The company, which has around 140,000 paying customers globally and is yet to turn a profit, is now valued at close to $1.5 billion.
This is a staggering achievement and something I wanted to dive into a little.
But first a bit of a disclaimer, as a proud New Zealand, I’m happy for what Xero has achieved, it’s great for the investors but, more importantly, it’s great for New Zealand as a whole. With the market cap as it stands, CEO and founder Rod Drury looks likely to achieve his three stated aims; to build a billion dollar business from the beach, to achieve an exit at a higher price tag than that which TradeMe achieved and to personally achieve his aim of being able to afford a private jet. Personal ambitions aside, it’s time to noodle on the share price a little.
The other day I was talking to a friend who told me that his retired father has suddenly discovered Xero on the bourse, and is considering investing.
This is a reflection on the level of maturity of the New Zealand market and the investing public. It’s also, to be frank, a reflection on the fact that institutional investors and advisers have suddenly decided Xero is a sure bet, no doubt encouraged by the stellar share price growth. They’re buying the stock and advising their clients to do similarly.
The day Xero entered the ranks as one of the top 50 market cap companies on the NZX they also suddenly gained visibility within the advisory community – the combination of a stock that isn’t heavily traded with this increased demand leads to an artificially high impact from low volume trades – this is great on the upside but painful on the downside.
It’s actually very positive for the maturity of the company that they recently cross listed on the Australian exchange – it brings them a greater level of savvy investors that actually understand the dynamics of a potentially high-growth/high-risk investment. Drury has also signaled a possible future listing on the US exchange – this too would give both some stability and some liquidity to the share price – both positive things.
However this greater scrutiny will challenge the company to find analogues for its business.
Drury has regularly pointed out the fact that Microsoft acquired enterprise social networking company Yammer for $US1.2 billion as justification for the sort of valuation Xero is hitting.
That might work for new Zealand investors who don’t quite understand the nuances, but Yammer was a very different deal for a couple of reasons:
- It had an exceptionally effective viral user growth pattern that Microsoft needed to learn about as they try and morph their business into the internet age
- It was an answer to the growing attention that social networking within enterprise was garnering – Salesforce.com’s Chatter product and Tibco’s Tibbr were increasingly making Microsoft look late to the party
For these reasons, and given the massive war chest of cash that Microsoft holds, the Yammer deal made sense. it may end up being a failure as a business division of Microsoft, but as a learning, marketing and corporate culture tool it makes sense.
Others rightly suggest that Intuit, the US’s biggest vendor of SMB financial products, is a potential suitor for Xero (some even going on to suggest that it is Intuit behind the buying that is sending the share price upwards – a theory I discounted).
People point to the fact that Intuit acquired the personal financial management product Mint a few years ago (for $US170 million) and has an appetite for acquisitions that shoehorn itself into this new world. The Mint acquisition was, in my view, a very different deal, in a couple of important ways:
- Mint had delivered an interesting mix of behind the scenes business intelligence. It was mining aggregate data to deliver insights to customers and hence had some very useful technology that could be back doored into other Intuit products
- Mint, like Yammer, had worked out the viral uptake model and, at the time of acquisition, boasted over a million users
While Xero is doing very well from a user numbers perspective, for Intuit to acquire the company, it would have to be showing stellar growth in the only market that really matters – the US. Xero has really ramped up its US presence, the company has shifted into its own space and has ramped up the team significantly, but it’s coming from a relatively small customer base.
While I recently reflected on the 100,000 customer milestone and suggested that this indicated that Xero had reached escape velocity, this statement becomes far more nuanced when we look at the joint factors of massive market capitalization and global market share dynamics.
I believe that Xero, at its current market capitalization, is yet to become a compelling proposition for a US acquisition. Rather, what a company like Intuit is likely to do is one of two scenarios:
Wait until someone enjoys meaningful customer success in the US and acquire them for a lofty sum, secure in the knowledge that they’ve gained a path to continuing market domination
Acquire a company for a far more modest sum that has potential to become the breakout product in the space
The cloud accounting space isn’t a zero sum game however and this creates another difficulty for Xero, it is unlikely that we’ll see a repeat of the emergence of a small number of companies that dominate in the three big geographies (Intuit in the US, Sage in the UK and MYOB in Australasia). Xero is helped by the fact that in the US there is no vendor that has really captured market share – Outright (recently acquired by GoDaddy) and Wave (an interesting company with a free model) are the two best known domestic providers, but potentially more compelling is FreeAgent, a UK based vendor that has recently entered the US market and is a savvy operator.
Xero is executing well and their potential is massive.
However potential only explains part of a business’ valuation, does Xero’s potential justify a $1.5 billion valuation?
Not in my analysis – surely it may go higher as market frothiness and low liquidity combine to drive the economics.
But eventually an equilibrium needs to be found, one that is based on customer numbers, market growth and eventual profit – which we've yet to see Xero deliver on.
Christchurch entrepreneur and cloud computing commentator Ben Kepes blogs at Diversity.net.nz.
Comments
Steve
I've lived through 3 recessions. The cycles are always same, appearing around the 7 year mark.
The same variables always appear when the market heads towards a peak - house prices increasing ridiculously, unrealistic shareprice growth, and companies being valued at stupid multiples when they can't even turn a profit.
Greed also appears when a market peaks.... look at Solid Energy, Mainzeal - everyone starts to think they are bullet proof. (In Don Elders case, it would appear that he is.)
