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Xero shares plunge to 10-month low as investors question US growth plans

Shares of Xero [NZX: XRO] dropped to their lowest level since October last year as investors weigh the high valuation of the cloud-based accounting software firm's shareprice against its US growth aspirations.

The stock fell 6.2 percent to $20.17, less than half its intraday record of $45.99 on March 6, and have shed about 44 percent over the past nine months after its soared more than 300 percent last year. Globally tech stocks have pared gains made early in the year, with the NZX Sci-tech index, which includes Xero and bio-tech company Pacific Edge, and the likes of minnow stocks including BLIS Technologies and Windflow Technology, sinking some 28 percent since January as investors mulled the high valuations relative to earnings.

"In general I think several analysts have captured the essence of what's been going on over a period of time here with technology stocks broadly and globally having peaked in March this year," Andrew Bascand, managing director for Harbour Asset Management told BusinessDesk. "Then investors just started asking questions regarding the business models of a number of tech stocks and how much cash they've got on their balance sheets and what their timeline is to becoming profitable and therefore the valuation of these stocks."

The Wellington-based company wants a million customers, and is targeting growth in the US market where it sees the potential to take market share of an estimate 29 million small to medium sized business owners. According to chief executive Rod Dury's annual general meeting presentation in July, the company has 334,000 customers worldwide, two-thirds of which were in Australia and New Zealand, and 18,000 in North America.

"Lets be truthful, how many clients do they have in the US right now?" said Bascand. "This was never going to be an easy path for Xero but their company is growing as well, it's just a question of what valuation it should be on."

Meanwhile, rival Intuit has "come out swinging" in the UK and US, Bascand said.

Drury told shareholder's at the company's annual general meeting in July he believed Intuit was on the wrong track trying to replicate Xero's open software eco-system approach, which sees partnerships that build new applications onto the Xero platform, by buying out eco-system partners.

"Intuit is spooked," he told the meeting. "Most of the things they do now are responses to us." It was trying to convert five million customers using a desktop software product onto a repurposed cloud offering, "which is not really a great product."

Still, investors think Intuit might pose a bigger threat to Xero. Paul Harrison, head of equities at Salt Funds Management said Xero has shown Intuit what it needs to do to grab market share.

"The Xero stuff just gets more bearish, all it looks like they've done is gone in and poke the giant that's Intuit and it's turned out they haven't managed to grab a first mover advantage in the market because their product wasn't ready for market in terms of the Xero product," Harrison said. "They've woken up Intuit and it's responded with a product that is."

The market was also aware that the escrow period after its $180 million October capital raise was coming to a close, Harrison said.

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Comments and questions

This makes sense. Xero's US product needs to be improved ASAP if they want to gain any meaningful share here. Australia and the NZ localized products are great but US QB or QBO users aren't going to switch unless the US iteration is meaningfully better than the local competition. I think Xero COULD get there, they just need to fix some things, would be happy to discuss with someone there.

Intuit has been sleepy for sometime but now Xero has poked the giant and they are doing innovative things in the US. The recent iteration of QBO is a solid product (despite lacking features as well). If Xero wants to be synonymous with the cloud in the US they need to release a game changing product in less than 6 months. Will it happen? Who knows?

US CPA's should still be getting their Xero certification, if a game changing product does arrive you want to be able to provide it to clients right away.

Xero is good but Workflow Max, the CA Workflow management software is not the best. Given one of their distribution models is partnering with CAs, I would have thought they should do better. Also every CA firm of any size knows their version 1 reports for producing statutory accounts are aweful. Far to cumbersome and slow to be used commercially with scale by CAs. Xero has a great GL, great add-on community. But crap reporting engine for accounts for professional advisors. So many larger NZ accountants are patiently waiting for version 2 reporting before they can consider adopting Xero as a serious backbone system.

Can't agree more. I told Rod about some of the problems for CA's years ago, but we don't seem to be important to the company.

Given they have a monthly transaction limit against their API I would have thought this would disqualify them from offering anything in the "CA firm of any size" market.

Since the customers of said CA firms are likely producing more transactions than the currently allowed limit, which in turn disqualifies them as prospective Xero customers what would be the point in creating a reporting engine that suited "CA firms of any size".

Its a chicken and egg problem. And the limits are very low. Last i looked it was about 1000 invoices a month. Anything beyond that an you're not Xeros target market.

And this is what I see as the major killer to their US growth aspirations - because even a "Small" business in the US context is likely to be pushing their limits and be classified as something Large from an NZ context.

The next couple of months will be very telling. US EoFY is December and most small businesses would churn then.

I also wonder if there isnt a lurking "gotcha" as some of that Xero code base must be 10+ years old, and they quite simply couldn't have planned/architected for the technologies available now, and that may also explain some of the delay trying to build new functionality on top of the old product?

My company was one of the first Xero customers and the code base isn't 10 years old. The product is very setup for current and future technologies.

Always has been, still is, and will still keep coming down.

Rod should focus on performance and not on share price - but we know that is hard for him.

Shares on steroids one moment; Prozac, the next.

Watch ERoad for further proof of this comment

The US market is all about competitive strategy - Intuit is dominant but does not have a "monopoly" on the market. Xero simply needs to understand the competitive dynamics of the market there and play the game correctly - hiring lots of ex Intuit staff probably isn't the smartest way to develop a US strategy - it'll be too much of the me too approach. In my opinion Rod needs to chat to some professional CI advisors like Fuld & Co to evaluate their strategy in the US.

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