the work equivalent to 50 full-time ServiceNow employees on an annualized basis. A lot of this GenAI capability is being powered by the latest tech from (who else?) NVIDIA.

ServiceNow Saas Metrics

It remains to be seen how much additional value GenAI will generate for ServiceNow. Yet the company has been doing pretty good prior to the implementation. Three of its workflow businesses now boast more than $1 billion in annual contract value (ACV) and 11 product lines with more than $250 million ACV. In Q4-2023 alone, ServiceNow inked 168 deals greater than $1 million in net new ACV, a 33% increase from a year ago. The company also added 10 new brands in deals worth more than $1 million in the last quarter of the year, including its largest-ever win at $10 million.

Expansion of ServiceNow customers and contract value since Q1-2022.
1,933 customers spending $1 million or more – Credit: ServiceNow

The good times kept rolling in Q1-2024. Subscription revenues hit $2.5 billion, a robust 25% bump from a year ago. The company closed 59 deals greater than $1 million in net new ACV in the quarter, with four deals greater than $10 million, representing 300% year-over-year growth. GenAI products were in seven of the top 10 deals, according to management. Over the past decade, ServiceNow has seen revenues grow at an impressive 32% CAGR.

Bar chart showing ServiceNow's revenue growth
Credit: ServiceNow

This is the point where we start to dig deep for red flags and poke a few holes in the narrative (like the $275 billion total addressable market the company claims), but our initial analysis finds ServiceNow stock is firing on all cylinders. We could take issue with the fact that the company only reports renewal rates (which themselves are a bit convoluted when you read through the SEC filings on how they’re calculated) and not net retention rate (NRR).

The latter metric represents how much more money existing customers are spending compared to the prior year. An analyst at UK investment firm Liontrust wrote that ServiceNow has an NRR of 125% without quoting the source or timeframe. If true, that would be decent. The company’s 98% renewal rate is certainly solid. We could also quibble that there is some geographic risk, with about two-thirds of revenues coming from North America but that’s no deal breaker. ServiceNow stock’s simple valuation ratio of 15 seems reasonable for a large rapidly-growing SaaS firm.

Conclusion

There is a lot to like about ServiceNow stock. The company consistently grows subscription revenues well above 20% per year, posts strong gross margins above 80%, and continues to add customers with higher annual contracts. It has nearly $8.8 billion in cash and investments against just $1.5 billion in debt and is in the midst of a $1.5 billion share repurchase program. It seems there is nothing ServiceNow can do wrong, which means any small misstep could rock the stock and offer even better buying opportunities in the future. We will add ServiceNow stock to our catalog as a like for now.