Why I sold Ecoya
After attending the Ecoya AGM in Auckland a week or so ago, I decided to sell almost all of my Ecoya shares. Here’s why:
I bought Ecoya at 68c, and they are now $1.10-$1.30 (I sold them over a bit). But after attending the AGM it appeared quite clear to me that the original reason for buying, essentially the marketing expertise of Geoff Ross and his team, was no longer valid.
There was no CEO at the meeting, although subsequently the COO Stephen Sinclair was named CEO.
Ultimately, my investment thesis was based on the understanding that Ecoya would be the Business Bakery (and Geoff Ross’s) main focus going forward. This no longer appears to be the case, particularly with the Moa IPO. There was also talk of more acquisitions which is something that makes me nervous.
In such a highly competitive market, it seems Ecoya has lost its only potential edge. Note, that this is not investment advice, so burn your own pots of money! 
Ecoya update
Ecoya have just released a news item, saying, unsurprisingly for a marketing company, just how fantastically they are doing. Or, since they’re a startup, how fantastically they’re losing money.
They’re predicting a loss of around 4 million, and, as predicted, have needed to raise more money. They state
“Taking into account current banking facilities, the company does not expect to have a requirement for further capital raising based on current forecasts.”
Which means that they had to go cap-in-hand to the bank and ask for money to pay the bills. But, they didn’t have to go out to the market to ask for more money to pay the bills. Yay. Smelly bankers instead of the unwashed masses like me. So no surprises there. The rest of the announcement is typical marketing/startup positivity, which is summarised as: “yay, we’re fabulous, blah, we *should* get more fabulous and wealthy if the planets align, yay us, ps, did I mention we’re awesome? pps., we’re kicking that Xero’s butt”
(actually that last PPS was mine… just kidding!).
The question then is, of course, should I buy shares? They’re predicting breakeven or profit in the next financial year, and revenues exceeding $20million, which would be an excellent result.
If thats true, Ecoya is a good speculative bet. See what I did there? I said “good”, which means “good”. And then “speculative” which means “good chance of losing all your money”. So Ecoya is a “good” “good chance of losing all your money”!
Hahahaha. Hilarious. I love this stock trading speak!
But the main thing is, Ecoya is a marketing company. They’re making SOS (same ol’ $#!t), but they seem to be marketing really well. And if you can market Vodka like the 42 below guys (which is essentially a pretty boring tasteless form of alcohol), they’re going to be like pigs in … er.. gooey smelly stuff marketing gooey smelly stuff.
So since I’m not a stock advisor, I have to make a call. And my call is, I think Ecoya will do well, assuming they still have facility to cover their expenses. They’re not super-expensive right now, you could buy the whole company for 30-40million.
But remember, you have a reasonable chance of losing the investment. Or doubling/tripling the investment. How much do you believe in their ability to market crap that everyone else is already making?
Xero versus Ecoya – round 1!
Happy new year everyone!
To kick off the new year, I thought I would look at the 2 ‘glamour startup’ companies in the NZX, Ecoya and Xero. Xero as we know are a online financial software provider, while Ecoya sell ‘eco’ candles, body type stuff (obviously I’m a guy, but think smelly stuff for house).
Both companies are relatively new, with Xero (~2006) having a few years on its younger brother (2008). Ecoya obviously target a mass-consumer market (mainly cosmopolitan reading girls and the guys wanting to impress them), while Xero targets small/medium business (and accountants wanting to impress them!)
Neither has made any profit, with the March 2010 Annual reports showing revenue of 3.4 million for Xero, and 3.9 million for Ecoya. The Xero net loss for that period was $8.45 million, and Ecoyas was $2.35 million. So both companies are currently burning investors cash like a new years bonfire. In their latest (30 Sept ’10) interim reports, both indicate accelerating revenues (3.8million for Xero, 4.4million for Ecoya – note this is in 6 months), and increasing losses as expenses also ramp up, in Ecoyas case increased sales and marketing (no surprise) and admin (not sure why?) expenses. Xero are a bit less informative in their interim reports (which is funny for a financial software company! I find it funny. But my sense of humour is too ‘advanced’ for a lot of people).
So all up, both are looking… fairly startup-ish. Increasing revenues, increasing expenses etc.
Xero has dug a deeper hole in terms of current losses, but has a well-capitalised balance sheet. Ecoya has a bigger market (girls, and guys wanting to impress them!) but only 1.3million cash in the bank. Ecoya will definitely need some cash in the future, whereas Xero has enough to survive to their theoretical breakeven in 2011.
