ServiceNow's Earnings Reflect Uncanny Ability to Resist Decelerating Growth

ServiceNow has delivered strong earnings results, which are expected to be among the strongest among software peers. The company has shown an ability to execute and resist decelerating growth, even years after its IPO. The generative AI bear market may be coming ahead, which could impact ServiceNow's performance in the future.

ServiceNow (NOW) released its second-quarter earnings report on July 23, delivering robust financial results that outpaced expectations. The company's revenue grew by 22% year over year in constant currency to $3.22 billion, driven by solid renewals, generative AI, and customer workflow adoption. Non-GAAP operating margin was 29.7% for the quarter, surpassing the high end of guidance on key measures [1].

Key highlights of the report include:

- Revenue Growth: Subscription revenue, which accounted for 96% of total revenue, grew by 22.5% year over year to $3.11 billion. This strong performance was driven by healthy large deals and demand from US federal accounts.
- Generative AI: Generative AI remains a key driver for ServiceNow, with deal count up more than 50% sequentially and deal size increasing.
- Financial Strength: ServiceNow's financial health is robust, with a net cash position of $4.3 billion, gross leverage of about 1 times trailing EBITDA, and free cash flow margin of 31% in 2024. The company has also begun share repurchases to offset dilution from stock-based compensation [1].

Morningstar analysts raised their fair value estimate for ServiceNow to $1,050 per share from $1,010, viewing the stock as slightly undervalued and offering the best union of growth and profitability in software. The company's wide economic moat, driven by high customer switching costs, is expected to allow it to earn returns in excess of its cost of capital over the next 20 years [1].

However, ServiceNow faces risks, including increased competition as it expands into areas outside its core IT function and potential execution missteps. The generative AI bear market may also impact the company's performance in the future [1].

ServiceNow's impressive results and future outlook make it a compelling investment for those seeking growth and profitability in the software sector. However, investors should be aware of the risks associated with the company's expansion and the potential impact of the generative AI bear market.

References:
[1] https://www.morningstar.com/stocks/after-earnings-is-servicenow-stock-buy-sell-or-fairly-valued