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.

xero half year earnings

13 thoughts on “xero half year earnings

  1. eugenio says:

    thanks for publishing your thoughts.

    Though financials were broadly in-line, I was underwhelmed by the uptake rate in monthly new paying customers. During the whole six month period it seems to have remained fairly stagnant at around 1,600 adds per month. We know this was approximately the rate of adds for the first three months, and it doesn’t appear to have increased significantly in the last three months. Perhaps this has to do with delays in implementing bank feeds.

    In my opinion it will be critical to see that there is a meaningful month-on-month rate of increase in paying customer adds. Based on my calculations, the monthly adds need to reach *at least* 2,500 by the period ending MAR-11 and at least 3,500 by the period ending SEP-11 to make the growth trajectory of XERO more compelling (assuming stable ARPU, which may be a leap of faith). If I felt that this rate of adds could be doubled with a halving of ARPU I would take it – presumably this will be something XERO managemnt will also be carefully studying.

    In my opinion, the current valuation makes this company indigestible as a potential M&A play, so the only exit I see at the moment is from genuine robust organic growth. We need to see customer adds growing incrementally, and I’m not even too fussed about which geography this happens in (the question is whether failure to capture a niche in America equals failure for this investment story. In a SAAP world, perhaps…).

    Thanks again for having shared your thoughts. Would be interesting in hearing your thoughts regarding my key concern.

  2. Hi Eugenio
    Thats a good point re: adds per month. For me, Xeros biggest issue is that they are selling a better mousetrap, and everyone already has a mousetrap. So I suspect that is why adds per month may be reasonably static.

    ARPU is under the ‘going’ rates as far as I can figure, I’m assuming that Xero is accepting lower rates because of partners taking a cut and also to achieve lock-in. I agree, customer numbers is what counts in this game, and the 2011-2012 year is going to be key. Although the percentages are the same, theres a big difference between jumping from 8000 users to 27000 users, and then going from 27000 to 80000.

    So completely agree. Those adds per month have to go up significantly for Xero to hit rocketship potential. Because I haven’t seen it, I’m sitting on the sidelines on this one, at least until 2011 results come out.

  3. Mike Porter says:

    Eugenio, Greg et al
    Everyone is valuing Xero on different mathematical models, based on early stage growth trajectories.
    My own musings as a qualified CA myself, and at present I’m a CFO it’s intriguing looking at the present value of revenue cash flows.
    Though stepping back, the product itself is simply the best accounting SASS on the market. Significantly ahead of it’s competitors (with substantial continued product development keeping a clear and actually a growing gap). The SASS model makes far too much sense for small accounting practices not to drive the client change, this will continue to happen no question. I do believe Xero is on course for a global growth level, it will ultimately be targeting millions of clients. I would place a value on Xero based on a multiple of 10-20 times revenues (not earnings) – the market will be that simplistic. Not many are out there predicting this result. But there are no reasons why they can’t multiply their current users by 20-50…100 (include US)
    Old colleagues in the UK were waiting for the bank feeds to go live prior to recommending it to their clients. The market size / potential is clearly a high multiple over nz (20times) and like wise Australia. Xero will shortly reach a slow snow ball effect. Not as fast as facebook/google, customers are stickier (which in the long term will protect the value)… it is the best product in this space. full stop. The Yodlee break through will allow a replication of NZ growth within both Australiana and UK market. Xero has a rare combination of an extremely well marketed, funded and market leading product, it has an evolving sales strategy embedding the product through accounting partnerships. The execution to date has been astonishing (IMHO). It’s found itself a niche sector and put material money/product investment betting on the SASS revolution.
    The Corporates in the sector Sage / MYOB should be beating down the door to buy even at the current market cap. These guys want to go all the way themselves and they have a head start and a shortly to be released referral program – turn your 30,000 plus clients into sales people and watch the customer growth rate rapidly increase. Free solutions? – lower cost will be available, but almost all SME’s i know would rather pay $500-600 per annum for the best product for their business.
    So… 1 million customers. 15 million monthly revenue (assume price cutting erodes av $ per user and a referral scheme offers further user discounts) $180M t/over – say $200m, 2 bn market cap, 10 times current share price. I’d beleive they’d then push on to a new target of 10m users. then the valuation model would reduce, but market cap would be astonishing.
    There’s my panglossian view ! If you’re waiting for a year to invest, you could invest some now, and hedge the position. The downside is probably 60 % reduction, the upside…

  4. Thanks for the comment Mike. I agree you should probably have exposure to Xero, but its far from a done deal. Its a big potential market, sure, and Xero AFAIK are executing brilliantly. But the big data points (lots of growth in UK and US) are still coming.

    Also as I pointed out before, SaaS is still not a proven money-spinner. Although SalesForce et al have great valuations, their margins etc show them not to be great businesses. Can Xero buck this trend? I sure hope so!

