00:00 Back in 2003 entrepreneur Fred Luddy felt there was a disconnect between business teams
00:05 and IT departments. Luddy set up ServiceNow to bridge that gap. Its software helps businesses
00:12 streamline and ultimately replace IT systems. The business has been an incredible success and
00:18 today the company is valued at $115 billion. With $7.2 billion of cash and investments
00:24 and $1.5 billion of debt, the enterprise value is $109 billion. Revenue over the last 12 months is
00:30 $7.6 billion. Net income is $400 million with $2.1 billion of free cash flow. 96% of ServiceNow
00:38 revenue comes through recurring subscriptions and the company has strong gross margins of 78%.
00:43 And ServiceNow boasts several other attractive qualities. Its products are used by 80% of the
00:50 Fortune 500 with a 98% renewal rate and a 125% net expansion rate. As seen by the chart, ServiceNow
00:58 does an excellent job of keeping customers and generating incremental revenue from each one.
01:03 In addition, ServiceNow's stock has been outstanding, providing almost 30% returns over
01:09 the last 5 years. Software investors often talk about the rule of 40, but ServiceNow
01:14 claims it occupies the rule of 60, since it previously posted 30% revenue growth and 32%
01:20 free cash flow margin. To be fair, last year's revenue growth dropped to 23% and revenue growth
01:27 rates have been declining steadily over time. But ServiceNow management is optimistic.
01:32 Its revenue target for 2026 was upgraded from $15 billion to $16 billion and management believes
01:38 its software can now be expanded across other company departments such as sales, legal and
01:43 human resources. ServiceNow has plans to grow in international markets as well.
01:48 This is clearly a quality business. The real issue right now is the valuation.
01:52 After a 45% rally, the stock trades at 14 times revenue, 290 times earnings and 52 times free
02:00 cash flow. That makes it one of the most expensive stocks on the market. That said,
02:04 ServiceNow is currently spending 40% of revenue on sales and marketing. As the company matures,
02:09 it will be able to reduce that spend and generate higher earnings.
02:13 Let's assume that ServiceNow hits its target of $16 billion revenue in 2026 and then continues
02:19 to grow at a rate of 15% a year. A 25% net income margin puts net income around $11 billion in 10
02:26 years time. And a 30 times multiple takes that valuation to $330 billion. That works out to an
02:32 investment return of 11.7% per year. That return sounds a little low, but even so, it's hard to
02:38 bet against this company. ServiceNow has got to where it is today without any major acquisitions.
02:43 It's got sticky products and its future cash flows can be used to buy back more of the company's
02:48 stock, juicing returns. It would be nice to get the stock a little cheaper, but right now I give
02:53 it a solid bullish rating. But these are my personal opinions, not financial advice. And I
02:58 do own shares in ServiceNow. For more detailed investing ideas, make sure to visit our website,
03:03 OverlookedAlpha.com.
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