Xero Buys Paycycle and Clarifies US Market Entry

At its AGM today, Xero announced a number of things, one of which was the acquisition of Australian payroll provider Paycycle in a deal worth $1.5M. When Xero launched they went on record as saying that payroll was outside of what they considered core functionality – this position was in direct contrast to that taken by their incumbent competitors who all provide a bundled payroll solution. In fact MYOB have recently (and relatively quietly) rolled out payroll for their own SaaS product, LiveAccounts. Apparently MYOB customer feedback was that an accounting product needed a built in payroll solution to fly.

Last year at Xero’s partner conference many payroll providers were a little dismayed to hear that Xero was developing it’s own payroll solution – albeit a very very simple one that was rudimentary to say the least. Customer and commentator feedback indicated that this was a sub-optimal approach – and the announcement today is a tacit admission of that fact – once integration with Paycycle is complete Xero will have a fully integrated offering that, with time, I would imagine being rolled out in New Zealand also.

What this means for the existing payroll partners is unclear, in the blog post announcing the deal Xero moved to ease their fears saying that;

We have, and will continue to promote, a best-of breed approach whereby a number of Add-on Partners offer our customers payroll solutions

I would imagine however that some payroll providers, having got a fright from Xero twice already, would take little comfort in this statement.

In other news, Xero gave some guidance as to their US market entry strategy – something I’ve asked for previously. Xero indicated that, while it would work on finishing its US specific version, true market entry in the US would be throttled back. As they told NBR;

Xero now had over 1000 customers in the US – where its CTO recently relocated – but would not “really put our hammer down” until a major partnership was secured similar to Xero’s marketing alliances in Australia with Telstra (which promotes Xero through its business portal) and ANZ in Australia, or BT in the UK (which pushes Xero on its BT Business site

I’m sensing a couple of things here – firstly that we’ll see the fully featured US version of Xero released imminently (weeks instead of months) and secondly that we’ll very shortly see the announcement of some significant funding for Xero. A few things make me think this;

  • The stated strategic shift away from driving for profitability but rather to target growth
  • The Paycycle acquisition shows that Xero isn’t overly concerned about spending money where it deems necessary
  • The fact that CEO Rod Drury has been spending significant time in the US lately
  • The seed funding that Peter Thiel put in – this needs to be leverage for the next round

While Drury is saying that it’s a marketing partnership that the company is waiting for – my pick is that it’s more related to a funding question and I predict that the next couple of months will see Xero raise significant funding to cover the costs of US market entry. Their research will have shown them just how much this is likely to cost and I’m picking a $50M-$100M fundraising round to give them the breathing room to grow to scale in the US.

The unknowns are how the market will react to the putting back of the profitability target, and how markets may react to the possible share-value dilution that a subsequent fundraising round may create. I’m picking that shareholders, who are strongly supportive and loyal to Xero, will regard both those factors positively and there will be no short term share price impacts.

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