AI Hybrid Model Will Shape Future Long-Term Usage

Key Takeaways

• ServiceNow's strategic focus on AI adoption may slow near-term revenue growth and earnings due to the introduction of a hybrid pricing model.
  
• Competitive pressures and geopolitical risks could impact pricing, net margins, and revenue stability, despite investments in data centers and global expansion.
  
• Hybrid consumption and subscription pricing models face challenges, potentially affecting revenue growth and predictability, amid increased competition and currency headwinds.

Catalysts

Provides cloud-based solution for digital workflows in the North America, Europe, the Middle East and Africa, Asia Pacific, and internationally.

• The rising prominence of ServiceNow's AI-driven offerings, particularly the agentic AI solutions, might not yield immediate subscription revenue due to the focus on adoption, potentially leading to slower than expected revenue growth in the near term. This focus suggests a strategic move to build long-term usage rather than immediate revenue, affecting both revenue and earnings projections.
  
• ServiceNow's introduction of a hybrid pricing model combining subscriptions with consumption-based monetization for AI agents could delay initial revenue recognition as consumption ramps up gradually, impacting short-term revenue and earnings visibility.
  
• Despite strategic partnerships and market expansions, the competitive landscape in AI software and large language models presents challenges to maintaining premium pricing, potentially impacting net margins as the company may face pressure to offer competitive pricing.
  
• Incremental costs associated with data center investments and global expansion, along with AI-related R&D expenses, may lead to operating margin pressure as the company adapts to evolving market demands, despite expectations of long-term efficiency gains.
  
• The geopolitical and currency fluctuations affecting U.S. federal business and global operations could introduce revenue volatility, particularly in the public sector, suggesting a cautious approach in projecting revenue growth amid potential FX headwinds.

ServiceNow Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on ServiceNow compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming ServiceNow's revenue will grow by 17.5% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 13.0% today to 12.7% in 3 years time.
• The bearish analysts expect earnings to reach $2.3 billion (and earnings per share of $10.57) by about April 2028, up from $1.4 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 110.6x on those 2028 earnings, down from 120.0x today. This future PE is greater than the current PE for the US Software industry at 28.3x.
• Analysts expect the number of shares outstanding to grow by 0.49% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.57%, as per the Simply Wall St company report.

ServiceNow Future Earnings Per Share Growth

Risks

• The adoption of hybrid consumption and subscription pricing models could encounter challenges in customer uptake, potentially impacting future revenue growth if customers do not embrace this model as anticipated.
  
• The shift towards more elements of consumption-based monetization could result in delayed revenue recognition, leading to short-term impacts on earnings visibility and predictability.
  
• There is a risk that the anticipated hockey stick growth from AI agent consumption may take longer to materialize than expected, which could affect projected increases in net margins and revenue growth.
  
• Increased competition in agentic AI across the enterprise software landscape might pressure ServiceNow's ability to sustain its projected revenue growth and market position.
  
• Exchange rate fluctuations introduce currency headwinds that may impact reported revenue and earnings, as highlighted by an FX headwind on the subscription revenue growth outlook.

Valuation

• The assumed bearish price target for ServiceNow is $955.52, which represents one standard deviation below the consensus price target of $1105.54. This valuation is based on what can be assumed as the expectations of ServiceNow's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $1426.0, and the most bearish reporting a price target of just $716.0.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be $17.8 billion, earnings will come to $2.3 billion, and it would be trading on a PE ratio of 110.6x, assuming you use a discount rate of 7.6%.
  
• Given the current share price of $825.95, the bearish analyst price target of $955.52 is 13.6% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.