EP50: Nothing Artificial About It
Stock Ideas From Investment Professionals
Welcome, subscribers! Today, we share pitches for two companies that stand to benefit tremendously from artificial intelligence (neither are Nvidia!)—plus a staffing company with a market cap under $200 million.
Read on to learn more. 📕👇
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Let’s get to it.
Deep Sail Capital detailed their thesis on micro-cap staffing company, RCM Technologies (RCMT). The company has specialties in three verticals: healthcare, life sciences, and engineering.
RCM Technologies is a diversified talent services holding company. The company operates in three segments: healthcare, Life Sciences and Information Technology (LS&IT), and Engineering. The company has a strong history of high-quality capital allocation, including smart M&A and opportunistic share buybacks. Recent commentary from the Q1 earnings call suggests that their Engineering business has built a backlog for 2023 that will materialize in future quarters.
After their 4Q earnings back in March, they noted "Material Weaknesses in Internal Control Over Financial Reporting" which caused the stock to drop 30%. I spoke with their CFO, Kevin Miller, about this after they submitted the filing. Kevin noted that the material weakness identified was related to their use of a third-party consultant to assist with the creation and ongoing development of their SAP accounting system. This work allowed those third-party consultants access to their accounting system, which is what caused the auditors to note a Material Weakness in Internal Controls. This came up during their most recent audit in 2022, and they are in the process of rectifying it in 2023, as they laid out in the 10-K. Currently, it is projected to be rectified in 2Q or 3Q of 2023. It seems highly unlikely that any material misstatements of their financials were made, and this material weakness should be resolved later this year with no impact on their financials.
Market Opportunity - Segments
RCM Technologies Healthcare segment is focused on providing nurses and other healthcare professionals with long-term and short-term staffing and placement services to hospitals, schools, and long-term care facilities. Since COVID, they have had success securing contracts with large school systems across the country in order to provide them with staffing for nurses, therapists, and other healthcare professionals at these schools. The Healthcare segment's revenues have more than doubled since 2020, driven largely by the school segment. Recent weakness in their Healthcare business was driven by lapping some COVID-related demand spikes that are soon to be behind them. Overall, as COVID has become endemic, the school system's demand for nurses and therapists has slowed, but I believe we have stabilized around Q1 levels, as suggested by management in the Q1 conference call. There is a huge opportunity in this space to expand to other School systems around the county, as they currently only service a small number of larger school systems. The total TAM of the school segment is likely 10–20x their current market share. On top of a large TAM in front of them, they have a huge opportunity to provide behavioral therapists to school systems, which are increasingly in demand by school systems to provide support to their students for behavioral and social issues. I believe we will see behavioral therapist demand outpace nurse demand in the future as more schools look to put in resources capable of supporting their students emotional health.
In the field of engineering, RCM Technologies offers a diverse range of services, including product design, development, and testing, as well as technical staffing and consulting. They assist clients in sectors such as aerospace, automotive, energy, manufacturing, and telecommunications. They have increasingly positioned their engineering business to be supportive of the shift to alternative energy. As new renewable energy resources and the shift to electric vehicles approach, there is a huge need for utilities to upgrade their transmission infrastructure. RCM Technologies Engineering Group has expertise in supporting a wide array of energy projects in the generation and transmission segments, including projects in solar, biofuels, fuel cells, batteries, substations, and transition upgrades. The engineering segment is well positioned in North America. Outside of that, RCM Technologies has recently launched an engineering office in Germany, which could be a launching pad for developing a business in Europe.
With regard to the Life Sciences and Information Technology (LS&IT) segment, RCM Technologies offers IT staffing, consulting, project management services, and life sciences support to assist businesses in various technology-related initiatives. They provide skilled IT professionals who can support clients in areas such as software development, data management, cybersecurity, and infrastructure management. This segment focuses on providing a full suite of IT services to middle-market companies within various industries. The LS&IT segment is the smallest of the three segments but has the highest gross margins at 34.5% (vs. 30% in Healthcare and 22% in Engineering). The segment has been an extremely reliable and consistent part of their business, generating roughly $3m / quarter of gross profit for RCM but growing only a few percent a year since 2020. In a way, you can think of the LS&IT segment as a cash cow that helps feed the faster-growing Healthcare and Engineering segments.