So thats the comparison in a nutshell. Xero, lots of cash on hand, high development expenses. Ecoya, pure consumer/brand play, huge market, not much cash.
On the face of it, the companies are pretty even. Xero is the more ‘glamourous’ stock at the moment, whereas Ecoya is flying very quiet. So its cash and celebrity that is the big difference between the companies.
So how much is Xero’s cash and celebrity valued at? In a startup, cash is worth much more than the face value. Cash in startup land = ability to survive another few months = not having to go back to market or raise debt = much less risk. If we do a quick market cap comparison, Xeros cash and celebrity are valued at approximately… $235 million! (thats the difference in market caps between Xero (270million) and Ecoya (33million).
Which… is quite a lot. Justified? Hmm. Ecoya will have to raise debt or go back to the market for more cash (unless Trilogy is an undisclosed cash machine). So there is a lot more ‘current’ risk associated with Ecoya. However, I would suggest that their model is easier, in that the high-end consumer products market is well proven, and the Ecoya board have a lot of experience (via 42below and the other board members) getting into that market.
So, although a much riskier current play, it looks like on pure revenue and model terms, Ecoya might be a reasonable bet. Oh yeah, if they can survive another year. Xero? At 10x Ecoyas valuation, the market sure does love Xero.
I love Xero too, but not so much at this valuation. I will be keeping a close eye on Ecoya, particularly with regards to cash flow over the next 6 months.
2011 is going to be an exciting/interesting year for both companies!
Xero – a great business?
The Xero share price has been rocketing up recently, making people a fair whack of paper money. Which is great, and why we invest in stocks right?
Right?
Well. Actually, not really. I know, the end goal is to make money. But I would submit that the “why” we invest is to actually own great companies at good valuations. Which end up making us lots of money, because they are great companies.
Why this definition? Well, many people in the stock market define winners as stocks where the price has gone up and up. As Xero has in recent months. Just like a rocketship after take off. So if you had bought at $0.75, and sold now at $2.68, you would have made a nice chunk of cash. But this is not how I invest (for better or worse!).
So Xero is a rocketship after take-off. My interest is whether Xero has enough gas to get out of orbit, and thats what is not clear to me now. I just can’t tell whether Xero is going to be a best-of-breed business, or a very successful company, or one of the also-rans in a highly competitive marketplace, or go bankrupt, or whether a big player will buy them out.
All of these scenarios are still on the table. My valuation of Xero portrays Xero as a ‘very successful’ company, with almost 2 million subscribers by 2018, and a ‘now’ shareprice around $3.75. Now, valuations can be wildly inaccurate, but they are a good ‘line-in-the-sand’ if you’re looking to work out whether a company will hit orbit. With the shareprice currently at $2.68… theres just not enough ‘up’ for me for all the risks still on the table.
So I’m watching Xero with interest. I suspect a buy-out might be the best outcome for Xero (and shareholders), but only time will tell.
Restaurant Brands, part 2…
Back to the beautiful world of deep fried chicken, with a serving of pizza, and a creamy coffee chocolate creme extravaganza!
So the first part of the story was just a simple look at how to identify a potentially undervalued company, in order to make yourself buckets of money which you can then use to buy buckets of deep fried chicken!
This second part goes more in-depth, and produces a snapshot image of the company, with a basic valuation. Heres the document, similar to the previous Michael Hill one, based on the Valueline reports produced by… well, Valueline, for US companies.
The big takeaways are that 1) the P/E is about ‘right’ for Restaurant Brands. 2) they have been increasing dividends fairly consistently after the Aussie Pizza Hut Debacle. and 3) margins are trending upwards, which is a sign that costs at Pizza Hut and Starbucks are under control.
An interesting aside is the treatment of leases. RBD obviously have some pretty big lease commitments, which are normally treated as an operating expense… But Damodaran argues that these should be treated as debt, because operating leases are much more like debt (in that if you don’t pay, really bad things happen to your company) than operating expenses. So I’ve broken these out and indicated that they are a form of debt.
So, my basic analysis indicates that Restaurant Brands is worth more. For people reasonably new to valuation, this is a pretty good example of a basic valuation. The “free cash flow” figure ($20,818,000) shows the money that the company gets every year. Assuming they keep making this forever, and pay off debt, how much is all those $20,000,000′s added up equal?
