# Xero, so… what?

I’ve had a few comments about my Xero valuation, a lot of which could be summed up by the words… “so what?”. In particular, people are asking if \$3.55 means they should sell the family home, and load up on Xero stock (currently at \$1.47). So understandably enough, theres a little bit of confusion around the value of Xero.

So what does \$3.55 mean? It means that if everything I predicted comes to pass, then yes, you should load up on Xero. But hold on there Flash, you have to have some idea of the likelihood of predicting all that correctly. Which is 0%. Some bits are going to be wrong.

so we’re down to probabilities. Xero is worth (\$3.55 x probability of sunny scenario + \$X x prob of scenario X + \$Y x prob of scenario Y + …) where all the probs sum to 1.

Lets look at a simple case, the sunny side versus the complete failure of the company.

(\$3.55 . 60% + \$0.47 . 40% )

So, 60% chance of being valued at \$3.55 versus a 40% chance of going broke, and selling assets at the net tangible asset value (\$0.47).

equals…. \$2.31!

Another scenario…

(\$3.55 * 33% + \$1.77 * 33% + 0.47*33%)

33% chance of sunny side or a 33% chance of being worth half that (because of lower customers/revenue growth) or a 33% chance of going broke.

equals… \$1.91.

In summary, depending on what you think the probabilities are will change your view of the current price. If you’re way bullish on Xero taking over the world, the current price is cheap. My take is that there is a lot of uncertainty around Xero, which will be reduced as each earnings release comes out. So for me, I would only have a small, speculative stake, waiting to add or reduce as those earnings releases come out.

Don’t sell your house in other words ๐

## 2 thoughts on “Xero, so… what?”

1. Jason says:

Hi Greg,

Well done on your valuation. However, when you look at other SAS examples around the world, they tend not to trade on rational bottom line numbers. Salesforce.com (the benchmark SAS business) in the US has turnover of around US\$1b and trades at 14x revenue with a market cap of US\$14b. Their bottomline is around US\$80-100m a year at the moment – so pretty high valuation multiples. Assuming Xero has anywhere near the potential of Salesforce.com (I doubt it, given Xero charge per company rather than per user like Salesforce), then on a revenue multiple basis – Xero is worth (\$25m x 14 = \$350m – about double the shareprice). Now, I would assume Xero is eventually sold to some other organisation offshore in the next 5 years, so who knows how that would increase that value mark.

I guess it is really difficult valuing a business on a DCF basis when you have a very unpredictable forward cashflow model. It truly is a best guesstimate thing.

Cheers,
Jason

2. Hi Jason… ah… the rationality of markets. This is a very good point. Salesforce is one of my favourite WTF? companies, where I don’t have any idea why its valued as highly as it is. I even wrote a bear spread, because I think its way overvalued. Of course, with my magic touch, the day after I wrote the spread it went up 17%… ๐

Is it possible that the market will completely ignore fundamentals, and trade on possible takeover opportunities and crazy salesforce multiples?

yes. But as Ben Graham said “Operations for profit should be based not on optimism but on arithmetic.”

And there seem to be a lot of other places to put money right now. So, I will wait a little until the next earnings release, and see how they’re tracking. And maybe take a position on a dip.