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Comparing high-flying Xero and Diligent

LATEST: Read Rod Drury's response here.

Xero's August dip seems to have brought a tinge of reality to broker tone about the market darling.

NBR ONLINE has been asking for months whether Rod Drury's NZX-50 online accounting firm is worth half a billion dollars.

Yet the market continues to believe that is the case.

Its share price (NZX: XRO) hovers just below $5, for a market cap of almost $530 million, despite August's ructions – with two share sale blunders and a "please explain" from NZX Markets Supervision.

Forsyth Barr analyst Andrew Harvey-Green said this week it was surprised the share price was so high in the first place.

Hamilton Hindin Greene director Grant Williamson had this reality check for investors: "We need to bear in mind the market has valued this company at such high multiples that the company is going to have to start to increase revenues and profitability in a pretty serious manner to warrant the share price remaining around the $5 mark."

It is worth comparing Xero to another of the year's top performers, Diligent Board Member Services (NZX: DIL), another software as a service company which has seen its star rise in tandem with the proliferation of tablets around the board table.

This former market dog – which was worth only small change a few years ago – has now broken into the NZX-50 and has a market cap of more than $300 million.

Neither company is talking about dividends yet, but a quick comparison of their financials, and their initial expectations, is an interesting exercise.

Growth still the aim

NBR columnist Shoeshine compared these stocks in January 2010.

It noted both stocks were listed in 2007 in well-hyped initial public offers priced at $1 a share.

Xero initially said its break-even point would come at between 15,000 and 30,000 customers.

At the 2009 annual meeting, chairman Phil Norman preferred the target of "around" 30,000.

Xero's full-year result to March 31, 2012, released in May, had a net loss of $7.9 million (+5%), on revenue of $19.4 million (+104%) and customers of 78,000 (+116%).

Xero announced in July it has 100,000 paying customers, with the second 50,000 achieved in 10 months, and annualised committed monthly revenue has leapt to $34.5 million from $25.5 million at March 31.

It wants a million-plus customers and is considering dual listing on the ASX.

Growth is obviously still its goal in the competitive online accounting market.

Five successive quarters of profit

Turning to Diligent, Shoeshine noted its prospectus projected revenue of $US7.6 million in 2008, rising to approximately $US30 million in 2009.

It hasn't quite hit those targets but has made an operating profit in five successive quarters and market watchers believe it is close to announcing a dividend.

Diligent's 2011 annual report, released in March, showed new sales of $US15.9 million (+430%) and revenue of $US18 million (+217%), with 570 new client agreements signed (+331%).

In the six months to June 30, revenue leaped 176% from the previous period to $US18.3 million, and profit from ordinary activities after income tax was up 308% to $3.36 million. Its cumulative client agreements (not a distinct six-monthly figure) was 1447, an improvement from 653 agreements a year earlier.

By the end of the period it had $17.2 million cash in the bank.

Diligent investor Aaron Bhatnagar, a former Auckland city councillor, says he was attracted to the stock because he used to lug around large council agenda papers and can see the software's use beyond the boardroom.

He bought his shares about a year ago. Xero was also on his radar but he didn't want to invest in two New Zealand-based software-as-a-service growth stocks.

"Xero was growing market share in a very competitive space, whereas Diligent was growing market share and earnings in a niche market that they were doing extraordinarily well in."

Xero and Diligent represent a good return from an initial $1 outlay – and even more for those who picked up Diligent shares at rock-bottom prices of about 20 cents.

In the last year, Xero has risen 85%, while Diligent has almost quadrupled.

Given Mr Williamson's warning this week, one wonders when Mr Drury will take his foot off the growth pedal and start increasing revenue and profitability – and catching up to Diligent, a stock worth considerably less.

More by David Williams

Comments and questions
9

Wait for it......here comes The Doctor.

Nothing more to be said.

Apart from - there will be tears in the near future - and not from me

You have to admire XRO
Not many companies have a vision of not making a profit

If they didn't capitalize R and D their lossess would be even greater

There is no comparison between these two companies

Diligent is performing and Xero is not

Whats wrong with David Williams [NBR] and the Doctor - Diligent and Xero are both proving you can build successful, high growth companies from NZ. Both companies are achieving their investment goal of providing healthy returns for their shareholders.
In Xero's case they are providing employment to over 250 people, mostly NZer's and genuinely improving the business information for small businesses in NZ and around the world.
Based on Mr Williams and the Doctor's assessment of Xero, Peter Theil - founder of Paypal and first external investor in Facebook; Craig Winkler - founder of MYOB, Sam Morgan, Sam Knowles and several large US investment companies know nothing about the strategy of builidng a global high growth SaaS business - it would be great to know their credentials relative to this group.
So congrats to Diligent and Xero. Hopefully the NBR could invest in some journalism horsepower to encourage more Drury types, rather than continually taking the easy street of "knocking"

I think most people will see, on balance, this story is hardly damning of Xero's performance to date or its prospects.

The degree of scaleability is what gives Xero more blue sky potential than Diligent. Investors likely see this rather than focusing on the current year or even the next years profitability and they will probably keep rating the stock as long as the growth in customer numbers keep rolling in. Xero has a good chance of nailing their future by doing everything now to gain market share while the option is still there. I think they should be commended for their couragious and visionary stance. Xero has a war chest of cash to see this strategy through and with some patience investors could be suitably rewarded once the company reaches maturity.

Question - where were the New Zealander investors in Diligent when it was struggling because of the bad publicity attached to David Henry? Took the Americans to see the potential and make Diligent what it is today.

Shame on you, New Zealanders, for your short-sightedness and lack of objectivity about a product and service potential.

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