Market Daily, 6 November 2013

Transcription

06 November 2013
Asia Pacific/New Zealand
Equity Research
Internet Software & Services (Information Technology)
Xero
(XRO.NZ)
Rating
OUTPERFORM*
33.15
Price (5 Nov 2013, NZ$)
Target price (NZ$)
45.70¹
Market cap. (NZ$mn)
4,227.41
Projected return:
0
Capital gain (%)
37.9
Dividend yield (net %)
0.0
Total return (%)
37.9
5.45-33.15
52-week price range (NZ$)
* Stock ratings are relative to the relevant country
benchmark.
¹Target price is for 12 months.
INITIATION
Emerging global leader in Cloud accounting, at
the outset of the largest s-curve
■ Initiate NZX/ASX-listed XRO with an OUTPERFORM rating and a
NZ$45.70 target price, with 38% potential upside. Our rating is based on: 1)
a sizeable TAM of US$4.2bn; 2) a proven record of execution; 3) customer
acquisition momentum over next 18 months; 4) potential for sustained 70100% revenue growth; and 5) valuation upside in a success case. XRO is
the innovation leader of cloud accounting globally. Relative to competitors,
XRO has gained the highest penetration of any single market.
■ Opportune environment: 1) Cloud grab – we expect cloud migration to
displace legacy accounting software and disrupt market leadership; 2) Cloud
is particularly suited to small businesses (SBs) and early adopters, both are
XRO’s sweet spot. XRO has the full package to succeed including: 1)
people, 2) leading innovation, 3) product, 4) GTM strategy, and 5) funding.
■ TAMplification: In a reverse of the norm, XRO starts its largest s-curve
(US) already proven, with leadership in three other markets. Overlaying scurves of individual markets escalating in scale (1: NZ; 2: AU; 3: UK; 4: US)
means XRO’s total s-curve should stay steep. Thus we expect 70-100%
revenue growth to be maintained over several years. Customer upside:
Our proprietary forecasting tool indicates upside to the near-term (Mar-14)
customer acquisition.
■ Extreme risks (pages 37-38): As with any tech company going global, risks
are extreme. XRO faces able competitors, especially INTU. Risks include:
execution, competitive response, key man, security, and high market beta.
■ Target price of $45.70 is based on probability-weighted DCF scenario
valuations. Very wide valuation delta depends on US customer acquisition.
We expect customer/revenue growth to continue to drive share performance,
as those will evidence whether XRO is tracking for failure or success.
■ Long runway: XRO could grow to a $10bn NASDAQ company within five
years. Long term, we see opportunities for: 1) a horizontal SaaS platform for
SBs globally; 2) innovative SB tools using big data analytics/benchmarking.
Share price performance
Xero Limited LHS
Financial and valuation m etrics
Relative to NZX50 (RHS)
34.00
510.0
26.75
407.5
19.50
305.0
12.25
202.5
5.00
Nov-12
Dec-12
Jan-13
Feb-13
Mar-13
Apr-13
May-13
Jun-13
Jul-13
Aug-13
Sep-13
Oct-13
100.0
Nov-13
The price relative chart measures performance against the
NZX50 index which closed at 4910.7 on 4 Nov 13
The spot exchange rate was NZ$1.207/US$1 on 5 Nov 13
Performance over
Absolute(%)
Rel-NZX50(%)
1M
61.1
57.9
3M
77.2
70.2
12M
458.0
432.3
Year to 31 Mar
Adjusted Earnings
EPS Adjusted
EPS Grow th
P/E
CPS
P/CF
EV/EBITDA
Net DPS
Imputation
Net Yield
Gross Yield
NZ$m
NZc.
%
x
NZc.
x
x
NZc.
