Quick thoughts on software post ServiceNow earnings
ServiceNow reported Wednesday afterhours. Their numbers came in slightly better than the sell side expected. Though based on the reaction not as good as the buy side thought. Not helping NOW was Microsoft’s earnings number and response, which also put some mid pressure on the software space. Meaning what might’ve been a 2 - 4% sell off on ServiceNow is indicated at -5% right now.
The numbers of ServiceNow we’re fine. Non GAAP EPS will likely be at 4.4 - 4.8 in EPS on a TTM basis by EoY 2026. That assumes a slight slow down in top line growth. Which would be depending on which metric you’re looking at potentially the 2nd or 3rd year in a row of slowing growth. Which makes sense. The base of revenue (or whatever metric) is bigger, ergo, nominally the number yoy might be bigger, but percentage wise its small. This is normal, and healthy.
Assuming a beat even on the current number of 4.8 in non GAAP eps, puts it at 5 bucks. Even after this massive sell off its had for the last few months, and acutely the last few weeks, ServiceNow is still above a market multiple at 120. STILL. That doesn’t mean its expensive here, nor does it mean that it isn’t cheap, but this is a name that was as high at 60 - 70x NTM earnings at points in the last 18 months, without implying much higher growth than it is hitting yesterday and today.
The software basket doesn’t pay any dividends (they don’t want to due to high stock based comp). They also talk about huge stock buybacks, but when looked at over the last few years, for most of the software names few net shares have been retired since 2021/2022. For the average investor you are not receiving any cash/real/tangible returns on your investment in software, except the stock price fluctuations. Let’s forget for a second the multiples and growth rates of semis vs software. I don’t think that’s entirely fair of a comparison.
Late last year you could’ve bought GE at 30x NTM earnings, growing backlog, some military exposure, and one of a handful of players in a vital market, plane engines. For that 30x payment, you would’ve received about a 1%~ dividend yield, which you can use to either buy more GE, buy some Meta or maybe even NOW, but its yours, and you get net buybacks of stock. With a management team that understands boom bust cycles of business.
That is what you have to think about as a software focused investor. Software will see growing growth again when the economy start inflecting to the upside. But so will industrials, which almost all pay you to own them and have C-levels that have real scares of lean times and understand (mostly) how not to be stupid. Heck, even in the ad tech space, Meta was at 18x NTM earnings if they aren’t stupid earlier this year. I don’t mean to pick on ServiceNow, but again, at the same time Meta was at an under market multiple, with a dividend (though again no real net retirement of stock) ServiceNow was at 3x that multiple with similar levels of growth.
I’m made the point repeatedly that software management teams are starting to split into two camps, the ones that understand that software is a mature industry and are starting to act like it, and those that are just getting ticked off by the market and trying to reclaim former glory. Two months ago I wrote up Zoom saying it was a steal in the 80s at <8x FCF. Potentially as low as 6x. Does it have stellar growth? No. But it does have a management team who wasn’t trying to regain the momentum it had during covid, instead focusing on sticky enterprise VOIP growth and defending its share of streaming video, keeping a thumb on SBC and buying back stock like crazy. Occasionally making small investments here and there. All while buying back their stock in droves. On pace to have retired net 4%+ of shares in 2025. All while also increasing their cash pile.
Meanwhile there was this interaction on the ServiceNow call, where Bill McDermott was upset by the market selling the company down 10b due to a purchase of another company.
Is he wrong? Probably not, the market maybe did overreact. But the market had spent the last three years ignoring the growing risks in the software space, and now was over correcting. The real risk to the long ServiceNow thesis is that you have a management team who might not get it. Might think that 2018/2019 valuations are coming back. They just need to obey some fake not real at all rule of 40, and do it via lower and lower value to those beats (adjusted EBIDTA up vs revenue up).
The good news is ServiceNow might start to realize they need to change things. They announced a 5b buyback and Big Billy McD said that they’re going to try to blow through 2b of it quickly (as soon as possible was the exact quote). This is a good start, it would be better if they announce a target for net share returns after SBC. In the same vein the next thing ServiceNow needs to do is announce a dividend. Not just them, but almost all the largecap SAAS names need to start. They need to signal to the market they’re going to take SBC seriously.
Even ignoring valuation comparisons the market has a bit of fear in it related to what has happened to Paypal. While not a one:one exactly, there are rumblings by some investors that these management teams will just continue using shares as a piggy bank until growth disappears. They’re not waiting around to see if that comes to pass.
I think those fears are overblown, but even putting aside the AI stuff as a neutral market force (which I think is more accurate than not), the market is worried about the long term value of these companies, and the viability that they will be around in 5/10/15 years. Many of these names are already twenty years old. Historically they’re ancient. They need to start acting like elder companies, not the hot flash in the pans.
The thing is, if any of them do stabilize and the market realizes they’re not zeros, they’re huge upside to be had. ServiceNOW is likely to keep top line revenue growth at 20%~ for the next two years. Assuming their costs don’t balloon with it, that points to a company pushing 6 in EPS in NTM earnings by mid 2027. If this pullback continues and it falls to 100 - 110, that puts it at 15x earnings. If the market doesn’t think that growth will go 20, 20, then 0 in 2028 they become a strong buy. Now they just need to reward those buying at those levels and above with real returns. To get them to stick around and not just sell on the first pop.
thanks for the analysis