After more than a decade of rapid cloud-computing growth, 2023 has finally been the year the industry has slowed a bit. Companies are in cash conservation mode, and they're finding far less use for new subscription-software services than in the recent past.
But one theme has been resilient: artificial intelligence (AI). Or put more simply, automation. With the economic slowdown and high inflation pinching budgets, companies are looking for ways to do more with less. As a result, ServiceNow (NOW 1.02%) has bucked the slowdown many cloud software companies have been reporting, and a new partnership with Nvidia (NVDA 6.18%) announced earlier this year could help sustain the company's lead.
A full-blown automation platform
ServiceNow provides a software-based platform for businesses to digitize their workflows. Be it technology, employee, or customer-facing tasks, ServiceNow helps integrate data across an organization to uncover inefficiencies and help its customers delete or automate these inefficiencies to boost productivity.
In other words, ServiceNow's software is designed to increase profit margins for its customers. If ever there was a software suite ideal for the 2023 economy, it might be this one.
Earlier this year, ServiceNow said it would be integrating Nvidia's new AI chips and AI training software to help make its platform even more efficient. In turn, Nvidia would use the resulting ServiceNow AI products to flatten any bumps in its own research and development operations.
More recently, ServiceNow, Nvidia, and tech professional services giant Accenture expanded previous partnerships to create AI Lighthouse, a comprehensive computing product that will help early adopters find and develop uses for generative AI (read: even more automation and cost savings).
ServiceNow sails through the cloud slowdown
There's no better proof of the value that ServiceNow customers are getting than in the software company's financial results. In the second quarter, subscription revenue increased 25% year over year to nearly $2.1 billion. The outlook for full-year subscription revenue growth was also increased to at least 25.5% over 2022, or about $8.6 billion.
For the record, full-year 2022 subscription revenue grew 24%, so ServiceNow expects that to accelerate in 2023, a testament to the platform's power to help customers fight against fears of an economic slowdown. Many subscription-software peers have been reporting a significant cool-off in their revenue growth this year as customers tighten up their budgets.
ServiceNow has also been profitable on a free-cash-flow basis for some time. And now, net income under generally accepted accounting principles (GAAP) is rapidly increasing and narrowing the gap between the two metrics. Employee stock-based compensation, or SBC, is the primary reason for the difference between the two, but free-cash-flow profit margin, which excludes SBC, is expected to be a very healthy 30% this year.
Data by YCharts. TTM = trailing 12 months.
Is the stock a buy?
As with other software companies (like what Snowflake recently reported), the installation of new hardware and AI software from the likes of Nvidia will take time to flow through to ServiceNow's financials. Perhaps by calendar 2024, the company will start revealing customer success stories from its new generative AI products.
No matter, though. ServiceNow is still making hay without the new AI partnerships. The stock trades for a premium 50 times trailing-12-month free cash flow, but deservedly so, considering the steady and profitable growth that this top-notch cloud software business has been reporting for years.
More profitable growth is management's forecast for the foreseeable future. For investors looking for the best software stocks to invest in right now, ServiceNow ranks as a solid option as a dollar-cost averaging candidate.