%
%
%
2012A
-7.9
-8.5
0.4
-392
2013A
-14.5
-13.1
54.6
-253
2014F
-35.7
-29.1
123
-114
2015F
-46.8
-36.5
25.3
-90.8
2016F
-49.2
-38.4
5.1
-86.4
-8.1
-408
-645
0.0
100
0.0
0.0
-12.1
-275
-364
0.0
100
0.0
0.0
-27.7
-120
-130
0.0
100
0.0
0.0
-34.3
-96.6
-107
0.0
100
0.0
0.0
-34.6
-95.8
-134
0.0
100
0.0
0.0
Source: Company data, NZX, First NZ Capital estimates
Market Daily
15
06 November 2013
Figure 1: XRO financial summary
Sector: Software & Services
NZX Code: XRO
PROFIT & LOSS ($m)
BALANCE SHEET ($m)
Year to 31 Mar
2012A 2013A 2014F 2015F 2016F Year to 31 Mar
2012A 2013A 2014F 2015F 2016F
Operating Rev enue
19.4
39.0
70.9
137
274 Cash & Equiv alents
39.0
78.2
210
139
75.0
Operating Ex penses
-26.1
-50.5
-103
-175
-305 Debtors & Inv entories
3.0
5.9
10.3
19.2
37.1
Operating EBITDA
-6.7
-11.4
-31.7
-38.3
-31.0 Other Current Assets
0.0
0.0
0.0
0.0
0.0
Depreciation
-0.3
-1.1
-1.8
-2.8
-4.8 Current Assets
42.0
84.1
220
158
112
Amortisation
-1.6
-3.4
-6.8
-11.2
-16.9 Fix ed Assets
4.2
7.3
10.8
17.9
30.2
Operating EBIT
-8.6
-16.0
-40.4
-52.3
-52.7 Inv estments
0.0
0.0
0.0
0.0
0.0
Other Income
0.2
0.0
0.3
0.3
0.3 Intangibles
10.3
17.6
30.1
48.3
69.8
Abnormals
0.0
0.0
0.0
0.0
0.0 Other Non-Current Ass.
1.3
1.4
1.4
1.4
1.4
Reported EBIT
-8.4
-16.0
-40.1
-52.0
-52.4 Total Assets
57.8
110
262
226
213
Net Interest
0.6
1.8
4.3
5.2
3.2
Pretax Profit
-7.8
-14.2
-35.7
-46.8
-49.2 Interest Bearing Debt
0.0
0.0
0.0
0.0
0.0
Tax
-0.1
-0.3
0.0
0.0
0.0 Other Liabilities
5.5
7.8
15.5
25.9
44.4
Minority Interests
0.0
0.0
0.0
0.0
0.0 Total Liabilities
5.5
7.8
15.5
25.9
44.4
Equity Accounted Profit
0.0
0.0
0.0
0.0
0.0 Minorities
0.0
0.0
0.0
0.0
0.0
Reported NPAT
-7.9
-14.5
-35.7
-46.8
-49.2 Conv ertible Capital
0.0
0.0
0.0
0.0
0.0
Abnormals (net of tax )
0.0
0.0
0.0
0.0
0.0 Ordinary Equity
52.3
103
247
200
169
Adjusted Earnings
-7.9
-14.5
-35.7
-46.8
-49.2 Total Funds Emp.
57.8
110
262
226
213
RATIOS AND CAPITAL STRUCTURE
CASH FLOW ($m)
Year to 31 Mar
2012A 2013A 2014F 2015F 2016F Year to 31 Mar
2012A 2013A 2014F 2015F 2016F
Profitability & Growth
EBITDA/Op Rev
%
-34.7
-29.3
-44.8
-28.0
-11.3 Operating EBITDA
-6.7
-11.4
-31.7
-38.3
-31.0
EBIT/Op Rev
%
-44.5
-41.0
-56.9
-38.2
-19.3 Other Cash Income
0.2
0.0
0.3
0.3
0.3
Effectiv e Tax Rate %
-1.4
-2.1
0.0
0.0
0.0 Interest Paid
0.6
1.8
4.3
5.2
3.2
Return On Equity
%
-21.4
-18.7
-20.4
-20.9
-26.6 Tax Paid
-0.1
-0.3
0.0
0.0
0.0
ROCE
%
-93.1
-84.9
-130
-106
-67.6 Working Capital / Other
1.2
2.4
3.2
1.6
0.6
EPS Adjusted
c.
-8.5
-13.1
-29.1
-36.5
-38.4 Operating Cash Flow
-4.9
-7.5
-23.9
-31.3
-26.9
EPS Grow th
%
0.4
54.6
123
25.3
5.1
Net DPS
c.