    On another note, I’ve owned stocks that have been multi-baggers, and its great!. But, I’m also very happy to have a stock double in price!

    So I have no problem waiting to buy Xero at $5 per share, if I am very confident it will be hitting $10 per share. I’ve learned not to beat myself up about ‘missing out’, and focus on what is likely to occur. At the moment, theres a lot of pressures, which may or may not result in the Xero rocketship hitting orbit.

    Intuit et al should probably buy Xero, but perhaps they believe the competitive advantage is not there? Get some hotshot designers to redesign their systems and maybe its a simply upgrade procedure from Quicken to Quicken online? How confident are you in the moat that Xero has?

  5. Mike Porter says:

    Greg, you might be able to answer that question better than I? Given your software background. But these are my own musings.

    I do believe that engineering a program to Xero’s specifications is not a moment in time, there’s no quick fix or even a medium term fix, grab some talented people and replicate. It’s taken a substantial development team multiple years to get to this current product. Existing established (non SASS based) competitors do not have a development team dedicated to a SASS model (Intuit, Sage MYOB) not on the scale of Xero’s team….
    So they have to recruit, design, roll out and Xero isn’t standing still in the mean time. They have to change their entire profit retention and development model. Rod has referred to this a number of times, and it makes sense. The corporate oil tankers take a while to turn around. Acquisition for these corporates would be the obvious leap frog forward. Kashflow or the like. As for how they deal with their existing customers, I imagine it’s a nightmare trying to create a brand new model in SASS and data migrate from desktop applications. Not without changing the SASS reciptical and making compromises… so you just create a new product and talk your existing clients through the change… accept they don’t talk to their clients, the accountants DO. And they won’t be loyal, but will go with the best alternate product….

    All this I hope will create enough time for XERO to build a global brand and stay ahead of the curve. That’s the moat. I have worked in IT companies in my finance capacity and have seen software development cycles targeted at 1 year take 3 years. I believe Xero have a development cycle and program designed to keep the draw bridge up, and the moat is getting wider and deeper with every monthly release.

    I believe Xero is better placed and not as easy to leap frog as some are concerned about. Yodlee is perhaps the weakest link in the chain, though i look forward to main stream banks letting direct access occur once the customer base reaches a critical mass.

    I agree, it’s not a done deal, i do believe 30,000 users already mitigates a substantial part of the risk. I don’t believe Xero should work on achieving break even next year, but should be working hard on an expanded sales model to market share grab while they have a clear competitive advantage. if they have global aspirations, then why worry about b/even… very glad to see the Amercian investment and therefore that strategy in play.

  6. eugenio says:

    Hello Mike and Greg,

    Thanks for keeping the discussion going.

    It will be critical to see all of XERO’s impressive attributes translate into a robust rate of growth in customer additions. The rate of growth in the last reporting period appears to have been weak (delay in bank feeds?, initially poor UK execution?). The bottom line is to see a significant pick-up in rate of customer additions, even if this comes at the expense of ARPU.

    XERO’s public listing I would think is a double-edged sword. The listing provides attractive and inexpensive currency with which to pay employees (so long as morale and the stock price stays on the up and up). Some customers may also take comfort in the corporate governance check-marks that a public listing affords as well as XERO’s decent balance sheet situation given its stage of development. However the listing also creates an M&A valuation bench-mark, which at current prices, seems to be a bit rich – this could complicate an acquisition and even the valuation for follow-on funding.

  7. Mike Porter says:

    Welcome back Eugenio

    I think partly the bank feed, HSBC only feeds didn’t deliver a convincing story in the UK.
    We should see a rapid advance in the rate of growth both in Australia and UK following Yodlee integration. It’s the single biggest USP and a game changer for Xero. Word will spread.

    Further DD done by any UK accounting firm prior to making a client recommendation should now provide a green light.

    UK – from what I hear from ex colleagues and from what i can glean has been well executed to date. It has been seeded/set up ready for transition from innovators to early adopters and so forth.

    Eugenio, i’m not sure the public listing will be a barrier to further growth (or funding concerns). Given that cash break even is only a number of months away, other debt instruments could be utilised to accelerate expansion plans. Plus I believe the public listing serves nicely to protect the long term interests of initial shareholders who are looking for a prolonged global strategy and not an early sell out. The market has priced the latter out.

    I agree totally about the staff retention/reward tool of the share options. Ideal for the first few years. I’m hoping it’ll provide a real draw for some exceptional silicone valley talent. XERO’s a compelling story for key executive US talent. That and the ‘name’ US investor.

    SP … it’s certainly interesting that 2c + might be a new level.

    Enjoying watching the strategy evolve and play out, there’s sure to be some very interesting corporate jostling.