White Falcon Capital went into great detail on their thesis for IT services provider, EPAM Systems (EPAM). The company has dealt with a number of issues of late, including having 60% of their workforce in Ukraine/Belarus/Russia as a war broke out. The company has de-risked operations, and White Falcon recently added to their position.
EPAM Systems is a high quality IT service provider that has been a compounder stock. EPAM's winning streak came to an end in 2022.
With Russia’s invasion of Ukraine the stock fell from $550 per share to $180 per share as the market was worried about EPAM’s workforce/delivery centers in Ukraine, Belarus and Russia. The management at EPAM did a wonderful job derisking the company from this exposure. They exited Russia by not only leaving their clients there but also by closing their delivery centers in the country. By the end of 2022, EPAM’s exposure to these volatile countries had reduced from 60% of overall workforce to 30% of overall workforce. EPAM moved some of the affected employees to neighboring countries and ramped up their hiring efforts in India and Latam. Due to this, the stock moved up to $450 per share a few months later in August 2022.
However, very recently, EPAM reduced their guidance for 2023. They first reduced their guidance during their earnings but then followed this up with a further reduction in guidance a few weeks later. The management is now expecting negative growth in 2023.
We first got involved with EPAM after it sold off in March 2022 but have recently added to the position. EPAM is currently available for 21x depressed 2023 earnings per share. It is a $12 bn market capitalization company with $1.7 bn in net cash and a $500 mn share repurchase authorization. An investor purchasing shares at these valuations can expect to compound with earnings growth with the added call option of multiple expansion if EPAM is once again seen as a durable growth franchise. We believe that is the most likely outcome.
Here are the historical financials:
EPAM is a global IT services firm. It competes with the likes of Accenture and provides IT services to a diversified end-market consisting of clients in the financial services, travel, retail, software, healthcare among other industries. EPAM held its IPO in 2012, and since then, has grown more than 10x until the year ended 2022 with revenues of $4.8 bn and EBIT of $573 mn. Like all IT services companies, EPAM is well placed as a ‘toll booth’ between technology and corporations who increasingly need technology to transform their business.
Their stellar track record came to an end in 2022. For 2023, EPAM guidance that its revenues will de-grow from 2022 levels. Management mentioned that clients are deferring projects due to which there will be little or no growth for the next few quarters. They guided for growth to come back in 2-4 quarters as clients can pause these projects but not cancel them.
What happened?
1. IT spending is indeed slow. Like many other industries, IT services also ‘over earned’ during covid and had a stellar performance in 2022. Some of this is now normalizing.
2. Some clients have de-risked EPAM due to their still substantial exposure to Ukraine.
3. Overall, revenue growth in this industry is very dependent on employee growth. EPAM has not grown its net employees - the losses in Russia and Ukraine have been made up by gains in India and Latam. It takes time in this to train employees and bring them up to high levels of productivity.
In addition to all these issues, there is debate amongst investors on AI - Are EPAM and other IT services providers AI winners or AI losers? Most IT services are billed on a ‘time and material’ basis and the ‘bear’ argument is that as software engineers become more productive; fewer software engineers will be needed thus affecting growth for all IT services companies. In this report, we will highlight EPAM’s strengths and debunk some of the narratives surrounding the thesis. We believe the risk reward on EPAM is very attractive.
IT services and EPAM’s competitive advantages
All IT services companies look the same. They all provide bodies that specialize in technology to businesses that need to either cut costs or improve processes. Under the hood, however, they are all a little different. Understanding these nuances can be the difference between a value trap and a compounder.
According to Gartner, IT services is one of the fastest growing segments of overall IT spend. The IT service providers play in this bucket and grow due to three factors,
● Increasing IT spends: These spends are typically a function of IT budgets. These budgets are typically a certain percentage of revenues and can be economically sensitive. The trend is that most corporations are allocating a larger and larger part of their spends to technology - software is in fact eating the world. These spends have further tailwinds from Cloud computing, Cybersecurity, Work from home and Digital marketing.
