Yesterday, ServiceNow’s (NOW) largest shareholder, Sequoia, filed a Form 4 disclosing its first major divestiture of NOW shares. The May 1st filing discloses a 6m share distribution that Sequoia quietly made to its limited partners on Monday (April 29th). This reduced Sequoia’s stake to 18.3m shares and transferred ownership of the 6m shares to an assortment of pension funds, endowments, and fund-of-funds that make up Sequoia’s limited partner base. While a direct share distribution partially absolves Sequoia from market timing decisions, it can place heavy selling pressure on a stock. This is because limited partners are typically not equipped to analyze individual public securities, preferring to instead sell shares immediately upon receipt. Since Monday’s 6m share distribution, NOW’s share prices has fallen by 7.8% on an average of daily volume of 2.4m. It can then be argued that this abnormal volume and price activity is the direct result of Sequoia’s distribution. As Monday’s distribution only represented 25% of Sequoia’s total ownership stake, additional forced selling may lie ahead.
Sequoia, along with JMI Equity and Greylock, was one of ServiceNow’s original venture capital investors. Sequoia first built its stake in November 2009, investing $51.6m for a 23.9m share stake. This equates to a cost base of just $2.15/share relative to NOW’s current price of $38.80. But as Fortune recently put it, “for many VC firms, getting into a hot company is easier than getting out.” Following NOW’s June 2012 IPO, Sequoia had their shares locked-up until the beginning of February. Rather than immediately distributing their shares after the lock-up expiration, Sequoia chose the hold shares through NOW’s April 25th Q1 2013 earnings release. They were rewarded as NOW shares traded to an all-time high of $43.39. While Q1 Billings were above consensus and revenue slightly beat estimates, forward-looking comments from management suggest that NOW’s growth may have topped out. On the Q1 earnings call, CFO Michael Scarpelli commented, “We’re still expecting a strong quarter in Q2. But we kind of expect going forward…Q2 to Q3 are pretty much going to be flat quarters from a bookings perspective.” The sell-side overlooked this comment, as well the weak Q3 and Q4 revenue numbers implied by full-year guidance, and issued their typical round of congratulatory research notes. Sequoia, on the other hand, decided it wanted to partly cash out.
After Wednesday’s Form 4 filing, Sequoia continues to hold 18.3m shares. As Sequoia’s limited partners are sitting on roughly 2000% paper gains, they will be eager to crystalize these profits. If a 6m distribution causes a two-day 8% correction, then further distributions may result in a similar outcome. And once the makeup of NOW’s shareholder registry completes its rotation from locked-up VCs to momentum investors and retail traders, future growth stumbles are less likely to be tolerated. This week’s Sequoia distribution, combined with the foreboding statements on the quarterly call, may finally induce a correction of NOW’s dotcom-era 16x 2013E Revenue multiple. We’ll be following the Form 4 filings closely.
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