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Xero's overseas rivals rate the upstart start-up's chances

Two of Xero's biggest rivals say they are taking Rod Drury's company seriously.

However, they're predicting tough times ahead – both for the New Zealand-based company and its investors.

Xero's market capitalisation has bewildered New Zealand market analysts this year, as the cloud accounting software company's value hit $500 million and sailed comfortably beyond, including a lift from this month's ASX listing.

At Thursday morning's opening share price (NZX: XRO) of $6.35 – after a 4.1% jump the previous day – the company was valued at $680 million.

This is just a week after it posted a half-year net loss of $7 million, double the previous period, while more than doubling revenue to $16.9 million.

Its regional revenue numbers make interesting reading.

New Zealand revenue in the six months rose almost 70% in the previous comparable period. But Australian revenue – now just $2.1 million behind New Zealand – more than tripled and United Kingdom income more than doubled.

Xero's real game, it seems, is offshore.

Ready for a fight

That is what Australian rival Reckon thinks. The ASX-listed company (ASX: RKN) is gearing up for the fight – it will release its own cloud-based offering in the first quarter of next year.

"I think you're starting to see Xero plateau in places like New Zealand," Reckon's Sydney-based chief executive Clive Rabie told NBR ONLINE.

With more than 500,000 customers, Rabie's company is the Australian No 2 to MYOB's one million customers.

MYOB is owned by Bain Capital, the US investment firm founded by unsuccessful presidential challenger Mitt Romney.

Reckon has grown by "Australianising" a range of personal and small-to-medium business accounting products developed by US giant Intuit.

It posted first-half revenue of $A48.2 million, for a profit of $A9.3 million, and at Thursday's share price of $A2.43 the company is worth about $A310 million.

But Reckon and the Australian accounting software market is about to get a shake-up.

Intuit quit its deal with Reckon earlier this year and plans to enter the Australian market itself next year. The perfect storm could be complete across the ditch if British company Sage also wades into Australia, as predicted.

All of this spells trouble for Xero, Mr Rabie says.

"You're going to start seeing people like ourselves and MYOB come to market with far more aggressive platforms. You're also getting quite a lot of the big players, like the Intuits, come into the market in Australia and throughout the world."

Let us remind ourselves Xero listed in 2007 at $1 a share, saying it would make a profit when it hit between 15,000 and 30,000 customers. 

The company says it has 111,800 paying business customers at the end of September and Mr Drury says Xero is "absolutely in the growth phase".

10 years of investor pain

Two months ago, Xero had $30.6 million in the bank but Mr Rabie says at current growth rates it is probably going to run out of cash by September.

"If they continue getting money I think there's a possibility they could one day be a business which will be significant in this space, but I think that there'll be another 10 years of pain for investors.

"I think investors are going to have to put that kind of money into the business for many years."

He says Xero has some "absolute flaws", with enticements of free products, big commissions for on-selling accountants and a high "probably not sustainable" price.

The best option is to sell out to a bigger company – he uses Reckon as an example – so it can get access to the cash it needs to achieve gains in competitive overseas markets.

To justify its current share price, Xero has to start earning at least $50 million a year, he says.

"For me, I might as well put my money on the roulette table, or in the casino, because it might be a great hit but there's a quicker way to double your money."

Speaking from Intuit's Californian headquarters, global business division president Alex Lintner immediately adopts a complimentary tone about Xero, saying it has a "compelling offering".

But he warns cloud-based accounting software is exactly what Intuit is doing in the US and abroad. It already has 360,000 users for Quickbooks Online and growing.

The 30-year-old start-up

The listed company (NASDAQ: INTU) is a global behemoth, worth $US17.2 billion and with revenue of $US4.15 billion in 2012.

It has maintained a compound annual growth of 10% over the past five years.

Intuit first dipped into what Americans call "financial management" software for small businesses 20 years ago, but it has a reputation of continuous innovation. 

This year it made Forbes magazine's annual list of the world’s 100 most innovative companies, with an article in September referring to it as "the 30-year-old start-up".

Mr Lintner says Xero will face a sterner test Stateside than in Australia and New Zealand, with the company having to show it can compete "with somebody who knows what they're doing".

Intuit is the world's largest accounting software company, he says, followed by Sage and MYOB. The next tier down is occupied by a slew of smaller companies, which Intuit's research puts at 23 right now, including Xero.