Obviously, a deep fried chicken coated in 11 different herbs and spices in the hand is worth 2 still clucking, so next years 20,000,000 is not worth as much as this years, and so on. The mechanics require a discount rate, which is makes next years (and the year after etc etc) 20,000,000 worth less. The discount rate chosen was 7.7% (PwC WACC), which includes 2% of growth (ie, rate of inflation, we assume that RBD can increase prices along with inflation). I suspect that the actual WACC should be a bit lower, which would increase the shareprice.
So finally, when all the mathmagic has been done, we get a share price of … $3.58! Current share price is $2.60, so RBD is sort of cheap according to me. The dividend is still around 4.8% which is pretty good for a stock with some potential upside. Rabobank are paying 5.3% for a 1yr term deposit, so at most you’re really risking 0.5%, and the KFC brand should see more boosting as the rest of the store upgrades start paying.
Let me know any comments, suggestions, corrections, blatant errors etc.
Disclosure: I sold out of RBD at $2.35, before I had done this valuation
xero half year earnings
Xero released half year earnings today, so I thought I should do an update. The numbers from the report:
| - Near tripling of half year operating revenues from $1.3m to $3.7m. |
| - Net loss of $4.7m – an increase of 24%, is expected to be the maximum |
| loss incurred as the company drives toward break-even. |
So that looks pretty good. It looks like they’re on track, although the increased loss, as expected, will make it interesting to hit breakeven, ie, EBIT = $0 by end of year 2011.
The previous model posted here looks good so far. The subscriber numbers are a bit lower than that forecast, but that suggests the revenue per subscriber is a bit below the $29 mark. Also, revenue numbers might be a little low, and expenses a little higher. But… not too bad for 6 months in the life of a rocketship!
Xero, spreading like a kiwifruit vine bacteria, taking over the world! (apologies to all kiwifruit farmers!). So… what to do? Does this change anything? For me, no. These results are good, but not spectacular, more or less what was expected/hoped. The Xero rocketship has cleared the launch-pad, hasn’t blown up spreading chunks across the landscape, and is pointing the right direction. These are all good things for a rocketship! There is a long way to go however to justify its current price (remember that Xero has made NO profit for owners, and has banked about $15 million in losses). Obviously the shares are up 5% in trading now, since the NZ market is pretty boring, and people need something to do.
PS. Don’t compare these results to last years results. Doing that for a startup is like comparing the altitude of a rocket before and after liftoff.
So, what to do? I would still suggest a part position, and waiting for the very big data points, namely annual results 2011, and annual results 2012. 2012 will be… huge.
Sure, it sounds like I’m being a wimp. And if Xero hits the afterburners, people who are in now will say “I knew it was going to work”, and “Greg, you’re a big, girly, wimpity-wuss”. But its my money, and I’m happy to miss out on the early upside and lock in (still significant) gains later in the piece when the clouds have cleared, and we know if Xero is going to the moon, or will be orbiting as a low flying satellite, posing a significant risk to adventurous birds.
how much is $25,000,000 worth?
Since no-one complained about me posting so much stock stuff, heres another! But first, a question:
How much would you pay for something that made you $25,000,000 each year?
Its not a trick question, but it is a pretty straightforward way of getting a quick feel for how much a company is worth (a trick I learned from Buffettology). The company in question here is… Restaurant Brands! Purveyors of fine dining experience, like KFC and Pizza Hut. And Starbucks for that frothed, ‘I can’t believe they call that coffee’ fizzy coffee flavoured beverages.
So Restaurant Brands are going through a super share-price ride at the moment. The best performing share on the NZ exchange. From about 60c in Feb 2009 to $2.85 today. Thats… well, thats a lot. If you bought $1000 worth of shares then, you would have approx $4500 now. Plus some pretty nice dividends on the way. A bank account paying 4% would have got you… a bit under $1070. Yay.
So, $2.85. Is that the top for Restaurant Brands?
Back to my original question: How much would you pay for $25,000,000?
RBD are expecting to make $25,000,000 in net profit. Assuming that you could put some money in the bank, and get $25,000,000 in interest, how much would you be prepared to put in?
Kiwibank just came out with this 5.00% sort of but not really on-call account. So 5% of whatever you put in is paid to you each year. To make $25,000,000 you would need to put in $500,000,000.
The point is: If you had the cash, and were happy with a 5% return, you would be prepared to buy RBD for $500 million… But right now, RBD can be bought, lock, chickens and deep-frying vat, for about $277 million. Which suggests that RBD is not as expensive as it might look at first glance.
Obviously this is a major simplification, with lots of assumptions. But all I’m saying, is… maybe theres a few more chickens to be hatched (and then killed, plucked, chopped-up, seasoned and deep fried) in the ol’ Colonels pantry yet.
