ServiceNow (NASDAQ:SERVICE) is arguably the prototype of a successful SaaS company. While many competitors are still struggling with the transition from a licensed model to a subscription model, this issue doesn't affect ServiceNow. The business model was based on a subscription model right from the start.
Instead, the company was able to focus fully on growing its revenue organically. To that end, ServiceNow has expanded the functionality of its workflow solution to cover more business areas and address specific needs from a growing number of industries. ServiceNow has set a crazy pace.
ServiceNow obviously has the right product
In 2012, sales were $244 million. Fiscal year 2021 has $5.9 billion on the books. While sales growth has been declining in recent years, it was still at 30% in 2021. By 2024, the company management around CEO Bill McDermott expects sales of 10 billion US dollars. By 2026 it should even be at least 15 billion US dollars.
Operating margin was 4% in 2021. This shows that ServiceNow is already operating profitably today. The free cash flow margin was even higher at 32%. Here, the share-based remuneration of the employees plays the decisive role. This item is non-cash. However, the shares of the shareholders are diluted by the issue of new shares for the employees.
In the coming years, however, ServiceNow should benefit massively from economies of scale. Currently about 10% of the turnover is invested and more than twice as much is spent on research and development. These figures are likely to develop at a slower rate than sales growth over the next few years. The gross margin of 77% shows the potential of further scaling for ServiceNow.
Why the investment is exciting
ServiceNow is largely funded by subscription fees paid upfront by customers. The remaining liabilities are covered by liquid funds in current assets. ServiceNow may use additional funds to invest in continued growth or to buy back shares in the future. This should put the criticism of the dilution through stock options into perspective over the next few years.
Using free cash flow generated in 2021 of $1.9 billion as the basis for the calculation, the free cash flow yield is approximately 1.7%. If we repeat the calculation with the 2026 revenue target ($15 billion) and the 2024 free cash flow margin target (33%), the expected free cash flow margin is 4.5%. I still expect double-digit growth at this point, so the company is definitely fairly valued.
However, I would only add to my own position in the event of minor price setbacks. In terms of quality, ServiceNow products meet an important criterion. I would like to try the ServiceNow platform myself and design workflows. Apparently, many customers feel the same way, as evidenced by the renewal rate of between 97% and 99% over the past five quarters.
The article ServiceNow – The SaaS Best in Class Delivers Strong Numbers Today first appeared on The Motley Fool Germany.
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Florian Hainzl owns shares of ServiceNow. The Motley Fool owns shares of and recommends ServiceNow.