"Because of their market cap, Xero gets a lot of press," Mr Lintner says.

"They're very proud of the 100,000 customers. The hardest customers to get are always the first one or the first 1000 so I applaud them for growing so quickly to that number.

"But, in the big scheme of things, it's a small number of customers – just like the other 22 small ones."

Xero under surveillance

Mr Lintner adopts military language for its foray into Australia, saying it will put "people on the ground". Sales staff, presumably, not software-toting marines.

He doffs his cap to Xero when he says it has no such plans for New Zealand, because the popularity of Xero and other accounting products has blunted Intuit's popularity. The market is probably too small for Intuit to worry about, anyway.

Don't think the American giant is ignoring Xero, however.

Mr Lintner explains that in this quick-moving industry even the small players are taken seriously and watched closely.

"If they have a good idea we will adopt what is legal to adopt and we will try to do even better than they did. And we have the resources to do that. 

"Xero has done a nice job innovating on some aspects. Well, let's see if they can keep this up. Because business is a bit like marathon running – it's not a sprint."

You expect rival companies to run each other down but it's interesting to note the respect Xero has earned from these profit-making, listed companies.

There is a feeling, however, Reckon and Intuit are circling each other more seriously than Xero, which is fighting in a lower weight class.

And they want to keep it that way.

"We respect them as competitors," Mr Rabie says of Xero. 

"And we'll try to take them on as a competitor – we don't want to see them grow so steadily they take over the market."


                                                 XERO                       RECKON                       INTUIT
Year listed                                 2007                           1999                             1993
Revenue                           $16.9m 1HFY13          $A48.2m 1H13             $US647m 1Q13
Profit (loss)                            ($7m) 1H                  $A9.3m 1H                   ($US69m) 1Q
Share price (21/11)                 $6.33                         $A2.40                         $US58.17 
EPS                                       -$.0111                      A7.1c 1H                        $US2.76 
Market cap                     $678.5m (21/11)               $A310m                     $US17.2 billion
Customers                           111,800               More than 500,000                50 million

More by David Williams

Comments and questions

Nice analysis. Bottom line. Sell Xero.

And that is the answer, this thing just has to get enough market share to be disruptive and bang, they will take it over.
This is not an investment in profitability but a gamble on someone big taking it over. Ala Charlies, 42 below...
Just keep watching user numbers grow you good thing....

Xero is swimming with the sharks and has to expect to be mauled. Chances of survival long term I would think are not good - unless investors are prepared to put in a lot more money for a lot longer.

Time for smaller shareholders to take profits and get out, whilst hoping than any volume selling doesn't crash the price.

The company is still very small by global standards and will soon run out of steam (or cash).

Where are the shares to sell, close 70% to 80% of shares are owned by founders and staff. Liquidity is not there to melt it, unless Xero under performs.

As an avid watcher and user of the development of the software Xero has revolutionised accounting and the way we can work with clients. We went through some pain in the early days with this product but WOW the pace of development, innovation & improvement is spectacular. While a small number of accounting firms have embraced Xero and have moved their entire client base over, the majority still have a mix of products, Banklink still a very dominant player. 70% growth in 6 months hardly constitutes a plateau. Go XERO.

True, there are many large accounting firms that haven't made the switch from rusty Banklink to Xero. However, this would be a low margin switch. Xero has plenty of room with in NZ itself. Xero is clearly taking business away from Banklink in NZ and MYOB in AU.

Who is your daddy: One should consider the segment of business Xero is involved in. SMB ( Small and medium businesses) don't need an extensive indepth products. Xero smartly opted for open API and if need arises it will shop one of its add-on partners in the cloud and offer it for free. So-called sharks are just responding to Xero's core cloud offering but they are not seeing the game ahead with open APIs and add-ons.

Xero is the Shark: For an end user switching costs are high and unless there is a ground-breaking shift in technology offered by competitors it is hard take away existing clientele from Xero. Undercutting the price of subscription doesn't win market share (if so Wave accounting would be market leader by now). Cheapest Xero product is $5 and none of the whales can offer this price point. Xero is indeed a shark swimming with turtles.