Disclaimer: I do have some RBD stock in the portfolio. Yay fried chicken!
Michael Hill. Jeweller.
Greg Day. Part-time stock analyst.
Hmm, doesn’t really work. No panache. I don’t even really know what panache is, but I’m pretty sure my supply is low. Disclaimer up front, I own some Michael Hill shares, which I bought because they had been hammered during the financial crisis, so looked pretty cheap. And I liked what I read in Michael Hills book, Toughen Up. And the Michael Hill financial reports are amongst the best I’ve seen, very focussed on shareholders.
So, heres the analysis I have just done. Its pretty basic, summarises everything (based on what you get from ValueLine.com), and performs a simple (so simple I probably got it all wrong) discounted cash flow valuation.
Summary, Michael Hill is pretty cheap right now. According to me.
Let me know what you think, or if you’re sick of reading about stocks!
Oops! Don’t do valuations with a cold…
Oops! A bucketful of apologies…
After getting over my cold, and having a break from all the numbers, I revisited the spreadsheet on Xero just to check it. Something didn’t add up. Once I looked, it was pretty easy to spot what I had messed up. The ol’ terminal value calculation, a beginners mistake. I blame the snot jamming up my keyboard.
The terminal value calculation basically adds the bulk of the value to the company, because it factors in all the cash flows after the company hits profitability. Its a big number, but I originally had it calculated as EBIT(1-t)(1-reinvestment)…
Doh! Which is actually just the free cash flow figure for the last year… oops. Sorry about that. Note to self: don’t do valuations with a cold.
So there were 2 steps missing. 1. Work out the terminal value from that cash flow figure, and 2. Discount that terminal value back to present value, and add it into the cash flows to get the firm value.
Which means, long story short, that there is a big number missing from the valuation.
Since I’m in revision mode, lets ‘improve’ some of the other figures. Firstly, lets cut down the Operating Margin to more realistic 15%, putting it in line with the best of the current SaaS firms. And lets boost the Sales/Capital ratio, maxing it out to around 4, hopefully reflecting that SaaS firms have lower capital requirements.
The end result of these changes is an addition of another $200,000,000 to the value of the firm, which gives a per-share value of $3.55. Sorry!
This is a very sunny-side valuation,so everything going pretty much perfectly for Xero. But whats in a couple of hundred million? The things to really focus on with Xero are: Growth rate in revenues (ie, customers and revenue-per-customer) and operating margins. If customer numbers don’t grow as predicted, for example if customers are only half of predicted, then the today stock price comes down to the $1.20 level. If operating margins drop (ie, expenses involved in moving to new markets are higher than estimated), value similarly drops accordingly. And alternately, if they go up, the stock price should increase. Roll on next earnings report!
In summary, note to self: be careful when doing these things! This is my first public valuation, so it was bound to go wrong. Learning from mistakes is always a plan… Apologies again! I will be tracking Xero on my spreadsheet as new news comes out, which I’m pretty excited about! heres the link to the spreadsheet.
Xero valuation – the final(ish) chapter
Lets just recap where we’re at. We’ve got a spreadsheet (see the last blog post) which projects revenue, customer numbers and EBIT. Sweet. So what more is there?
Well, the point of these posts is to do a discounted cash flow(DCF) valuation on Xero. And a DCF valuation needs cash flows, and EBIT is not cash flows. Net profit isn’t cash flow either, so theres a bit more digging to be done.
So what is cash flow? And why is it different to net profit? And who really cares, just tell me what I should pay for a Xero share!
Net profit is revenue – expenses – tax – depn – interest. So that all makes sense right? Money coming in, costs of doing business (including depreciation) and interest on any loans. And of course, the inevitable tax consequences.
Its an interesting number. Kind of. In a “mm, thats very interesting, whats on TV?” kind of way.
But as owners of a company, we’re much more interested in cash. Cold, hard, cash. Or, not cold, flappy paper cash. Any kind of cash. More = better. This cash is what we get in the bank at the end of the year, which lets us buy cool stuff. Like iPads. And food. Net profit is a more… airy definition, and you definitely can’t eat it.
So we turn to Cash Flow. Cash flow is intended to take the net profit, and work out how many iPads you can actually buy at the end of the year. The most interesting cash flow number is free-cash-flow-to-the-firm (FCFF). What this says is, sure, you’ve got some operating cash flows, but I want to know how many damn iPads I can actually buy at the end of the year! Dammit! FCFF in particular deals with capital expenditures.
And Xero has nearly 2 million per year of capital expenditure, mainly capitalised development costs. So it is pretty significant to them.
