ServiceNow Shakes Up IT Management

ServiceNow (NYSE: NOW), a provider of enterprise IT management solutions accessed via the cloud, is disrupting legacy vendors in the $13.6 billion IT management software market with its suite of applications (built on a proprietary platform) designed to automate workflows and integrate business processes.

Organizations deploy ServiceNow's solutions to create a single system of record for IT management and reduce operating costs through improved overall efficiency. A majority of ServiceNow's customers use its incident-management solution as the first point of contact to help resolve technology issues across the enterprise. With the on-demand model, customers can rapidly deploy the company's offerings in a modular fashion, solving immediate business needs right away and adding new applications as requirements evolve.

By 2016, ServiceNow's total addressable market is estimated to expand to $19.8 billion, according to IT research firm Gartner (NYSE: IT). ServiceNow targets organizations with $750 million or more in annual revenue and a minimum of 200 IT employees. While financial services companies represent ServiceNow's largest customer segment, generating roughly 12% of total revenue, the company has a growing presence in the technology, healthcare, and consumer verticals as well.

In the second quarter, ServiceNow's revenue of $56.7 million rose 93% year-over-year (accelerating from 88% growth in the first quarter) and was up 20% sequentially, making the company one of the fastest growing software-as-a-service (SaaS) providers. Subscription revenue, representing 82% of total revenue, advanced 89%. Billings rose 23% sequentially to $72.1 million and deferred revenue was up 13% sequentially to $131.1 million.

The company added 127 net new customers in the second quarter, bringing its installed base up to 1,201 customers. Upsells into the existing base are an important growth driver as customers add on new or additional services. For the June quarter, roughly 36% of the company's total annual contract value signed represented upsells, vs. 32% in the March quarter.

According to CEO Frank Slootman, who joined the company in May 2011 after serving as CEO of storage solutions vendor Data Domain from 2003 until it was purchased in 2009 (at a hefty premium) by EMC (NYSE: EMC), BMC Software (Nasdaq: BMC) and Hewlett-Packard (NYSE: HPQ) together represent as much as 60% of the legacy accounts ServiceNow displaces. The company, which is also winning business against CA (Nasdaq: CA) and IBM (NYSE: IBM), has a customer renewal rate of greater than 95%.

Slootman brought with him a talented team of former Data Domain executives, including CFO Michael Scarpelli. In addition, the vice president of worldwide sales and the head of engineering at ServiceNow each held the same position at Data Domain. Chief technology officer Arne Josefsberg joined ServiceNow after 25 years at Microsoft (Nasdaq: MSFT), with his last position there being general manager of Windows Azure Infrastructure.

For 2012, management expects revenue in a range of $233 million to $237 million, representing 83.5% growth at the midpoint. Analysts are forecasting 2013 revenue growth of 55% on average. Looking ahead, ServiceNow has a lot of opportunity to continue to take share because its penetration rate among Global 2000 enterprises is just 11%. Also, there's room to expand internationally, as North America is the company's dominant geography at 72% of total revenue.

ServiceNow just came public in late June at $18 a share (above the expected range of $15 to $17) and opened for trading at $23.75. At a recent price of $28.67, the company's market cap of $3.45 billion is 14.7 times the 2012 revenue guidance midpoint of $235 million and 9.6 times the 2013 consensus revenue estimate of $359 million.

With a huge pool of legacy back-office software out there that could be moved to the cloud, ServiceNow has a promising future. But given the pricey valuation, I'd watch this stock for now. A pullback into the low $20s would represent a better buying opportunity.