Home-turf advantage: Sage has it in UK, Intuit has it in US, MYOB had it in AU and across the globe there are local leaders in this industry. They built their products from the ground up in their local environment (tax, culture) from scratch. These companies know how to respond well to the local markets. Don't expect Intuit would be market leader in China/India/Japan/South America as they all have their local leaders. Xero managed to build this home-turf advantage so far due to MYOB' s incompetence and Banklink's (unsung hero & titanic) unwillingness to be a full-blown accounting system in NZ.

Jumping the boat: The day Xero finds it difficult to swim it will simply become part of another big one. Take a good look at the product range. It's all built in cloud centric and single ledger focused, and existing incumbents don't have this portfolio. It will take boat loads of money and time to develop them from scratch (remember So Xero is an attractive acquisition target to any incumbent. (Can't you see intuit, I reckon, are already flirting with Xero).

So what's the deal: Share price will go down once growth slows down. Current triple-digit growth will go down to double and single one day. By then it will be able to comfortably break even and becomes a feature rich product. A billion dollar acquisition can be justified in capital markets with $50 million revenue (heck, Instagram is worth a billion to Facebook - who cares revenue?). Xero can attain this revenue maybe in a year from now. If you work backwards, a $9 to $10 price is achievable in 1 to 2 years from now.

The "inflated" share price is driven by accountants and customers who know the alternative offerings. They understand the enormous untapped, protential of Xero. With the add-ons, Xero offers a pretty extensive and in-depth product. We at the tipping point in NZ and Aust. And Xero have had a six-year start on its competitors, who are playing catch-up. Buy now.

Driven by accountants? Maybe, but not ones who know what a prospective PE is.

The inflated share price is driven by two things:

1. Most of the shares are closely held by people associated with the company and those shares can't easily be sold (even if they wanted to) otherwise the price would crash. So there is limited supply of shares for sale.

2. Over-the-top hype from the company and its small coterie of avid supporters who are blinded by the tough realities of the market Xero operates in. That attracts sufficient demand to outpace the small supply. Economics 101.

On all realistic analyses, Xero is worth much less than its current share valuation suggests. It has major issues with its financial structuring and performance and, as Clive Rabie says, will run out of money soon and shareholders will be asked to contribute more. Eventually, some will start getting tired of this - or the alternative of dilution by bringing in new funders.

While it is a good product It is not 6 years ahead of its competitors. Intuit's Quickbooks Online has been available for a decade or so (though only in the USA until recently), Australia's Saasu has been around for longer than Xero and has more features at a better price. Even MYOB's LiveAccounts has been out for more than two years and is doing well. There is a ton of strong competition in this marketplace, including BankLink, which continues to perform strongly. I saw recently its processing record numbers of accounts.

Well, let’s assume 2009 as starting line for Quick Books, Saasu and Xero for measurement. Who owns the large subscribers now? Xero. (QB doesn’t talk about number of subscriptions. Instead, they count users. There could be minimum three users per subscription, so that puts 100k subscription base).

Banklink has been trying to crack UK since 2009 and they haven’t made any inroads in to that market. Banklink or MYOB can’t grow beyond NZ and AU (history 101). Saasu doesn’t have resources to customise tax module outside AU. No one has heard of it outside AU (check Google trends). QB online doesn’t have decent numbers outside US. Quickbooks don’t have time to allocate product resources in AU and NZ.

Global adoption is what is driving Xero. Even being a fringe player (less than 1% market share in each of 100+ countries), Xero can reach 100 million in few years. Banklink is an expensive data provider and its market share is being eaten by yoddlee. I guess Xero is at least two years ahead in product offering. Employees are the first ones to jump the boat; they sense changes in the market first-hand - check that metric.

Huge ongoing appetite for capital... Employees growing at same rate as sales, with relatively massive sales cost structure yet pricing well below any competitive offering, equals an unsustainable model... The fantasy of buying market share globally is illusory, must retract in time (or collapse) as dilution and new capital dry up...
Rod Drury, great guy and promoter, but wonderful backing can only go so far...

Are all these anonymous people still carping on? We've been reading this negative drivel on Xero for well over five years now, while they've achieved milestone after milestone. Just give up people, please.

Great to read this debate! Anonymous v Anonymous: why can't you two suckers get it together? My conclusion: I'm holding onto my Xero shares until they hit a downward trend that lasts for 6 months plus.{;-l}

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