● Increasing outsourcing: Larger businesses can afford in house technology departments but for most businesses technology is not their core expertise. It is also difficult to hire and retain good technology talent. So, they rely on consultants to keep them abreast of the latest technology trends. In the past, most companies let IT companies manage their costs but increasing IT services companies are helping businesses transform the way they do business.
Confirming this, Gartner mentioned that, through 2025, organizations will increase their reliance on external consultants, as the greater urgency and accelerated pace of change widen the gap between organizations’ digital business ambitions and their internal resources and capabilities.
The two biggest competitive advantages in this industry are scale and culture.
If you look at the history of IT services companies we observe that the big get bigger. Accenture currently has 700,000 employees. Why? Because scale matters in more than one way.
On the revenue side it matters because an IT services company will not get a $10 mn project from a client until they have done a $10 mn project in that practice in their industry and can provide a good reference. Many times, an IT services business has to organically get to that level or acquire another company that has a good reputation in that practice and industry. The phrase, ‘no one gets fired for hiring IBM’ came from the fact that until you have a proven history or executing and become a low risk choice for customers, you will not get hired. EPAM has a reputation for being a good partner for corporations.
On the cost side, scale matters as a company needs resources to train their workforce on the newest technology - something that changes all the time. The successful companies were able to transition their business from application development to ERP implementation to cloud migrations and now they will have to transition to AI related technologies. All this requires significant resources and a margin buffer that only the larger IT service providers can absorb.
Warren Buffett had been reading IBM’s annual report for 50 years before he bought the stock. He talked to Berkshire companies and reasoned that most companies do not switch their IT providers. He was absolutely right in his assessment of the industry - it is a very sticky business - but picked the wrong horse (he should have bought Accenture instead!).
EPAM is a founder-led Company. Culture is key. IT services are execution heavy businesses. Projects have to be delivered on time and on budget to satisfy the client. While projects start and finish, good IT services companies remain entrenched with the clients and endeavor to gain a bigger share of their IT budget. The financial services industry, for example, has a constant need for IT services due to complicated back offices, changing compliance requirements, mergers and acquisitions, or digitizing services. An IT service provider needs to work hard to take its fair share of the client’s IT budget but the good ones do just that. Whatever the client’s need, the IT service provider has a solution. EPAM is good at this! Due to this, the business generates more recurring revenue and is much higher quality than the market realizes.
With the IT services industry, there are some net winners and then some net losers. IT work is continuously getting commoditized. Companies such as Accenture or Infosys have a ‘legacy’ business that is facing pricing pressures and has negative growth as well as new ‘digital’ business lines that are growing like a weed. Newer IT service companies with very strong engineering capabilities such as EPAM, Endava, Globant, Luxoft (now acquired by DXC) have much more of these ‘digital’ revenues due to which they grow much faster but this also makes them more dependent on discretionary spend.
EPAM’s historical core competency is full life-cycle software development services including design and prototyping, product development and testing, component design and integration, product deployment, performance tuning, porting and cross-platform migration.
EPAM is well diversified within verticals (financial services, travel, business information & media, software, and life sciences). It takes a lot of time and effort to methodically diversify your business in this sector and each vertical can be thought of as a new business line. EPAM also not does not have large concentration risks when it comes to clients with top 10 clients making up about 23% of revenues.
"I would say in my experience in working directly with EPAM is that they have a core engineering expertise that is top shelf. They can bring that to bear on whatever projects or programs that they're involved with. They seem to have a team of core scientific engineers that aren't necessarily dedicated to any particular project but are there to help in any fashion to accelerate or solve very difficult problems that come into play that may stall a project. Their ability to do that is pretty profound."
-EPAM Competitor Jan 2022
“In my opinion, they're probably the best at doing this in the industry. They far away are better than TCS, Cognizant, your typical offshore vendors. They're really a specialist at modernization of product stacks, which has been great. They have a really good practice around DevOps and modernization. They've been fabulous. I use them also at Shutterstock when we did something similar for AWS, and they were just as good.”