The idea with capital expenditure is it is what you are reinvesting in the firm in order to grow it in the future. So next years revenues depend on previous years capital expenditure. So how much will Xero have to reinvest in order to grow like the previous posts predictions?
Actually, thats a big question, so should be in bold: how much will Xero have to reinvest in order to grow like the previous posts predictions? its big, because it is hard to tell. Theres not much data, so its very unclear.
So, another guess, the sales to capital ratio. How much do sales improve by reinvesting a dollar in capital expenditure? My guess looks like:
| Xero | Terminal year (2018) | 2017 | 2016 | 2015 | 2014 | 2013 | 2012 | 2011 | 2010 | 2009 | 2008 |
| Revenue from operations | $684,768 | $570,640 | $475,533 | $317,022 | $158,511 | $66,046 | $25,402 | $8,467 | $2,851 | $959 | $134 |
| EBIT | $171,191.92 | $142,659.93 | $118,883.28 | $57,063.97 | $23,776.66 | $7,925.55 | $1,016.10 | $0 | -8450 | -6751 | -4310 |
| Change in revenue | $95,107 | $158,511 | $158,511 | $92,465 | $40,644 | $16,935 | $5,616 | $1,892 | $825 | ||
| sales to capital ratio | 1.60 | 1.80 | 2.00 | 2.50 | 2.00 | 1.75 | 1.50 | 1.08 | 0.59 | ||
| Reinvestment (capitalised development costs) | $59,442 | $88,062 | $79,256 | $36,986 | $20,322 | $9,677 | $3,744 | $1,749 | $1,397 | ||
| Reinvestment (as percentage of revenue – interest only) | 10.42% | 18.52% | 25.00% | 23.33% | 30.77% | 38.10% | 44.22% | 61.35% | 145.67% |
The important line is the Sales To Capital Ratio line. This reflects my thoughts that SaaS systems take a chunk of capital expenditure, particularly when moving into new markets (eg: US), and that this will continue for the next 8 years. Putting these values up, ie, for every dollar of capital reinvestment, you get X dollars back in revenue in the next year, will obviously make Xeros valuation higher.
I’ve also estimated a stable reinvestment rate as a percentage of revenue of 10%, which is more or less in line with other internet companies. If anything, I think this number will be higher.
Theres a couple of other numbers that are needed before the final valuation. Beta, or the measure of the firms risk. I have started at 2.5 to reflect the significant risk with Xero initially, and decreased to 1.4 in 2017. It sounds about right. Risk free rate of 5.5% and a equity risk premium of 5%. Sounds pretty reasonable to me, but more guesses!
Ok. Phew. Damn this is a lot of work. Cutting a long story short, finally, how much is a Xero share worth, right now?!?
$1.12
And, according to me, thats a reasonably sunny outlook. Not blow you away stunning, but reasonably optimistic. I’ll put the spreadsheet up on google apps now, so you can have a play.
Xero 2-2: Guesstimates
So now we get to it, the guestimation. I’ve put in some educated *cough* numbers. You can tell these figures are 100% bang on the money because they have 2 decimal places attached. Sure fire way to ensure accuracy!
The actual live spreadsheet is up on google docs, so feel free to have a play (only change the numbers in blue). If you think I’ve made mistakes (which I probably have, this is hard and I have a cold), let me know in comments, and I’ll sort it out. Also, if you want me to change any of the numbers, tell me why and we’ll let everyone fight it out.
