BREAKINGVIEWS-ServiceNow exposes AI sand in software gears

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

By Pranav Kiran

TORONTO, Dec 19 (Reuters Breakingviews) - ServiceNow NOW.N may struggle to provide service later. The $162 billion business software developer has opened a clear window into the mounting fears over artificial intelligence threats to subscription-dependent incumbents. Getting clients to pay for AI features, and quickly, will be the best response.

The company, whose products help big organizations manage IT and human resources workflows, lost nearly $20 billion in market value after Bloomberg reported this week that it might buy cybersecurity startup Armis in a deal valued at as much as $7 billion. The mooted price tag would be 23 times the target’s $300 million in annualized recurring revenue. Palo Alto Networks and Alphabet have struck similarly expensive deals to beef up in network protection, suggesting that the sharp reaction in ServiceNow shares speaks to broader concerns about growth prospects.

It was originally expected to weather the machine-learning storm. Upselling clients to an AI-infused subscription tier could lead to an extra $2.5 billion of revenue, TD Cowen analysts estimated a year ago. Even after the stock-price slide this week, ServiceNow is valued at about 12 times preceding 12-month sales, per Visible Alpha, double the median multiple for companies tracked by the BVP Nasdaq Emerging Cloud Index.

The race against AI’s impact on business models is intensifying. Prospects for existing software suppliers depend on how many subscriptions they can sell and customers are disappearing or asking to be billed for usage instead. U.S.-based IT back-office employment has more room to fall after dropping in both 2023 and 2024, and “technology headcount-related revenue” represents about half of ServiceNow’s business, KeyBanc analyst Jackson Ader estimates. His analysis also suggests that free cash flow growth for nearly two dozen other peers could drop below 5% over the next five years, even before factoring in AI-native gatecrashers.

Newcomers aim to automate costly human labor involved in everything from legal research to administrative tasks. Such companies are reaching $100 million of recurring revenue a full year quicker than the previous generation of cloud software, according to venture capital firm Bessemer Venture Partners. Harvey AI, a large language model that helps law firms compare contracts and draft court documents, took just three years to reach that milestone and is now valued privately at $8 billion.

ServiceNow and others including design software developer Adobe ADBE.O spotted the existential danger. They have incorporated AI features, but are also struggling to keep up with the pace of change and flashier new rivals attracting investors and customers. It will only get harder to crack the code.

(Editing by Jeffrey Goldfarb; Production by Oliver Taslic)

((For previous columns by the author, Reuters customers can click on KIRAN/pranavkiran.t@thomsonreuters.com))