Xero Analysis

Xero has had a lot of media coverage in last couple of months.

They have announced a big capital raising and a number of new marketing partnerships, won some prestigious awards, and most importantly have signed up lots of new paying customers.

So, is now a good time to buy some shares?

Last week they announced that 70% of existing shareholders decided to buy some more in the recently completed round, at 90c per share (the market price as I type is $1.30).

Despite all that has been written there has been very little independent analysis of the company and its prospects. It’s been difficult for me to find information to point people at when I’ve been asked about this. So, I’m pleased to see the analysis that Sam Stewart has published on his blog.

As Sam correctly points out the key numbers to keep an eye on are:

  1. Average Revenue Per User (APRU), or how much the company earns from each customer (currently this is ~$33 per month).
  2. Operating Expenses, or how much the company spends to run the business (in 2008/09 this was $8.3 million, but this will increase as they hire more staff).

Depending on what you think will happen to these two numbers in the future you can can calculate how many customers you think they would need to break even. Or, looking even further ahead, to provide a return sufficient to compensate investors for the risk they are taking by investing at this early stage.

Sam thinks the first magic number is 28,000 customers (they currently have 7,500). But, there are lots of variables and assumptions, so I’d encourage you to read his post and play with the spreadsheet he has put together and form your own opinions.

The general advise to anybody who is investing in risky early-stage ventures like Xero, or thinking about it, is this:

There is a chance that the company will one day be worth a lot more than it is today. And, there is a chance it won’t. Make sure you are comfortable with either outcome.

What do you think?

For the sake of full disclosure: I am a shareholder in Xero. I was not part of the recent capital raising, but I did subscribe for the maximum number of shares available to me under the share purchase plan. I also worked at Xero from May 2007 until February 2008, but I no longer have any day-to-day role in the business. Naturally, as both a shareholder and interested observer, I continue to hope that they are able to build a significant and profitable business.

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5 comments on “Xero Analysis

  1. These guys have a long runway of cash to last them a couple of years so they can grow. But to get that cash, shareholders who bought in 3 months or more ago, (from what I understand) now have less equity in the business than they did before.

    Personally I think the share price will come down again as everyone begins to realise that they are long way off profitability, but in saying that… I really do think that Xero will pull it off.

    Ten years from now, when everyone will apparently be working in the clouds, Xero will be one of the world leaders. How else could you explain Mr MYOB buying in so early.

    So in essence…. if you can buy into the business now when the share price is low with the mindset that its a 10 year pay-off, then it could be a good buy.

    However, I would expect that in 10 years, your equity will be a lot less than what it is now as more capital raising will be required.

    This investment could come down to a coin toss.

  2. emissive says:

    It’s great someone has pointed out ARPU is a primary driver for Xero. That is one area Xero has been very quiet about of late.

    However, with this and with the November valuecruncher analysis, they both assume the number of outstanding shares on issue will remain the same. I think this is unlikely and the Valuecruncher analysis is already proven wrong. So?

    Xero only has 2 years worth of cash. Costs will increase for servicing more customers and customer acquisition further increases marketing costs and cash burn. Then there is the US banking system.

    A major point of difference with Xero is getting the bank data into the product. The US banking system for SME’s relies on small, local banks not big banks with national tentacles like the UK, NZ and Australia.

    Unless they have a cunning plan, entry will be slower than anticipated with a lot more development for Xero to accomplish a substantial market entry. They may need more cash to achieve this. More equity raised means issuing more shares.

    So back to the model. With, say 120 million shares on issue, they need another 80K customers and $25m revenue in 2014. This achieves the $100m in enterprise value required to get a simlar shareholder value to this analysis. That’s a big ask.

    It would be good for Xero to front up on their intentions in this area or say whether they have all the cash they need to meet their projections.

  3. Ben Kepes says:

    Great post Rowan (and fantastic analysis from Sam) – for some reason I’ve only just caught up on it now – despite watching Xero pretty intently and commenting on them frequently, I’ve purposely avoided making much comment on the company from an investment perspective – partly because I’m more interested in the product part of the discussion, partly because financial analysis isn’t my forte and partly because there are so many factors here beyond costs and ARPU (well – factors that impact on these indirectly but that are external). The competitive landscape and their differing georgraphical approaches towards a go-to-market all have an impact on their own bottom line.

    I’m not completely convinced however that the ARPU/OPEX discussion really speaks to the potential here – quite simply Craig WInkler (founder of MYOB) is no fool and I’d be surprised if he invested based on a projection of future dividend yield – one only needs to look at marketplace changes (Microsoft have just dropped their Money product, the large incumbents seem unable or unwilling to innovate and “the long tail” makes the playing field way more complex)to predict that the win in this instance will be via acquisition rather than yield…

    • Granted any analysis like this is somewhat simplistic – otherwise it would be like asking for a 1:1 scale map!

      But, I’m interested to know … if it wasn’t future dividend yield that convinced Craig Winkler to invest, what was it? Perhaps you’re right and he was investing on the assumption that somebody with deep pockets will come along and buy the company, but then what basis will they use (if not future dividend yield)?

      In the end it all boils down to that one way or another doesn’t it?

  4. Ben Kepes says:

    If my hunch is right, those with the deep pockets (and this is total assumption, no inside knowledge whatsoever) will see the acquisition as being complementary to their existing product offering both from a consumer facing perspective, and also from a technology perspective. As such it’ll be a strategic acquisition and hence not specifically related to yield. Or in other words… there is a potential here for a synergistic revenue yield far greater than that of Xero on it’s own…

    hmmmmm…..

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