July 29, 2012
Xero held its annual meeting last week and detailed its current performance. Xero annual meetings are always an interesting event, Xero has an incredibly supportive shareholder base, while most publicly listed company AGMs include a fair dose of critique and questioning, Xero’s events instead ring to the sound of hand-clapping from shareholders that buy into the Xero vision 100%. The recent event is no exception and performance metrics show why shareholders are so positive. Some highlights;
- Xero now has 100,000 paying customers – up from 45,000 at last year’s Annual Meeting
- Xero’s first 50,000 customers took 5 years to achieve, the second 50,000 was achieved in 10 months
- Annualised committed monthly revenue has risen to $34.5 million, up from $25.5 million at 31 March 2012
- 57% of Xero’s committed monthly revenue is from offshore markets, up from 51% at 31 March 2012
I’ve been critical of Xero myself in the past, and have had to suffer the displeasure of CEO Rod Drury, someone who doesn’t appreciate criticism, especially not from someone in his own country. As an aside, and having spent time talking with, and questioning other public and private technology CEOs, I would suggest that Xero needs to get a little more used to this side of public exposure – especially as it moves into the more critical US market. Anyway, that aside, the Xero numbers firmly put it into escape velocity, here follows my reasoning.
Many critical commenters point out that Xero has not yet reached profitability and continues to add expense to its business by way of staff hiring. This criticism is unsurprising given that Xero comes from a country which has little experience in high-growth software businesses. To understand the dynamic it is important to understand the accounting software industry where three vendors, MYOB, Sage and Intuit claim incumbency globally. Given this triumvirate, it soon becomes clear that anyone who wishes to break their hold on the market needs to scale quickly in terms of customer numbers – with 100k customers, Xero is now a recognized competitor and this leads it into the territory of the other big software trend, acquisition. This is not a “slow organic growth” opportunity – anyone wishing to challenge the incumbents (and contrary to public perception, Xero has a number of competitors in the space trying to do so – FreeAgent, KashFlow, Pearl, Zoho etc) needs to focus on rapid growth in order to both beat the other new upstarts, and gain the attention of the big boys.
When Xero was first formed, and perhaps in an attempt to appeal to parochial New Zealanders, there were many comments from the leadership about wanting to build a long term New Zealand business. This has softened recently with an admission in the past year from Drury that an acquisition would occur should the price be right (in that instance Drury suggested that his personal metric was a higher price than that garnered by TradeMe, a $700M acquisition). With the market capitalization hovering around the $600M mark now, a close to $1B takeover looks plausible. Obviously the number of potential acquirers reduces as the price goes up but both Intuit and Sage are no doubt putting a ruler across Xero as they realize their own cloud strategies are lacking. There are also a number of other vendors who sell to the SMB space who will be looking at the company – it’s worth noting that Xero competitor Outright was recently purchased by large US hosting company GoDaddy – it’s a natural fit for GoDaddy who has millions of SMB customers, so don’t look past other ISPs, general technology companies, banks or business service provision organizations taking a look at Xero. Given a very low level of liquidity for Xero (share turnover is incredibly slow and the vast majority of the stock is owned by 100 individuals) and the $1 per share initial purchase price at IPO, there could well be some pleased investors who could reap a 5x or more return in the event of an acquisition.
Xero has its share of detractors – many venting their spleens anonymously on New Zealand’s NBR website. Most of their criticism focuses on two distinct areas;
- Criticism of immature investors who seem unwilling or unable to question the Xero strategy
- Questions around profitability
The first criticism is probably fair. As I’ve said before most investors seem a little too eager to give Xero free realm to do as they see fit – it’s unusual for this to be the case with public companies and sometimes lulls them into a false sense of complacency which is dangerous when new markets are entered, as an aside it will be very interesting to see what happens if and when Xero lists on the Australian stock exchange where it has neither the home town advantage nor the lower maturity level of investors. I do note with interest that institutional investors are taking more of an interest in Xero now – this should improve the level of debate.
In terms of the second question about profitability – despite being a critic of growth-at-all-costs strategies – Xero is one example where the only option is to scale to size – and in doing so become a target for acquisition – this is clearly what is occurring and, given the fairly large cash reserves, and the positivity and deep-pocketedness of some of its backers (notable MYOB founder Craig Winkler, TradeMe founders Sam Morgan and Rowan Simpson and uber investor Peter Thiel), extra cash injections shouldn’t be hard to come by.
There’s no such thing as a sure bet, and I’ve had some people within the orbit of some of the incumbents in the space suggest that these players are finally going to counter Xero’s rise, in their words “the empire is about to strike back”. It’s hard however to see clearly how any of the incumbents could really do what is needed, which is to disrupt themselves before Xero (or more likely, Xero’s acquirer) does it for them. Xero looks set to make a handful of people a pretty impressive return.
Disclosure - I have consulted for MYOB and Xero and aman investor and director of Connect2Field which is 30 percent owned by Accounting software company Reckon. I am also co-founder of LiveMigrate which provides migration services from desktop accounting software to Xero. I advise many companies (either formally or informally) in the accounting software ecosystem.