Research Team, 4 August 2017

Stock Comment - Xero XRO

Xero (XRO) provides an online accounting solution for small businesses and consumers primarily in New Zealand, the UK, Australia and the US. It offers Xero software for online accounting – including general ledger, bank reconciliation, and invoicing.


One of XRO’s key innovations has been to use accountants as the key sales channel. XRO has enticed accountants with great success in Australia, New Zealand and the UK by enabling them to offer better value services to clients, and providing cloud based software that is fully integrated with the end user software allowing the accounting practice to move fully into the cloud, while also providing the software at no cost.

Although XRO is currently making an operating loss, gross margins continue to improve as revenue growth continues to build. XRO expects to reach a cash flow break even position by FY19, and achieve a gross margin above 80%. This will be achieved via operating leverage; as revenue grows quicker than costs, margins will improve. This leverage has begun to develop in XRO’s more mature markets of New Zealand and Australia, where the costs associated with sales, marketing and product development have stabilised. As some of XRO’s other geographies mature, such as the UK and the US, the business model has the potential to be highly profitable over the long-term.

XRO’s entry into the US has not gone as smoothly as the company would have liked. XRO invested heavily in sales and marketing, but Intuit has proved a tough competitor able to successfully transfer its existing Quickbooks customers onto its online offering, Quickbooks online, with tax being a key advantage. XRO recently announced that it will dial back its direct sales and marketing efforts and focus on selling through the accountant partner channel which has worked well in other geographies. We view the change favourably as it will limit US losses and enable to the company to move to breakeven. With XRO’s share price having moderated in recent years despite improvements in core markets, we don’t believe the market is pricing in a high level of success in the US, providing upside potential if execution improves.

XRO has created a strong brand presence in the New Zealand, Australia and UK accounting markets, leaving it in a position to build and strengthen its position and move to cash break-even. XRO’s growth and market share in New Zealand is beginning to mature but the opportunities to grow in Australia, the US, the UK, and other markets are substantial while the company’s execution has improved. XRO provides a New Zealand exposure to the technology sector and adds a growth angle to portfolios, in-line with our current strategy.

Risks to XRO include; 1) security breach, 2) increased competition, and 3) economic downturn.