-CTO of Priceline.com (June 2023)
The other way to get scale and capabilities is acquisitions. Good providers do many tuck-in acquisitions to gain either expertise or clients. EPAM had done many successful acquisitions over its history and integrated them into their culture. We have not seen large acquisitions succeed in the industry due to cultural differences.
"When they identified in the past that there's a capability that's going to be in higher demand in the market, and they lack the capability internally, they did the smart thing in my estimation. They went ahead and purchased one or two or several really strong players, and integrated them."
-EPAM competitor (Jan 2022)
We believe that EPAM is a superior business and is shielded from the common problems in the industry. Its services are essential to its clients' success. EPAM has proven to be a good IT services company and invested ahead of new technologies in order to stay relevant with its clients and increase its share of wallet. There is very little reason to believe that this will not be the case going forward.
AI Narrative
We think IT services companies such as EPAM are AI winners. Indulge me here but I asked chat GPT on how AI can help businesses and here is the response:
“Here are some key areas where corporations can leverage AI for benefits:
● Automation and Efficiency: AI can automate repetitive and mundane tasks, enabling corporations to increase operational efficiency and productivity.
● Decision Making and Analytics: AI-powered analytics can process vast amounts of data and provide valuable insights for decision-making.
● Personalized Customer Experiences: By leveraging machine learning algorithms, corporations can analyze customer data, preferences, and behavior to tailor product recommendations, marketing messages, and customer support interactions.
● Enhanced Customer Service: AI-powered chatbots and virtual assistants can provide instant and round-the-clock customer support.
● Risk Management and Fraud Detection: Machine learning algorithms can analyze patterns in financial transactions, customer behavior, and cybersecurity data to identify potential risks, anomalies, or fraudulent behavior.
● Product Development and Innovation: AI techniques like natural language processing and computer vision can assist in product development and innovation. By analyzing customer feedback, social media sentiment, market trends, and competitor data, AI can identify customer needs, suggest product enhancements, and support the development of new offerings."
And on and on and on…..
AI is great but how does a corporation incorporate AI into their business? It seems like machine learning is an integral part of the process. So, what does one need for machine learning? I again asked chat GPT:
“To effectively implement machine learning, several key components and considerations are necessary. Here are the main requirements for machine learning:
● Quality Data: This involves relevant, accurate, and properly labeled or annotated data. The data should be representative of the problem domain and cover a wide range of scenarios and examples.
● Data Preprocessing: Before feeding data into machine learning algorithms, preprocessing is often required. This includes cleaning the data by removing noise, handling missing values, normalizing or standardizing features, and performing feature engineering to extract meaningful representations.
● Machine Learning Algorithms: A variety of machine learning algorithms exist, including supervised learning, unsupervised learning, reinforcement learning, and more. Selecting the appropriate algorithm(s) for the specific task at hand is crucial.
● Training Set: A labeled training set is needed for supervised learning, where the input data and their corresponding target values are available. The training set is used to train the machine learning model by adjusting its parameters or weights based on the provided examples.
The other key points mentioned are Model Selection and Tuning, Model Training, Model Evaluation, Deployment and Integration and finally, Monitoring and Maintenance”
In essence, what we read above is that there is a LOT of work that needs to be done in order to enable a corporation to reap the benefits of AI. All this work has to be performed by someone! We think EPAM and other engineering focused IT services providers will be the key enablers of this move to AI. Further to this, corporations that still have their data on premises on different platforms and they first need to bring it in one place and on the cloud to even begin implementing AI. This work is also performed by EPAM.
There is an excellent transcript on Stream by the CTO of Priceline.com that sheds light on these factors:
“I've had prior experience working with EPAM in prior companies. They are what I'd say a best-in-class company for modernizing tech stacks and moving them to the cloud. We hired them to accelerate our move out of our data centers and into Google Cloud.”
