Xero Limited (XRO) is a software company that provides a cloud accounting software solution for small businesses. The software enables small business owners to run their business quickly and easily on the go by uploading their banking transactions and invoices. The software reconciles the transactions and provides the user with accounting services and dashboards for a subscription fee.
Xero has been regarded as one of the easiest and clutter free accounting software in the world. The firm currently has over 2 million subscribers worldwide and generates operating revenues of over $700 million.
The firm generates most of this revenue in Australia and New Zealand. While it is also grown in popularity in the UK, USA, and parts of Asia. The below picture shows Xero’s market highlights as of FY2020.
Source: Xero Limited Annual Report
The growth in subscribers has been immense all across its geographical segments, with New Zealand accounting for the lowest growth due to the smaller market size compared to the rest of the regions. An interesting fact among small businesses is that ANZ has a >50% cloud accounting adoption among small businesses, compared to <20% in the other regions.
Xero’s software seamlessly integrates with bank accounts and other 3rd party software to provide users with an incredible customer experience – which can be seen with its strong retention numbers.
Xero continues to invest in product development with strategic priority towards driving cloud accounting, growing small business platforms, and building Xero with global scalability in mind.
The firm’s performance in FY2020 has been a show of strength as for the first time, Xero was able to generate positive net income.
The stock has recovered all its losses during the market crash in March and has continued to rally as tech stocks that are not capital intensive have been doing since April. The recent surges in August have come amid Xero announcing the acquisition of Waddle – a cloud platform that helps small businesses with invoice financing.
The cloud accounting industry is picking up among small businesses. Australia and New Zealand small businesses are one of the earliest adopters and have driven growth in the industry. The industry is sure to have been impacted as several small businesses in the USA and Europe have gone under due to the pandemic. However, the silver lining is that covid19 will increase the adoption to cloud based software providers from the small businesses that do pull through.
Since Xero is still in the very early stages of its expansion overseas, it is forecasted to remain relatively unaffected in terms of demand.
The gig economy has increased globally with more freelancer service providers. Start-up ecosystems are surging as well in all developing markets, all pointing towards Xero to be successful in the years to come.
The subscription model requires certain metrics to be tracked to determine performance. Unit economics play a crucial role in determining just how good the firm’s product is, essentially the most important part of their business.
Xero’s revenues have an increasing trend. In FY2020, the total revenues posted was $695m at a growth rate 31% from the previous year. The average revenue growth rate over the past 5 years has been 41%. The metrics that are used to measure the performance of subscription as a service business model is below
Source: Xero Limited Annual Report
Among these metrics, CAC or customer acquisition cost, LTV or Lifetime Value and churn are the most important. They measure the costs associated with acquiring a customer, how much value a subscriber brings on average to the firm, and how much revenue is lost by virtue of customers leaving. These metrics determine the profitability of the firm and are only forecasted to become stronger over time.
Xero has very impressive numbers, as it can be seen from the above picture. The firm is able to acquire customers for a low cost of $14, and these customers are projected to spend $2422 over their lifetime. A very low churn also emphasises that customers love the product and are willing to pay for it on a recurring basis.
Looking at the balance sheet of the firm, the cash position has been increased to $519m at the end of FY2020. The firm has enough current assets to mitigate risks in the short-term. Xero serves 2 million plus customers with assets just shy of $1.2billion – such is the nature of software companies. Total assets exceed total liabilities by 1.5x. The capital structure of Xero consists of 54% debt and 46% equity – a mix that is slightly concerning. However, it should not be a cause for concern with the business model that Xero has. The current life cycle of Xero suggests it is in the growth stage – indicating heavy investments to be made to drive growth and hence, growing into a bigger business than it already is.
Xero is a high growth company with stellar performances. The firm’s SasS metrics are on point and as strong as any. The balance sheet is capable of handling any unforeseen risks in the short-term. The stock is trading close to it’s all time high that was set last month. With more businesses going online, we expect Xero to continue to gain market share. However, in light of covid19 impacting small businesses the most and small businesses being the customers of Xero, we recommend investors who already have exposure to Xero to “Hold”.