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What Do Hedge Funds Love About ServiceNow?

Some big name funds have been buying the stock this year

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Rupert Hargreaves
Aug 25, 2021

Summary

  • High-profile funds have been buying ServiceNow.
  • They may be attracted to its growth and CEO.
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One of the most bought stocks among hedge funds in the second quarter of 2021, according to 13F filings, was ServiceNow Inc. (

NOW, Financial).

This activity really stands out to me, not just because of the volume of acquisitions but also because of the names that were buying. Some hedge funds heavyweights were adding to their positions in the stock during the three months to the end of June.

These hedge funds have a reputation as successful technology investors and private market investors, so they may know quite a lot about the industry in which ServiceNow operates.

Hedge fund buying

The hedge funds that were adding to their positions in the stock during the second quarter include

Steve Mandel (Trades, Portfolio)'s Lone Pine Capital, Viking Global Investors, Chase Coleman (Trades, Portfolio)'s Tiger Global and Lee Ainslie (Trades, Portfolio)'s Maverick Capital. All of these hedge funds are successful technology investors, and Tiger Global is rapidly becoming one of Silicon Valley's largest venture capital investors.

Recent earnings

ServiceNow recently reported an incredibly strong second quarter. The maker of cloud-based management software reported adjusted revenue of $1.4 billion, up 32% from a year ago. Subscription revenue was $1.3 billion, up 31%.

Secular trends are driving revenue growth. The most important of these trends is digital transformation, which has been accelerated by the pandemic.

The company is becoming the leading platform for digital transformation at many different businesses. Its principal Now Platform makes this possible with one data model, one architecture and one platform for workflow.

Strong CEO

Presiding over the company at this pivotal time in its history is Bill McDermott. McDermott's resume is impressive. From 2002 to 2019, he worked at the European software giant SAP. He became the CEO in 2010 and, in eight years, increased the company's market value threefold.

McDermott stepped down from SAP to move to ServiceNow in 2019. At the time, he cited "the company's strength in cloud computing and enterprise software and the challenge of building an already vibrant company further" as his reasons for joining. He is an empire builder looking to build another empire.

The visionary CEO is targeting $15 billion of annual revenue for the group by 2026. Considering its recent outperformance, I think the chances are it will hit this target. Customers are also relatively sticky. It's challenging to change workflow management software when ServiceNow's system is already inbedded in the organization. This should support the firm's growth by providing a stream of recurring revenue to support marketing initiatives and acquisitions.

The company is also incredibly cash generative. In the first six months of the financial year, it generated free cash flow of around $800 million. Therefore, it seems as if the enterprise has the cash to spend on growth initiatives.

Richly valued

The one downside of the stock at current levels is its valuation. Shares in the company are currently trading at an enterprise-value-to-sales ratio of around 17. That looks cheap compared to the sector average of 22, but it does not leave much room to maneuver if growth does not live up to Wall Street's lofty expectations.

However, for investors who are prepared to look past this valuation, the stock does appear to offer an attractive proposition. It is a rapidly growing technology business with sticky customers, a visionary and successful CEO, impressive growth targets for the next few years robust cash flows, which management can use to support its growth strategy.

Something else to consider is the insight the hedge funds outlined above may have into the company's interaction with other businesses. They may have seen how ServiceNow's software can revolutionize processes and believe the business has further potential.

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Disclosures

I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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