As the semiconductor sector takes a hit, tech bulls turn to AI applications! ServiceNow (NOW.US) shares soar against the trend, Morgan Stanley focuses on "AI agent consumption + workflow upgrades"

According to Zhitong Finance APP, while the semiconductor sector suffered a major blow, software company ServiceNow Inc. (NOW.US), which specializes in optimizing digital workflows, posted a strong performance against the trend, highlighting that the stock market is re-evaluating the robust profit opportunities on the AI application side. From October 19 to 23, the company’s stock price rose for five consecutive days, surging a total of 11.97%. Over the same period, the Philadelphia Semiconductor Index fell 3.21%; on October 22, while the SOX dropped 6.72% and the Nasdaq Composite declined 2.60%, ServiceNow rose by 2.53%.

As of October 26, its closing price was $158.18, down 0.49% on the day. Therefore, this round of strength was mainly reflected in significant excess alpha returns during the week before earnings, highlighting the market's optimism for the company’s accelerated growth trajectory in the context of the AI agent application boom. At the same time, its share price is also expected to break out of the sluggish trend of recent years, driven by AI-powered fundamentals expansion.

Morgan Stanley’s ServiceNow earnings preview report on October 26 stated that its core bullish thesis is based on steady core workflow demand, a gradual increase in AI product and consumption-based pricing, and improved federal procurement, which together create conditions for re-accelerated growth. However, as the stock price had already risen more than 70% over the prior three months, further upside requires more substantial operational performance and an earnings outlook that exceeds expectations.

Morgan Stanley’s analyst team continues to maintain the most optimistic “Overweight” rating for ServiceNow with a target price of $180, which, compared to the report’s use of the $158.96 stock price, implies 13.2% upside, or 13.8% based on the October 26 closing price. The research indicates that Q3 orders will exceed expectations and twelve-month forward earnings will see modest upward revisions. However, the key bullish theme depends on whether, excluding contributions from acquisitions, organic growth improves, and whether quarterly outperformance can drive a full-year guidance increase.

Stock Surged 70% Ahead—Earnings Need to Surpass the “Re-accelerating Organic Growth” Threshold

As of the October 23 data used in the report, ServiceNow’s stock price had risen over 70% in the past three months, but Morgan Stanley’s Q3 base growth forecast is not aggressive: subscription revenue around $3.978 billion, total revenue $4.092 billion, adjusted EPS $1.02, all close to market consensus. The true source of variance is the current Remaining Performance Obligation (cRPO, i.e. revenue to be recognized over the next twelve months from contracted sources)—the market consensus and company guidance both point to roughly 20% growth at constant currency. However, after excluding the impact of Armis (~1.5pp), Moveworks (~1.1pp), Veza/Pyramid (~0.4pp), organic growth drops to about 17%.

The firm believes that investors are actually expecting about a 22% constant currency cRPO growth from ServiceNow, 2 percentage points above guidance, reflecting a mild acceleration in organic growth. The company should also reflect some of this outperformance in its full-year subscription revenue guidance. Over the past eight quarters, subscription revenue has averaged about 1% above consensus, meaning typical levels of outperformance may not be enough to lift valuations further.

Channel checks and feedback led by Morgan Stanley support this expectation: IT operations management, IT asset management, security operations, as well as customer service, HR, and field service demand are generally steady; partner performance is in line or slightly above expectations; and the pipeline of large deals shows no clear weakening. Federal government business has improved vs. 2025, with several contracts worth millions or tens of millions of dollars, and the public sector as a whole accounts for about 10% of company revenue.

On AI application products, a partner reports that over 25% of its own customer base has already deployed AI Control Tower, indicating that governance needs are beginning to turn into actual purchases. Morgan Stanley notes that the critical next step in AI commercialization for the company (ServiceNow) is for customers to move from simply buying AI features to consistently consuming and buying extra usage limits, such as Assist Packs. However, clients are still reviewing the hybrid pricing model and Token cost transparency. Additionally, the company previously disclosed that some federal on-premises deployment revenue was recognized in Q2 rather than Q3, so this quarter’s revenue pace needs to be assessed in context with contract growth.

