• Best-of-breed SaaS solution for ITSM
• Marching on towards US$10b
• Pullback creates opportunity

Taking Pole Position in a Large Market

ServiceNow Inc (NOW) offers a portfolio of products that supports critical aspects of its customers’ digital transformation process. Management believes its Total Addressable Market (TAM) can grow at a 8% CAGR from US$110b in 2018 to US$165b in 2023. We believe that NOW enjoys a dominant market position, especially in the IT Service Management (ITSM) space, and this has helped to construct a robust partner ecosystem, including professional services and integrations.

Land and Expand

While its ITSM offering is widely known to be its flagship product, NOW has expanded its product offering, which has allowed it to grow its existing installed base of customers by cross/up-selling. In 2018, NOW’s dollar-based net expansion rate was slightly higher than 130%, with 81% of its net new Annual Contract Value (ACV) coming from its existing installed based of customers. Its compelling suite of solutions has also resulted in a high replacement hurdle, with a renewal rate of 99% in 3Q19.

Dispelling the Concerns Post Q3

Management highlighted that the demand environment globally remains very strong – including Europe, which had been a particular source of concern for many investors. This corroborates with NOW’s strong Non-GAAP adjusted total Remaining Performance Obligations (RPO), which is up 36% YoY. Separately, we believe NOW’s incoming CEO, Mr. McDermott, brings with him a wealth of enterprise tech experience from SAP, and will be able to help NOW plot its journey to move from a $3b revenue company to a $10b one.

Valuations Undemanding

From its recent high in Jul’19, NOW has pulled back ~21.3% (as of 24 Oct’19 close), similar to its Software-as-a-Service (SaaS) peers. On an EV/FCF basis, NOW is trading at ~36x, which is approximately at the 3-year mean; we do we not deem this to be stretched. Unlike some of its SaaS peers, NOW has a clear and durable ~30% FCF growth opportunity in front of it. Management has kept FY19 operating margin guidance at 21%, with a FCF margin guidance of 28%.

Strong margin trends should help translate into further FCF growth. We base our valuation on a DCF approach, assuming a WACC of 9.5% and a terminal growth rate of 2.25%, thereby deriving a fair value of US$302. Initiate BUY.

Source: OCBC Research - 25 Oct 2019