So some comments on what I tried to do:
- Note that the 2014 revenue and customer numbers are about the high-end of Xeros ‘potential customers’ from Rod Drurys AGM presentation
- The breakeven point is placed at second half 2011 (more or less – the march 2011 EBIT figure is close) so assumes Xero hits their predictions exactly
- [1] Intuit have yearly revenue of around $500millionUSD from QuickBooks. Note:Intuit is not SaaS but this seems a nice figure in 7 years
- [2] The operating margin for these kinds of companies seems to end around 25% so am letting Xero max out reasonably early
| Xero | 3/31/2017 | 3/31/2016 | 3/31/2015 | 3/31/2014 | 3/31/2013 | 3/31/2012 | 3/31/2011 | 3/31/2010 | 3/31/2009 | 3/31/2008 |
| Revenue from operations [1] | $526,022 | $438,352 | $292,234 | $146,117 | $66,417 | $25,545 | $9,123 | $2,851 | $959 | $134 |
| Guesstimate – Operating revenue growth rate | 20.00% | 50.00% | 100.00% | 120.00% | 160.00% | 180.00% | 220.00% | 197.29% | 615.67% | |
| Average customers @$29 – this is just an interest number | 1,511,557 | 1,259,631 | 839,754 | 419,877 | 190,853 | 73,405 | 26,216 | 8,193 | 2,756 | 385 |
| Average customers @$40 | 1,095,879 | 913,232 | 608,822 | 304,411 | 138,369 | 53,219 | 19,007 | 5,940 | 1,998 | 279 |
| Guesstimate – operating margin [2] | 25.00% | 25.00% | 18.00% | 15.00% | 12.00% | 4.00% | -20.00% | -296.39% | -703.96% | -3,216.42% |
| EBIT | $131,505.45 | $109,587.88 | $52,602.18 | $21,917.58 | $7,970.03 | $1,021.80 | -$1,825 | -8450 | -6751 | -4310 |
| Net operating loss at beginning of year | $0.00 | $0.00 | $0.00 | -$12,343.81 | -$20,313.84 | -$21,335.64 | -$19,511.00 | -$11,061.00 | -$4,310.00 | |
| Taxable income after tax write-off | $131,505.45 | $109,587.88 | $52,602.18 | $9,573.76 | 0% | 0% | 0% | 0% | 0% | 0% |
| Tax paid | $39,452 | $32,876 | $15,781 | $2,872 | $0 | $0 | $0 | $0 | $0 | $0 |
| Effective tax rate | 30.00% | 30.00% | 30.00% | 13.10% | ||||||
| Company tax rate | 30% |
So there it is, the first table of guesses for Xero, the 500million company! Let me know what you think.
Xero valuation part 2-1: Revenue
In part 1, we looked at a sanity check type valuation for Xero, the most exciting company on the NZ sharemarket. Xero does SaaS accounting, and their software rocks. And, world domination is the goal. I like that.
But whats a share worth?
In this part of the valuation, we need to start looking at projections. In particular, revenue projections. What is Xero going to earn in the future? Who the hell knows? Well, no-one really knows, but we will try and do a best guess exercise to find out.
The first step, particularly with fast-growing companies is: get the most recent data you can. The latest annual report came out in June 2010, and covers the period up to March 31, 2010. Which is cool. Or would be if it wasn’t bloody July! But at this point, its the best we can do. I firmly believe the next 6 month report, due I think in December, will be a crucial data-point in Xeros history, so we will revisit this valuation again then.
Revenue
One of the keys for valuing startups is… pretty obviously, working out how much revenue they are going to get in. This is hard. But there are some pretty key things to keep in mind:
- What do past growth rates look like?
- Size and growth rate in target market?
- Competitive advantages
Past growth rates. The tendency is, as startup companies gobble up all the low-hanging fruit (which is probably NZ for Xero), revenue growth rates begin to tail off. And we have seen some evidence of this at Xero, where revenue from ops looks like:
| 2010 | 2009 | 2008 | |
| Revenue from ops | 2851 | 959 | 134 |
| Growth rate | 197% | 615% |
so… hmm. Ok, theres only a couple of data points, but the trend line looks unhealthy. Mark as a fail. But thats why I think the next 6 month report will be fascinating. But anyway, 200% is still nothing to sneeze at, because as revenues increase, the compounding effect of those multipliers gets big. So its not just the growth rate thats interesting, but how long Xero will be able to maintain those rates. The key for Xero is, how long before it runs out of cash?
Size and growth in target market
This one is difficult to estimate. The size of the market is enormous, since every SME needs to do its books somehow. Growth in the market? This is probably best estimated by viewing growth in Xeros competitors. MYOB is the main one that springs to mind, but unfortunately has been delisted, so details are scarce. So lets look at Intuit in the US for some growth figures. Unfortunately, Intuit is a bit of a different beast than Xero, in that it gets revenue from several different sources, including payroll and payments applications, tax, and a few other things I don’t really get. But a reasonable chunk just comes from QuickBooks, which is basically playing in the same sand pit as Xero, so I’m going with that.
| Q1 ’09 | Q2 ’09 | Q3 ’09 | Q4 ’09 | Full Year 09 | Q1 ’10 | Q2 ’10 | Q3 ’10 | Q4 ’10 | Full year ’10 |
| % change YOY | 7% | (1%) | (9%) | (5%) | (2%) | (7%) | (3%) | 16% | 2% |
Hmm. So thats about as clear as mud. No idea what happened in Q4 ’10, but I think the story here is that there is not a huge amount of growth happening in the market as a whole, at least from the Quickbooks example. Maybe there are other players growing fast, but… mark that a fail.
