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.
- 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.
Present value calculation is : =PV(0.83% (ie, 10%/12),60 months,$40/mth, beginning)