“They were doing cloud modernization, I'd say, about 10 years ago before it was a big thing and now it's a big thing. They have really good relationships with Google and AWS. They bring EPAM into deals as well with customers. What winds up happening is for AWS or Google contracts, if you lock in to, say, a five-year deal worth $500 billion, Google then gives you what they call PSF, which is professional service funding, in order to make the migration to the cloud. They'll give you, say, $60 million, $70 million to do that. You can only spend that PSF money against certified Google partners. Quite honestly, there's maybe a half dozen that are really good and EPAM is one of those.”
“They're (EPAM) building out our real-time data infrastructure for us now to train and build out all of our machine learning models. They're doing that right now and they're well-positioned to do that. The generative AI stuff, we're going to do in-house just because we have a large data science population already and have been doing machine learning for quite some time. Any of the heavy lifting around modernizing our data infrastructure over the next couple of years, EPAM will be doing that work.”
-CTO of Priceline.com (June 2023)
The current narrative is that corporations are going to hire a team of software engineers and then with the help of chat GPT or Bard they will be successful in enabling corporations to build AI capabilities. We believe this is totally wrong.
The IT services industry has suffered from these false narratives in the past. A few examples:
Initially, all IT work was application development but when SAP and Oracle brought packaged software the narrative was that IT services is done but IT services pivoted to implementing ERP and made out like bandits. Then cloud software started to become dominant and this software did not require a lot of implementation and the narrative again shifted to the death of the IT services business. But, IT services pivoted to cloud migrations and digitally enabled custom projects that were increasingly possible because of the flexibility offered by the cloud. We believe this current shift of narrative where investors believe that IT service companies are net losers from AI is misplaced.
As long as IT budgets are increasing, the better IT service providers will find things to do. Cloud providers such as AWS and GCP bring EPAM into deals so that they can more effectively modernize tech stacks for clients! We believe AI is a net enabler and will lead to accelerated growth in revenues and earnings for IT services companies like EPAM.
Conclusion
EPAM remains a high quality founder led business that has hit a rough patch. We believe that this is a small bump and EPAM will get back to growth in a few quarters.
Overall, the company can be had for 21x depressed 2023 guided earnings. This is on a non-gaap basis. Before 2022, analysts had estimates going to $16 per share in earnings for EPAM by 2025. While this is no longer possible, we model $14 per share in 2025 and $16+ per share in 2026. In addition to the reduction in growth, EPAM is also not optimized when it comes to margins. We believe it can move on to high teens margins in a more normalized environment.
In all this, AI remains a big variable and we think the surprise is likely to be on the upside.
This is a $320-400 stock in three years if they can do $16+ in earnings per share in 3 years and get valued at 20-25x earnings. It is more likely than not that the multiple will be much higher if they do return to 20% plus growth.
Importantly, EPAM has a strong balance sheet with $1.7 bn in net cash and can buy back more shares or do tuck in M&A to further enhance shareholder value. EPAM has a $500 mn buyback authorization in place which should help with dilution and earnings accretion.
Economic cycle is a big risk. IT service providers are dependent on IT budgets which are then dependent on revenues. If there is a downturn in the economy and revenues come down - that will affect IT budgets.
Ensemble Capital Management walked through their ServiceNow (NOW) investment thesis. They believe the company can act as a key software integrator by layering generative AI capabilities on top of their NOW Platform.
In the next section we’ll talk about why we think ServiceNow is well positioned to capture part of the AI profit pool. But investors need to recognize that while AI will disrupt some companies and greatly benefit other companies. The biggest winners of AI might not be AI companies themselves, but existing companies that can use AI to improve their own business, or new businesses that will be founded to use AI to solve old problems in new ways.
Today, most people thinking about the opportunities of AI see the world from the standpoint of the first frame of the comic. How great if we can just write a bullet point and AI can write long, compelling emails! Think about how much time it would save and how big of a positive impact it would have on the quality of the emails we send!