Behind the $180 Target: Strong AI Applications Premium Must Ultimately Be Realized via Stronger Cash Flow

Morgan Stanley’s model estimates that subscription revenue will reach $15.77 billion, $18.887 billion, and $22.479 billion in 2026, 2027, and 2028, respectively; adjusted operating margin will rise from 31.5% to 32.5% and then 33.5%; and adjusted EPS will climb from $4.09 to $5.06 and $6.05. Adjusted free cash flow for 2026 is expected to be about $5.666 billion with a 35% margin, rising further to around $6.875 billion in 2027.

The “re-acceleration” process discussed in the Morgan Stanley report primarily refers to the recent significant improvement in organic orders and AI product line consumption indicators. It doesn’t mean sustained annual acceleration—subscription revenue growth in the model still gradually drops from 22.4% in 2026 to 19.8% in 2027 and 19.0% in 2028. The report points out that ServiceNow's continued growth in revenue and free cash flow is fundamentally supported by: high renewal rates stabilizing its revenue foundation, selling more workflows, AI features, and governance products to existing customers, and significantly boosting contract value. As revenue growth outpaces expense growth, operating leverage is gradually released, elevating profit margins.

In terms of valuation, Morgan Stanley assigns a $180 target price based on a $11.8 billion 2030 free cash flow forecast and a 21x terminal multiple, discounted at a weighted average cost of capital of 11.9%, and includes net cash. The bull case target is $220, corresponding to faster expansion in non-core workflows and AI products. The bear case target is just $75, reflecting slower-than-expected new market expansion and significant compression in valuation multiples. Relative to $158.18, these represent about 39.1% upside and 52.6% downside, respectively.

The model shows the massive difference between bull and bear targets, meaning the market is pricing in more than just how much the company can earn next quarter. It's also about whether ServiceNow can own the gateway to enterprise workflow and AI agent orchestration long-term. The intensifying competition in next-gen AI-driven enterprise digital operations, sales execution, partial AI replacement of human seats, as well as post-acquisition integration and cash collection, all impact this long-term premium. The 35% free cash flow margin mentioned in the report is on an adjusted basis and is not equivalent to all deployable cash after acquisition expenses.

From Enterprise Workflow to Agent Governance: Why Are Wall Street Analysts Raising ServiceNow’s Target Price?

ServiceNow’s core business is enterprise workflow software, built on IT service management, extending to assets, operations, customer service, employee services and security risk management; subscription revenue accounts for about 97% of total revenue. Its AI edge comes from integrating large models into real business: Now Assist provides generative and assistive capabilities; Otto, combined with Moveworks, understands requirements, retrieves company knowledge, and assigns tasks; agent orchestration bridges cross-system operations; AI Control Tower handles permissions, governance, and audits.

AI large models/AI agents can generate plans, but to turn them into paid deployments, enterprises still need ServiceNow’s long-standing reliable data context, approval chains, and execution controls. In Q2, the company’s AI annual contract value exceeded $1 billion, and the deployed number of AI agent applications grew ninefold in nine months. On October 21, the company announced the official availability of its long-running agent, Arc, developed with AI chip giant Nvidia, and made progress with AI Passport and runtime/hardware-level permissions. Arc is included in existing packages rather than as an upsell, so its business value is more likely realized through customer adoption, package upgrades, and subsequent consumption growth.

Recently, senior analysts at other Wall Street financial institutions have also cited this conversion process as their bull case: On October 23, Bank of America maintained its “Buy” rating and raised the target price from $150 to $180, noting broader AI adoption and incremental spend. Citi maintained “Buy” with a $170 target, citing optimism for new AI products and improved federal channels. Piper Sandler maintained “Overweight” with a $175 target, emphasizing Q4 organic growth and increased consumption. Relative to $158.18, these imply upside potentials of about 13.8%, 7.5%, and 10.6% respectively.

On October 26, Cantor Fitzgerald raised its “Overweight” target price to $201, offering 27.1% upside; Bernstein maintained “Outperform” with a $266 target (+68.2%), based on more optimistic assumptions about upgrades to new packages and effective price increases for renewals. While target prices diverge significantly, the common focus is now clear: whether AI agent-led software applications can continue to convert demand into robust paid usage, contract expansion, and even stronger free cash flows.