    Interesting that Craig Wrinkler put a $20m bet on Xero… who’s the best placed Australasian investor to make an assessment of Xero’s potential, I doubt he thought it was a 1 in 10….. on paper he’s doing rather well.

  8. @Mike re: technical moat. My feeling is the technical moat of most technical stocks is actually very underrated. And I think Xero have done such an excellent job, the moat is actually quite substantial.

    But, the question is, how much does the technical moat count? There are other services doing the same thing as Xero, with plenty of cash. And once a client has bought the product, I can’t see them changing easily.

    So, its a race. Who signs the customer up first. Not so much about ‘best’, or ‘easiest’. Just … first.

    And thats the case that hasn’t been proved in Xeros big markets so thats what I’m waiting for. The stock price has rocketed up recently, seemingly fueled by confirmation of some numbers that were announced at the AGM, and a speculative investment by a large VC. But it is fun to watch!

    I’ll stay on the sidelines until 2011, or they hit ~80-100K users with traction in the US. At the moment, theres a bit too much enthusiasm around for my liking, but… go Xero! NZ to the world!

  9. Vince says:

    One key issue missing from this discussion is the continuing downward pressure on price in the SaaS accounting market. In Xero’s IPO they were targeting $75 per month.They then launched at $49 per month. They then launched restricted versions at lower price points and various discounts are available for purchase via partner accountants. The downward trend is very clear.


    Because their competitors are also dropping prices. For example in Australia (Saasu and MYOB) have launched competitive offerings at even lower price points than Xero.

    This is a natural and irresistible outcome of the SaaS business model. In the wake of Facebook everyone thinks customer numbers is the vital factor. As the competition is fierce (there are at least 50 companies doing what Xero does) and the costs of each new customer to the SaaS business are minimal SaaS businesses respond by dropping prices to try and get more customers.

    We’re seeing this internationally with the launch of even cheaper or even free online accounting products.

    The question is not whether Xero is the best accounting product. Rather, it is whether Xero has a business model that will ever deliver a return on the $25m+ already burnt when its revenue model is under continual downward pressure. Ultimately ROI is what determines the success of a business, not customer numbers. And while cashflow breakeven may occur in 2011, Xero is a long way from generating any meaningful ROI.

    For now, I’m like Greg – cautious about Xero’s prospects. This is a very competitive market. There will be a lot of losers and very few winners. Most of those 50+ companies I mentioned won’t make it. Don’t be surprised if it turns out the ultimate winners in this market are the incumbents such as Sage, MYOB and Intuit (Quickbooks). They have the deepest pockets of all.

  10. Hi Vince

    Very good point re: downward price pressure, I had forgotten about the initial $75/month target, not a great sign, although there may be possibilities of upselling if they get enough customers.

    The valuation I did has a very sunny-side current valuation of $3.83, still somewhat above the current market price. But assuming everything goes right for Xero and they hit 2,000,000 users in 2018, the valuation is only 70% above the current price.

    To me, thats too expensive for the stage the company is at. I want a chance at a multi-bagger for this much risk, and I don’t see that here. So I will stay out for now, but keeping watch closely!

  11. Mike Porter says:

    Greg, Vince, Eugenio
    Any thoughts on the recent share price rises. At time of writing current price $2.60.
    Seems little to support it in the current domain…
    Yodlee feeds aside. Rumours?

    1. eugenio says:

      Hello Mike,

      I don’t know exactly what is driving demand, but fair to say Xero stock is currently on an emotional upswing following recent news (potentially value-add investor, bank feeds..). Time will tell whether this price trajectory is in line with underlying performance (it could be… until figures are published only insiders would know).

      In the meantime, it’s worth remembering that Xero stock is highly illiquid. I.e., a small magnitude of buying (or selling) can cause big swings in price. From the perspective of most mid (or even small) sized funds, the stock does not have sufficient liquidity to even consider a purchase, as there’s a high risk that if an exit were necessary, it would be impossible to accomplish without significantly disrupting the share price. Although it’s a listed company, for all practical purposes this is still very much a “venture capital” investment proposal.

      Therefore, in my analysis, I give minimal importance to share price movements. All I care about is whether the current price can tie-in to my projected valuation estimate. It’s currently way-off the mark, but robust changes in the growth rate of customer additions could quickly alter my opinion.

  12. Hi guys

    Yes, have been watching it, up 5% today on no news. 27 trades, $108K worth of shares so its fairly widespread. Be interesting if there is some news tomorrow.

    Theres certainly an upward trend, but I don’t really see any justification. Xero to me is highly priced for a very speculative stock, in a tough market without any sort of network effect that I can see.

    So I’m ignoring this from a practical point of view. Perhaps someone is buying Xero shares for christmas presents?


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