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Is ServiceNow Stock a Smart Buy?

ServiceNow (NYSE: NOW) helps businesses manage complex workflows, a value proposition made all the more compelling by digital transformation. In this Backstage Pass video, which aired Oct. 27, 2021, Motley Fool contributors Nick Rossolillo and Brian Withers discuss the company's third-quarter earnings, while also weighing in on its prospects as long-term investment.

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Nick Rossolillo: ServiceNow is that software as a service platform that helps all sorts of businesses generate new efficiency. It's a subscription business where a large enterprise would subscribe to the platform and you get access to this low code development platform where you can build new efficiencies into your business. Really cool stuff. ServiceNow is in there with other companies like Salesforce and Adobe that talk a lot about digital transformation. Massive opportunity there as businesses migrate their operations over to the cloud.

They had a quarter that was basically what everybody expected. Let me get the slides shared here, there we go. Beat on revenue, beat on earnings per share, some of the highlights specifically though, besides just the analyst expectations, subscription revenue, that's the bulk of revenue, and the metric that you really want to look at. Subscription revenue up 31% year-over-year. Free cash flow, I like this much better than earnings-per-share. Even though it could be one beat quarter-to-quarter, but it's the real profitability metric I look for in all businesses, especially software-as-a-service businesses like this. $226 million generated in the quarter. It's a growth business, but it's also highly profitable. Net free cash flow was up 51% year-over-year in the quarter, up 30% year-to-date, $1.06 billion generated so far this year.

This company's finding no shortage of places to grow and all along the [laughs] way generating plenty of profitable returns. This is just one of those amazing businesses that you can look at as a template if you're trying to start a software business or if you're looking to invest in a software business. What's the eventuality? What does this scale to eventually down the road? ServiceNow, this is just a fantastic example of that.

Some concerns. Of course, this is a crowded space. All businesses operating in this digital transformation realm, but there's just no shortage of new spending coming online and digital transformation. They cited a report showing that annual spending worldwide on digital transformation projects is going to exceed four trillion dollars this year. It's just huge. IT is migrating to the cloud at a rapid pace and it's the future. It's still got a long long way ahead of it. In spite of [laughs] the crowded space, it's not like anyone's hurrying for opportunity out there.

Brian Withers: I think ServiceNow provides a unique service for its customers. It's all about what they call digital workflows, and if you go to their website, it says: "See how digital workflows create a hybrid workplace that works for everyone," and so they're all about it. If you think about working with your work colleagues and things that happen in the office, very few things happen in a corporate space where one person does something and then it's complete. One person does something, they have to pass it to another person or get it reviewed by a third person, and that's a workflow. That's what ServiceNow does.

I just think throughout my career where we're passing around forms or folders or pieces of paper that track, that's all going digital and as more companies look to do more with less. It's a labor shortage, even in the corporate space, these things that workflows that track things digitally reduce the amount of inefficiency in the process. I think ServiceNow has a long tailwind of growth ahead of it.

Brian Withers has no position in any of the stocks mentioned. Nicholas Rossolillo owns shares of Adobe Inc. and Salesforce.com. Trevor Jennewine owns shares of Adobe Inc. The Motley Fool owns shares of and recommends Salesforce.com and ServiceNow, Inc. The Motley Fool recommends Adobe Inc. The Motley Fool has a disclosure policy.


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