Competitive advantage
Theres not too much doubt that Xero is the coolest piece of accounting software around, and it would be (and is) difficult for competitors to move into this space. People think that you just need to chuck up a few servers and a web-page, and its all done, but the high-volume SaaS space does not work that way. The difference between a crap piece of software and a user-friendly loved product can be very subtle. And I think Xero have done an excellent job.
So there is some competitive advantage there. But that assumes that you are in the market to ‘buy’ accounting software. Everyone who currently needs one has some form of solution to this problem, so there is a built in anti-competitive advantage for Xero, namely resistance to change. So each sale has to be earned.
Summary
So what have we learned? Well, we’ve learned that the market for accounting software is probably not booming, Xeros revenue growth is trending down with no big markets coming on board in the near future, and that, while some competitive advantage exists simply because Xero is excellent, making new sales is probably pretty hard.
Its not a great story so far for Xero. In the next section, I’ll stuff some arbitrary revenue numbers into a completely falsified spreadsheet, add a couple of decimal places to everything, and pretend the revenue projections obtained are as factual as a Oprah show. And probably start to look at operating margin. Which, while not the mostest fun you’ll ever have, is at least better than a root canal.
Xero valuation – part 1
So went off to the Xero AGM the other day. For those who don’t know, Xero is a online accounting system, SaaS stuff, and generally most excellent. Its basically the most interesting company on the NZ stockmarket, given that it is operating in a global market, and with massive potential for growth.
Its an awesome example of … dreaming big from NZ. This is the kind of thinking that NZ needs. So I have super-high expectations for Xero.
But… what is Xero worth? Someone asked me whether Xero was a good buy and I went… hmm. I love the story, but do I love it at this price?
So I thought I would do an investigation and attempt a valuation on Xero, to answer this question and to practice. This is part 1, which is a super simple look at the business of Xero, and perform a basic sanity check valuation.
Summary of Xero: SaaS accounting business, revenue from user subscriptions per month.
Assumed numbers:
- 20,000 -number of current subscribers. The annual report says 17,000 but I vaguely remember the 20,000 figure from the AGM.
- $40 – average revenue per month per user (ARPU). Probably pretty generous, since I imagine a lot of users are on the lowest price point ($29/month).
- $1.59 - current share price
- 83,455,000 – Weighted average shares
- $130,000,000 -current market capitalisation, probably a little on the low side
So thats pretty basic. 20,000 subscribers, each paying $40 per month, so $800,000 per month revenue. This value is forward looking so, if we stop customer growth from now on, this is how much revenue would be received. So what does that mean?
To work this out, remember that $40 today is worth more than $40 in a month, because of inflation and opportunity cost. So to work out the present value of the monthly income from subscribers, we need a discount rate. This number is a bit arbitrary, and can be calculated a lot of different ways, but its meant to reflect the risk free rate, ie, if you stuck the money in the bank (and the bank didnt go bust!), plus a bit because stocks and companies are risky. So, I’m going for a risk free rate of 5.5% and a extra risk bit of 4.5%. Which all is obviously a complicated way of saying 10%!
I’m going to look at a subscriber staying with Xero for 5 years. Why five? Simply because 5 years is quite a long time in internet world. I might look at a 10 year period too, just to see. So, lets work out how much those future cashflows are worth to us now:
Present value of 1 person paying us $40/month for 5 years: $1,898.30
which is obviously less than $40*12*5 ($2400) which reflects the discount rate.
So each current subscriber, assuming they stay with Xero for 5 years, is worth $1900 to Xero. Now, if we look at Xeros market capitalisation, $130 million, and divide that by the number of subscribers (20,000) we get a market cap per subscriber of : $6500
Therefore, if you bought the whole company now, you’d be paying $6500 in order to get $1900 back over 5 years.
Which is completely whacked out, padded-cell, rubber spoon, straight-jacketed, 2 eggs short of a dozen nuts. So, whats wrong here? Why is Xero priced so much higher? Answer: growth and estimated market, and… risk.
But this is a warning sign. When the current valuation per subscriber is so much off the revenue that subscriber will generate… theres potentially an issue here. Bear in mind valuing early stage companies is … hard.
Let me know if I got anything wrong, which is highly likely, and any questions/thoughts. In part 2 (and maybe 3-10!) I’ll go through a more detailed evaluation of Xero.
Appendix:
Present value calculation is : =PV(0.83% (ie, 10%/12),60 months,$40/mth, beginning)
iPad rocks!
so, the iPad. Everyone has an opinion, and since I have an opinion on everything, even new technological tools I havent even seen, I should write a post.
