If I was Sage I’d be very scared of Xero

Den Howlett for diginomica writes: Valuation of cloud based businesses are notorious for running well ahead of profitability yet the advance in Xero’s stock valuation since the beginning of this year is little short of stratospheric. If I was Sage Software I would be deeply concerned. Here is Xero’s stock chart for 2013 compared to that of Sage:

Compared to Xero, Sage is flatlining. It gets more interesting. Check the following:

Sage Software

Xero

Market capitalisation

£4.2 billion

£1.3 billion

Last reported annual revs

£1.3 bn

£20 million

Cap/revs

3.2x

65x

No of customers

6 million

157,000

Annual value per customer

£216

£127

Xero’s valuation is insane, even by the standards of the most optimistic market analyst and its directors must be under incredible pressure to perform. However, they have something that Sage doesn’t have – a fresh way to approach the market that isn’t encumbered by a set of legacy business models that have to be fed.

Even though Sage recently held an analyst day (PDF) that emphasised its cloud efforts and completed the disposal of a non-core business, the market wasn’t that interested.  But then it doesn’t help itself. Is this image the one you’d want to show as the introduction to your latest strategy?

Where’s the energy? Where is the ‘new’ in showing an image of a person working in a dying industry? Why the re-emphasis on the global brand?

It doesn’t make sense.

Xero by contrast has admirers among its competition. This is what Brad Smith, CEO Intuit said about Xero at the end of 2012.

“I admire them. I think Rod Drury and the team have built a really good company, they have built a very easy and compelling product. We’ve learned some things from Xero that are helping us think differently, which is the highest compliment you can pay to someone who competes in your space.” Alongside and despite its very limited resources, Xero is recognised as the main cloud challenger in the prized US market.

I’ve followed Xero for many years. They, along with others, were always companies I felt are doing things differently enough to make a serious dent in the universe. What I could never have predicted was this level of market cap and especially the growth it has enjoyed since the beginning of the year.

We should not be so surprised. Workday’s market capitalisation is tracking a similar path. The difference for Workday is that its competitors are so much larger than they are today that Workday represents less of a threat in the next few years than Xero does to Sage.

If Xero achieves its near term stated goal of reaching 1.5 million customers then goodness knows what this means for its market cap. If it takes advantage of its outsize market cap to make useful acquisitions then their position gets significant;y stronger. If it uses that same market cap to tap the bond market then it grows its war chest at low or no cost. Whichever way you cut it, Xero has a LOT of options.

I’ve said it before but it is worth repeating. The writing is on the wall for Sage unless it makes radical changes and takes the hit that goes with that.