ServiceNow Beats, Raises, And Aims At $1 Trillion Generative AI Opportunity

Investors usually reward companies for exceeding quarterly performance expectations and raising their forecasts.

When a company does that and adds to its revenues by winning customers in a new, fast-growing market, investors should sit up and take notice.

ServiceNow, a Santa Clara, Calif. provider of digital workflow services, did all those things October 25 when it reported its third quarter 2023 earnings. Yet October 27, the company’s shares closed 21% below $698 a share — their all-time high in October 2021.

To be sure, ServiceNow’s stock has risen 4.5% since it announced those great results last Wednesday. However, given ServiceNow’s success at winning customers to Lighthouse — its Generative AI fueled platform launched in September — its stock price could be undervalued.

ServiceNow’s Third Quarter Performance And Prospects

ServiceNow
NOW
beat and raised in its Fiscal Year Third Quarter financial report. The company “once again delivered beyond expectations, significantly surpassing the high end of our topline growth and profitability guidance – and raised 2023 subscription revenue and operating margin guidance,” according to a company spokesperson.

Here are the highlights of ServiceNow’s report:

• Revenue up 22.7% to $2.29 billion — $20 million above the analyst consensus, according to Yahoo! Finance.
• Subscription revenue up 27% to $2.216 billion — “more than” one percentage point faster than ServiceNow’s revenue growth guidance, according to the company.
• Current remaining performance obligations up 27% to $7.43 billion — this leading indicator of revenue exceeded revenue growth “guidance by 2.50 percentage points,” the company noted.
• Adjusted earnings per share: $2.92 — 14.6% ahead of analyst estimates, Yahoo! Finance noted.
• Free Cash Flow
  FLOW
  of $175 million, down 60.9% from the previous quarter, Yahoo! Finance reported.
• Customers paying over $1 million: 1,789, Yahoo! Finance noted.
• Customers paying over $20 million: 49 — 58% more than the year before, according to the company.
• Gross margin (GAAP): 78.3%, “in line with the same quarter last year,” wrote Yahoo! Finance.
• 2023 subscription revenue guidance in the range of $8.635 billion to $8.640 billion — implying 25% constant currency growth, the company noted.

ServiceNow was delighted with the report. “ServiceNow is an outlier for profitable growth. We are the only large capitalization enterprise software company that is higher than rule of 50 — [an industry rule of thumb is the sum of revenue growth rate plus free cash flow margin should be greater than 40]. We beat on subscription revenue, free cash flow, CRPO and operating margin,” ServiceNow CEO Bill McDermott told me in an October 25 interview.

ServiceNow is proud of its ability to grow through internally-generated new services. “The big message: Of five software companies with more than $10 billion in sales, Snowflake
SNOW
is growing fastest and we are doing it organically. Innovation leads to growth. We have 5,000 new innovations. We are getting high value from Generative AI Lighthouse across all industries,” he said.

ServiceNow Aims Lighthouse At $1 Trillion Generative AI Opportunity

ServiceNow’s Lighthouse service — a Generative-AI powered set of industry-specific services to boost productivity — opens up a significant growth opportunity.

ServiceNow estimates Generative AI could add $1 trillion to the company’s total addressable market. “Gartner
IT
says $3 trillion will be invested in IT between 2023 and 2027. $1 trillion of that will go into Generative AI. This adds to Snowflake’s current TAM of $200 billion,” McDermott said.

Lighthouse aims to boost the productivity of companies in by tailoring applications to their specific industries. As I wrote in July, ServiceNow uses Generative AI in its own operations and hopes to offer companies insights from its own experience.

McDermott struck me as very excited about Lighthouse’s potential. “We are partnering with Nvidia’s CEO Jensen Huang and Accenture
ACN
to bring the best engineering talent to provide companies with high payoff Generative AI applications for their customers and frictionless employee onboarding,” he told me in July.

Industry-specific solutions include case summarization — which uses GAI “to read and distill case information across IT, HR, and customer service cases,” according to ServiceNow.

In addition, the company said it offers text to code, text to workflow and a natural language human interface, to improve operations in industries including telecommunications, financial services, public sector, and manufacturing.

In the third quarter, ServiceNow won customers. “Our clients include CBRE, Nvidia, and Deloitte that went to Generative AI in September. We have Phillips, FedEx
FDX
, Mars, Bank of California, U.S. Department of Defense, and Ashahi Mutual,” McDermott told me.

ServiceNow says its services meet an important customer need: to boost productivity “in the face of macroeconomic crosswinds,” he said. “We deliver 30% employee productivity by replacing 13 application platforms with one ServiceNow platform. We replace bad customer service with customer self-service. We enable text to code. It’s all happening with ServiceNow. [Our clients] are achieving operational excellence, their costs are going down, productivity and revenue are rising”

ServiceNow uses its product internally. “People ask how we generate so much free cash flow. I tell them we use our own software. We are doing 15 Generative AI pilots and we are seeing significant improvement,” McDermott concluded.

What’s Next For Service Now Stock?

Wall Street expects ServiceNow stock to rise. The 33 analysts offering 12-month price forecasts for ServiceNow have a median target of $650 — implying 17.4% upside, according to CNN Business.

One analyst suggests the company is undervalued — with a price target of $730 — as its fundamentals are improving in the face of macroeconomic headwinds. Analyst Dair Sansyzbayev used a discounted cash flow analysis to estimate ServiceNow’s fair value at about $150 billion — representing 35% upside potential.

He sees considerable strength in the company — while remaining concerned about how macroeconomic headwinds could hurt the stock. The company’s “fundamentals are improving even in the current unfavorable environment with several macro headwinds. The management continues successfully delivering stellar revenue growth, profitability improvement, and massive reinvestments in innovation. The valuation also looks very attractive,” he wrote on SeekingAlpha.

If ServiceNow reports revenue from Lighthouse — enabling the company to exceed expectations and raise guidance, its stock would be more likely rise.