My prediction: Another win for Apple, it might be a bit of a sleeper, like those damn commie agents during the cold war. Sure, theres things missing, namely a web-cam and a SD-card slot. These are the big omissions I think. And the geek boyz will whine about things like multitasking (lack of), and no flash. My responses, I couldn’t care less about multitasking, similarly to how I don’t care about multitasking on my iphone. Flash is rubbish, and its been in Apples sights for a while now. I think the iPad is the final nail in the coffin for Flash. RIP.
Version 2 of the iPad will solve all these issues (without the flash), and Apple will completely take over the sub-$1000NZD network market. The iPhone and iPad are computing done right, people are looking for simplicity and function, and Apple are the only company delivering at this point. Very nice.
Disclosure: I own Apple stock…
Apple 3rd quarter earnings…
Apple have just released their eagerly awaited 1st quarter 2010 earnings. Pretty exciting stuff!
Its kind of exciting
By any accounts, Apple had (another) pretty stunning quarter. Sure, coming out of the recession we were bound to see a pickup. But, net income for the entire 2008 year (ended Sept 2009) was 8.2 billion dollars. The net income for the 1st quarter 2010 was 3.4 billion. So in 1 quarter, Apple produced 41% of their previous years income. Thats pretty good, even if 2009 was a ‘bad’ year (which it really wasn’t).
(note: these figures are those using the new accounting practice for IPhone and Apple TV, so the 2008 year will differ considerably from that in the 2009 annual report).
Mac sales continue to increase (cos macs are cool!), but surprisingly, their desktop sales rocketed. ITunes is contributing around 1.1 billion, which is up 10% across the dec quarter. I would have hoped for a bit better there, since I see Itunes as one of their big growth areas – particularly due to iphone sales, but maybe I’m being greedy. The mighty IPhone (which is actually much better than you might have expected), contributed 5.6 billion, compared to 13billion for full year 2009, or this quarter produced ~40% of the last years entire iphone contribution. Very surprisingly, IPod sales were stable compared to the dec 2008 quarter, around 3 billion. Who needs an IPod when you have an IPhone?
But the IPod touch is a Iphone without the phone, so I’m guessing plenty of people are buying the touch. And, if you add skype, your touch becomes a phone.
I’m not quoting a target price for Apple, since I’m not that far through my valuation book! But if you take their earnings per share in the quarter of $3.67, annualise it by x4 (silly because december is the xmas quarter) and round it ridiculously, you get about $14 per share. How much would you pay for something that earns you $14 per year? Or to put it another way, how much would you have to invest to earn $14 per year? BNZ are quoting 4.8% on their term deposit, which means (ignoring taxes) that you’d need to invest $281 to earn $14 in interest. So, as a completely whacked out price guide that I think errs towards conservatism… $200-$300!
flames welcome!
No Gordon, Greed is NOT good
As I’ve taken a more intimate interest in stock picking and trading, I’ve noticed something that I’ve never really experienced before. A sense of… greed.
For example, one of my stocks has been improving recently. So I feel this urge to put more money into that stock so I “don’t miss out!”. Pure simple greed. I have overseas shares, and I feel an urge to time the exchange rate fluctuations (ignoring the fact that I have no idea what the exchange rate will do!) to make more money. I recently sold Xero shares on the assumption that they would go out to the market to raise more capital, diluting the current shareholder base substantially and thus devaluing the shares. Now, Xero have gone to the market, they have devalued the share base, but the shares have shot up about 40%. I feel an urge to buy more Xero shares to not miss out! Even though rationally, I have little idea other than speculation why the shares have appreciated so much.
Pure, simple, unadulterated greed. I find it fascinating that it appears to be a very base emotional response. Now I’m very aware of it, so my rational mind can (most times!) crush it, but I never realised it is such a fundamental part of me. And I’m guessing I’m not alone…
xero comments
Kelvin has an excellent commentary on Xero, NZs own online accounting provider. I suspect Xero will have some very big problems this financial year, but all power to them! My major concern is simply the burn rate, and the fact that the Xero model relies on SMEs and SME accounting service providers converting to Xero. This appears to me to be a low speed model of acquiring customers, basically organic growth. Now this strategy is fine, if you have enough money to survive until customer numbers reach breakeven point. My suspicion is Xero doesn’t.
Xero is awesome. Its a fantastic piece of software, super-easy and very useful, and everyone should be using it. I just hope Xero has enough time to enlighten the world to its superiority.
