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An Undervalued Disruptor Firing on All Cylinders

Dan Romanoff, CPA

Dan Romanoff: We see wide-moat ServiceNow as an interesting investment opportunity throughout 2019, as it's the fastest organic growth story under our large-cap software coverage umbrella. Specifically, we are modeling greater than 35% EPS growth in each of the next three years, driven by revenue growth of at least 25% annually. With shares hovering near $270, we see approximately 10% upside to our $290 fair value estimate. 

ServiceNow is perhaps most easily understood as an ERP system for the IT function within the enterprise. This is a story of disruption, and one that should sound pretty familiar by now. ServiceNow has consolidated market share in IT service management much more rapidly than Salesforce did in salesforce automation. They have done so by introducing a modern SaaS-based and richly featured product into a niche that has not been well-served by incumbents. Fortunately for them, the platform was aimed squarely at the IT function, so when IT users saw the power of the workflow-automation logic built into the core solution, users began tailoring it for use cases beyond IT. Basically anything that has an incident response workflow is a potential use case for the platform. As such, management launched specific solutions aimed at areas outside of the IT function, notably HR and customer service. 

ServiceNow is similar in size to Salesforce five years ago when it had loosely a $40 billion market cap, with one critical difference being that Salesforce had already done big acquisitions by then, whereas ServiceNow's growth has been organically driven. We expect strong growth to continue with revenues driven by robust addition of new logos, continued strong cross-selling, and increasing traction in emerging products in areas like HR and customer engagement. We expect earnings to continue to outgrow revenues as the company continues to scale its GAAP operating margin expansion by several hundred basis points annually for the next five years. Importantly, free cash flow margins are already better than Salesforce.