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UPDATE: Xero shares [NZX:XRO] slid 9.09% to $7.00 Tuesday, pushing the company's market cap back to $820 million.
Rod Drury is a smart guy.
And Xero is a clever company, with a great product.
But is it $ 1billion worth of great?
On June 1 this year, I asked those questions in a blog called "Is Xero worth a cool half-billion?"
Now, I need to rephrase.
Since then, the company's worth has almost doubled. Yesterday, the company's shares closed up 11.92% to $7.70
In the two trading days since companies controlled by Facebook and Paypal billionaire Peter Thiel injected $60 million, Xero's market cap has risen 18% to a cool $902 million.
Is that a little over-heated?
We're looking at a company that is growing fast.
Revenue in the six months to September was $17.3 million, vs $7.9 million in the year-ago half-year.
And customers more than doubled to 111,800.
But its half-year loss also doubled, to $7 million, and the company says it will lose even more over the next half year.
By any conventional value measure, Xero is not worth $902 million.
Xero's September half-year quick summary. Click to zoom.
Three years' breathing space
But of course we're not looking at traditional value measures; we're looking at a high-growth company that created a new field (online accounting software). Will it push aside traditional accounting software companies, which are only just starting to push online products?
Can Rod sweet talk influencers in the key US market?
Will the likes of MYOB, Sage and Intuit smack Xero down; get trampled by its success; or try to buy it?
Can it hit a million customers, and turn a modest profit? That was the level MYOB was at when it was sold to private equity company Bain Capital for $US1.3 billion ($NZ1.6 billion), or an estimated 11.3 ebitda.
I don't know.
What I do know is that Xero now has a lot more breathing space, thanks to the issue of 10 million new shares at $6 each (the trading price at the time).
Forsyth Barr says Xero now has enough cash to last three years' at its current burn rate.
Of course, nothing stays current for long at Xero. On Friday, Mr Drury told NBR the company would hire around 200 more staff over the next 18 months for a total of 500 as it continued to focus strongly on growth over profit. Against this, more money money should be coming in through the door.
Xero 12-month NZX performance. Click to zoom. Source: S&P Capital IQ.
From reduce to hold
In June, Forsyth Barr had a reduce rating on Xero and a valuation of $2.63 - with a sensible proviso "“While we believe Xero has positioned itself well for success, it is still early days and we believe the market is already factoring in a high chance of success and overlooking the downside risks.”
Oh to have bet on yesterday's horse race.
ForBarr's latest note - issued after yesterday's big run up to $7.70 - has a hold rating on Xero and a 12-month target price of $6.32.
Too much cash
ForBar raises a curious problem: $85 million is too much cash.
The $30 million the company had in the bank ahead of the Thiel deal was sufficient for immediate needs.
According to ForBar's sums, $85 million is around $40 million more than needed to get to cashflow breakeven, "unless Xero significantly ramps up costs."
Said ramping up is a clear and present possibility.
As noted above, Drury has already told NBR he plans to hire 200 more staff. And while Xero has so far favoured the guerilla tactics that worked so well in NZ, Australia and the UK (winning over accountings, working industry events, and exploiting social media), you could spend what you like on an attempt to crack the US market.
And there is a lot of room to grow in the US. Although Xero continues to expand overseas at pace, most of its customers were NZ-based as of its September half year report, which listed
- NZ customers: 57,300 (last year: 36,600)
- Australia customers: 32,500 (10,400)
- UK: 15,100 (7300)
- US/rest of world: 6900 (3,000)
"Having a large pile of cash increases the challenge that Xero's board faces to ensure spending is focussed such that investors receive an adequate return on
capital," ForBar analyst Andrew Harvey-Green writes.
"The size of the capital raising raises questions about Xero's investment plans in the US and the UK. We had assumed a significant ramp up in expenditure (in line with the customer growth), but not to the extent implied by the capital raising." (Dury told NBR the cash would be used to fund growth across the board.)
Harvey-Green mentioned to NBR another possibility (not covered in his note): that Xero might be planning more acquisitions. That would help explain why Xero raised more cash than it needed, he said.
While ForBar's forecasts are unchanged, the analyst noted the "downside risks associated with poor spending." (I'm going to take it as read that Rod reckons they'll be smart spending.)
"I'm not saying that will happen, at all, but when the money's in the bank there's always the temptation to spend it," Harvey-Green told NBR.
There are worse problems to have.
Current share price assumes growth to 1.1m customers
Using fancypants financial modelling, ForBar says Xero's current share price assumes around 1.1 customers in about five years a "not unreachable target."
Compared to the slagging ForBar gave Xero in June, it's positive stuff. However, it's nothing analysts or journalists have said that's caused Xero's 18% run up in to trading days; it's that sophisticated investor Thiel has put his money where his mouth is.
At the same time Thiel upped his stake, Drury sold $5 million worth of shares, co-founder Hamish Edwards $2 million and director Craig Winkler $15 million. The sale was guaranteed to provoke cynical comments. Personally, I don't have a problem with it. Drury has to pay the grocer. And he's not lying around the beach spending his fortune on cocaine, he's been an active backer of other NZ startups.
Rod Drury has always said he's in it for the long-haul with Xero.
But NBR does note he has (very successfully) sold two previous companies.
And we did spy his tweet the other day about another SaaS (software-as-a-service) company - selling for $US1.2 billion.
— Rod Drury (@roddrury) November 19, 2012
No doubt Drury was looking to highlight the inherent hotness of SaaS companies, rather than hint at the kind of money Xero could go for in a trade sale ...
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