But the second frame reveals the problem. AI isn’t just for you. The dramatic, revolutionary potential of large language model-based chatbots is that everyone, for free (!) can use AI. Who exactly is going to be reading emails in an AI world? Wouldn’t you love to have an AI that processed all your emails for you, simply presenting a list of choices to make, and then firing off a bunch of responses? But in that world, does a long, compelling email even matter? Does email even exist in a post AI world? If each person is going to have an AI assistant, why are long, compelling written messages important? Maybe we will each have short, concise conversations with our AI assistants and then our AI bots will communicate directly with one another, negotiating on our behalf before returning to ask us to make another short list of choices.
The initial impact of AI has already arrived. The changes have already been set in motion. But the counteractions as just beginning. Many of the amazing solutions you see today are solving a problem that won’t exist in just a couple years as the target of the solutions begins to adopt AI tools of their own.
But while we can’t know today where AI will lead, we can see clearly that it is something big, moving fast, and it is just as important to recognize what is not yet known, as it is to try to understand what will happen next.
ServiceNow (NOW): AI has been all over the news lately and we’ve seen some amazing results in terms of a step up in intelligence, productivity, and creativity come out of it. Nvidia, the semiconductor leader in GPUs (Graphical Processor Units), has gotten the spotlight as the hardware enabler of the technology while Microsoft, Open AI, and Google have been highlighted as the companies that brought the technology to the market.
However, the ramp in the use and application of the technology is just starting. As we’ve seen with previous innovations, the majority of the value often accrues more broadly to companies and societies who incorporate the technology into their offerings – creating new applications and enhancing existing ones – and see higher productivity and better living standards. Of course, there are also companies that get disrupted and have to figure out new business models or become obsolete.
We can think of ServiceNow’s core offering, the NOW Platform, as a “Platform of Platforms” within the enterprise, and as we’ll explain, it allows companies to stitch together their disparate, siloed software and data systems so that they can be accessible, modernized, and integrated to create more efficient workflows to unlock better customer services and increase productivity.
Adding Generative AI capabilities on top of ServiceNow’s core platform and applications only serves to further enhance its value proposition because it serves as one of the key complimentary tools large enterprises will need to take full advantage of Generative AI’s capabilities and benefits.
If we think about the nature of the IT systems in a large company, it’s likely to look like a spaghetti mess of systems that have an alphabet soup of acronyms like ERP, SCM, CRM, HCM, etc. and these systems have been implemented and incorporated into the way enterprises run their businesses in a piecemeal way over 40 years or more. Often times each system is managed by teams of people operating separately from one another with siloed pools of data.
We’ve all experienced this jumble of software at work and even at home. You have a separate login into each one and you switch screens to get the data and functionality of each one. You download spreadsheets of data from one system to upload into another system or even manually entering data from one system to another to keep them synched.
Enterprises often tried to manually link systems so that they could have workflows built across different systems that needed to interact with each other, but these manually built links are often fragile and unscalable and expensive to fix and maintain. The whole hodge podge of systems and custom connections was not upgradeable to the current instant access, instant gratification world that the mobile internet has brought to us all as customers and employees.
The dream was to have a system that sat on top of the underlying transaction systems and seamlessly integrated the software applications and the data they had within them. That more elegant and scalable solution was called an “Enterprise Service Bus” that would be able to connect these disparate systems and access and translate data between systems that had different terminologies and fields and function calls. Various companies attempted to do this, in the early 2000s but it was relatively kludgy, expensive, and unscalable. They sold the dream but didn’t really execute it because their technological architecture was not quite up to the job.
Enter ServiceNow… which leveraged the cloud-based software architecture to build a scalable integration platform, called the NOW Platform, at a time when cloud-based software systems were starting to take off and enterprise had standardized and implemented a few key systems like an SAP, Oracle, Salesforce, Adobe, Workday and Microsoft to name a few.
ServiceNow was able to create an integrated software model in the cloud that connected to these systems, which still didn’t talk to each other, yet had core data models that were known and standardized. By building an integration platform in the cloud, ServiceNow was able to become the enterprise service bus akin to a central nervous system for the enterprise, connecting to the key functional systems that enabled the enterprise to operate its daily business. This central platform could communicate between systems and access the siloed data in these systems in a scalable, standardized way that was both elegant and cost efficient.