I like Xero and I like Rod Drury.... but I'm also at the point where I believe Xero is starting to show the signs of a market loosing its ability to invest sensibly.... when that happens we should all be afraid.
#3 by Mike Porter 10 hours ago
Ben- you've held a similarly cautious view on Xero's growth for
years. You've previously picked that the incumbents pose a significant
risk to Xero achieving their market share ambition. I recall you
pointing to MYOB posing a bigger threat to their growth than has turned
out (and i suspect will continue to turn out) to be the case. Whilst
the incumbents are compotent, Xero have proven correct in their analysis
that they can't cope with their legacy baggage. There is no reason
that anyone has written or blogged that looks rationale to me, why Xero
won't gain a respectable degree of market share in the US, given their
pedigree / track record to date + being dismissive of the value Xero
could gain in the rest of the world seems wrong. Xero appear to have a
great chance in the long term of achieving a multi million user base
outside the US. Why shouldn't Xero achieve a dominant market share in
their primary markets ?
Back to the US - supporting US growth, they have more capital, their product is richer and deeper, their talent pool stronger, their product moat is growing more rapidly, free access to further capital at minimal dilution rates to existing investors... but most important of all, businesses understanding and accountants understanding of a connected cloud environment (thanks to industry pundits like yourself) has significantly changed. They're pushing against an open door in the market. Much of Xero's new customer base doesn't come from a competitor. They're converting the spreadsheet / cashbook generation. We've all seen cycles and bubbles before, but occasionally a company achieves that potential. Xero seem to have a good chance of this. Will we see Xero billing annual equivalent revenue of $100m in circa 12 months and then $200m after that.. their track record does support this. If that plays out, it's clear that investor appetite will sustain a very high forward value and todays price will look like Xero's price 3 years ago (ie bloody cheap). They're only just on the start of a something massive, it's not going to slow down any time soon, at some stage it might accellerate beyond 100% CAGS compound annual growth rates. As has happened in Australia.
Back to the US - supporting US growth, they have more capital, their product is richer and deeper, their talent pool stronger, their product moat is growing more rapidly, free access to further capital at minimal dilution rates to existing investors... but most important of all, businesses understanding and accountants understanding of a connected cloud environment (thanks to industry pundits like yourself) has significantly changed. They're pushing against an open door in the market. Much of Xero's new customer base doesn't come from a competitor. They're converting the spreadsheet / cashbook generation. We've all seen cycles and bubbles before, but occasionally a company achieves that potential. Xero seem to have a good chance of this. Will we see Xero billing annual equivalent revenue of $100m in circa 12 months and then $200m after that.. their track record does support this. If that plays out, it's clear that investor appetite will sustain a very high forward value and todays price will look like Xero's price 3 years ago (ie bloody cheap). They're only just on the start of a something massive, it's not going to slow down any time soon, at some stage it might accellerate beyond 100% CAGS compound annual growth rates. As has happened in Australia.
by Ben Kepes (verified) 6 hours ago
in reply to Mike Porter
Mike - thanks for your well thought out response. You're right in
terms of the incumbents, I have to hand this one to Rod, MYOB have gone
off the rails post private equity deal. I'd be surprised to see them
come back with anything compelling.
Intuit is another story, though - their QuickBooks Online product is pretty middling, but not completely terrible, and they've shown that they have an appetite for smart acquisitions (a la Mint) - if anyone can cope with their legacy baggage, it's likely them.
It seems to me that the days of one major vendor in any one market are gone - the future will be made up of a number of competing solutions. If that's the case, then what is the realistic level of customers that Xero can achieve, what revenue does that equate to and what market cap does that support?
Re your comments about Xero having more capital and a richer and deeper product - no argument on the capital part (although if, for example, intuit acquired FreeAgent, that would certainly change). In terms fo the product, however, I disagree that Xero stands a million miles ahead of the competition in terms of functional breadth - that's simply not the case. Xero is beautiful and does what it does very well, but other products do the same or more, albeit to an arguably lesser level of beauty.
I speak to accountants in the US a lot - and I'm not convinced that they're yet pushing against an open door. Yes, the door is starting to open to them but it's not a done deal yet.
Anyway - here's hoping. I'm not an investor, but all of us here in NZ want Xero to pull this one off.
Intuit is another story, though - their QuickBooks Online product is pretty middling, but not completely terrible, and they've shown that they have an appetite for smart acquisitions (a la Mint) - if anyone can cope with their legacy baggage, it's likely them.
It seems to me that the days of one major vendor in any one market are gone - the future will be made up of a number of competing solutions. If that's the case, then what is the realistic level of customers that Xero can achieve, what revenue does that equate to and what market cap does that support?
Re your comments about Xero having more capital and a richer and deeper product - no argument on the capital part (although if, for example, intuit acquired FreeAgent, that would certainly change). In terms fo the product, however, I disagree that Xero stands a million miles ahead of the competition in terms of functional breadth - that's simply not the case. Xero is beautiful and does what it does very well, but other products do the same or more, albeit to an arguably lesser level of beauty.
I speak to accountants in the US a lot - and I'm not convinced that they're yet pushing against an open door. Yes, the door is starting to open to them but it's not a done deal yet.
Anyway - here's hoping. I'm not an investor, but all of us here in NZ want Xero to pull this one off.
Just having a quick look at Freshbooks.com.... they have over 5 million users already, 50 times more than Xero. They call themselves the #1 cloud accounting platform in the world.