That’s a really nice thing to be able to do technically, but in order to drive value from this capability, ServiceNow built applications on top of the core NOW platform. By creating a single data integration model with underlying commonly used functionality built in, the NOW platform allows ServiceNow’s R&D team to quickly create these applications that leverage the underlying technology. These applications are quick to build for its internal R&D team resulting in high ROI (return on investment) for the company and quick to deploy and fast time to value for the customer which also delivers to them high ROI.
These applications are tools that dramatically improve IT management of enterprise systems and devices, bring greater employee efficiency through lower cross system friction, and improve customer service through integrated systems visibility and automation. If you think about what applications are, they are basically collections of scripted workflows that enable a certain end functionality that the user is looking for to fulfill tasks or goals.
Think of a new employee joining a firm… HR has to add the employee to the payroll system, IT has to allocate laptops, software licenses, and other equipment, facilities has to allocate a space for the employee to work, legal and compliance has to vet and train the employee, etc. These are all different systems and teams of people that touch the new hire workflow, than at least one HR person has to coordinate and access. With an integrated workflow platform like ServiceNow, you no longer need a person to coordinate the steps and people, these can all be automated and reduce hours of time across the enterprise to get the job of onboarding done. You can think of a similar workflow for a customer service issue where the internet service is down, or logistical deployment and tracking of COVID 19 vaccines from the Federal level to the local level, which was a real problem ServiceNow helped solve in weeks not months by leveraging its core system.
This makes ServiceNow uniquely able to serve as the cross-systems workflow platform via its integration hooks into major systems used at companies. And the importance of these workflows in the daily operations and interactions of employees and customers in companies makes it very sticky and its value very visible to key decision makers. And the underlying capabilities of the NOW platform, once implemented in the enterprise, create opportunities to build new applications that couldn’t have been possible without it.
We can see how successfully ServiceNow has been able to leverage that core platform with its high margins and fast revenue growth coupled with increasing annual contract values (ACV) at existing customers nicely demonstrates the value of the platform and success of the growth strategy.
This leads to one of the most amazing customer growth stories we’ve come across. Even the oldest, most mature ServiceNow customers who were onboarded during the 2010-12 era have seen a revenue growth rate of about 28% per year with the youngest cohorts added in the past 4 years averaging 50% growth. To be able to grow customer annual contracts at a nearly 30% CAGR over a decade and maintain the sustained levels of high growth during challenging economic times, indicates a very compelling value proposition for customers backed by strong company execution.
There are always certain marketing buzz words that pervade the technology industry and the most common one during the COVID period was “Digital Transformation”, i.e., creating an agile organization that can support remote employees with consumer app level technology expectations (not green screens!), fast changing customer demands in a mobile first world, and intelligence from data within the organization to create new value. ServiceNow’s value proposition aligned really well with this theme.
The most recent buzzword of course is Generative AI. As we’ve highlighted, the NOW platform creates the capability for enterprises to really extract value and productivity from their own data. The NOW platform’s single data model and ability to access data from various siloed applications, means that ServiceNow becomes a key lynchpin in the enterprise’s ability to utilize and extract value from their own customer and transactional data in their systems. Therefore, Generative AI becomes a new complimentary value creator that improves ServiceNow’s already strong value proposition as a critical enabler.
Furthermore, the workflows that can be built atop the NOW platform leveraging AI can become even more effective at raising the level of productivity for employees via deeper, more intelligent automation that can both generate customer insights and deploy routine procedures with employee oversight needed only for exceptions. In an era of labor shortages, growing wage pressures, and the Fed’s singular focus on battling price increases, this sort of technology creates the ability to offset higher labor costs with higher productivity without the need to raise prices commensurately to protect margins. For other business models, more productive employees mean higher margins that can be achieved. In both cases, we believe it makes ServiceNow’s value proposition even more compelling and opens further opportunities for continued growth for years to come.
Until next time! - EP