0.0
0.0
0.0
0.0
0.0 Total Capex
-4.0
-4.6
-5.3
-10.0
-17.1
Div idend Cov er
x
Acquisitions
0.0
0.0
0.0
0.0
0.0
Asset Backing & Capital Structure
Div estments
0.0
0.0
0.0
0.0
0.0
Net Cash (Debt)
$m
39.0
78.2
210
139
75.0 Div idends
0.0
0.0
0.0
0.0
0.0
NTA / Share
$
0.4
0.8
1.8
1.2
0.8 Equity Raised
35.6
60.0
180
0.0
18.2
Equity / Tot Assets %
90.4
93.0
94.1
88.5
79.2 Other
-4.8
-8.7
-19.4
-29.3
-38.4
Net Debt / EBITDA x
6.0
6.8
6.7
3.7
2.4 Change in Net Debt
22.1
39.2
131
-70.5
-64.2
Interest Cov er
x
14.1
8.7
9.3
10.0
16.4
Shares on Issue
Capex /Depn
%
1,238
404
294
355
355
Ordinary
m
93.5
110
122
128
128 Capex /Rev
%
20.4
11.7
7.5
7.3
6.2
Fully Diluted
m
93.5
110
123
128
128
Customers ('000)
FY14 Customer Composition
1200
US/ROW
16%
1000
NZ
20%
800
UK
19%
600
400
200
AU
45%
0
2012
2013
2014
2015
2016
Source: Company data, NZX, First NZ Capital estimates
Market Daily
16
06 November 2013
Executive summary
Proven track record
XRO has already proven more successful in cloud penetration for two of its individual
markets (both NZ and AU) than any of its competitors has achieved in a single market.
Below we show the annual uptake of global cloud accounting customers for XRO versus
its most important competitor, INTU. We also compare XRO’s cloud penetration of SBs in
NZ and AU to INTU in its home market of the US in Figure 3. While INTU is clearly the
incumbent in desktop, scale and particularly growth is quite different when considering the
cloud in isolation.
Figure 2: INTU (QBO) vs XRO in cloud accounting
Figure 3: Cloud customers per 1mn small businesses
(global annual growth in customers, 000s) (Mar y/e)
(XRO vs INTU)
250,000
300
250
200,000
200
150,000
150
100,000
100
50,000
50
2013A
XRO
2014e
2015e
QBO
Source: Company data, FNZC estimates
XRO NZ
2012A
XRO AU
2011A
INTU US
2010A
INTU ROW*
-
0
Target price of $45.70
The following table sets out our valuation estimates under seven different scenarios, which
naturally produce a very wide range of outcomes. We primarily use a discounted cash flow
(DCF) valuation approach, as well as a revenue multiple approach. We probability-weight
each scenario, leading to a composite spot valuation of NZ$41.34/sh, and we set our
NZ$45.70/sh target price based on a 12-month roll-forward of that spot valuation. Please
refer to theValuation section for a full discussion.
Figure 4: Summary of valuation scenarios
US scenario
UK/AU scenario
US Traction (Base)
Base
US Blue Sky
Base
US Success
Base
US Low
Base
US Low
UK sub/AU base
US Low
UK base/AU sub
US Fail
Base
Probability-weighted valuation (spot)
Probability-weighted valuation (12 month)
Potential upside to current share price
Customers
FY20
4,302,507
7,003,778
5,653,143
2,276,555
2,026,625
2,033,680
1,601,237
Penetration
FY20
12.0%
19.6%
15.8%
6.4%
5.7%
5.7%
4.5%
Valuation methodology (spot)
DCF
Rev mult.
Composite
$/sh
$/sh
$/sh
$43.48
$45.60
$44.33
$75.55
$81.29
$77.85
$58.50
$63.44
$60.48
$20.96
$18.92
$20.15
$18.52
$16.92
$17.88
$19.33
$17.50
$18.60
$13.50
$10.11
$12.14
$40.74
$42.25
$41.34
$45.06
$46.73
$45.72
36%
41%
38%
Probability
%
35%
10%
20%
10%
10%
5%
10%
100%
Please also note the DCF risk warning in the Valuation section, given the wide range of
potential valuation outcomes for XRO.
Market Daily
17
06 November 2013
‘TAMplification’: Higher growth for longer
XRO is the inverse of most large tech companies, which tend to start in the US, building a
strong domestic brand, before embarking on a global strategy. XRO is already the leader
in SB cloud accounting in NZ, AU and UK markets, and recently built out its team and
product suite to take on the US market where it is reaching the end of its start-up phase. In
the US, XRO faces by far the largest s-curve of adoption.
With amplification of total addressable markets (TAMs), XRO’s evolution and progression
of markets has a pronounced consequence for its revenue growth. If XRO does indeed
prove to be successful in these larger markets, we believe it could achieve 70-100%
revenue growth for some time as it gains traction in progressively larger markets. For
example, the US has roughly 64 times larger total addressable market (TAM) than XRO’s
original NZ market.
Figure 5: Number of small businesses and current
Figure 6: Projected XRO customers by market (000s)
penetration in XRO’s markets (000s)
30,000
25.0%
5,000
4,500
25,000
20.0%
4,000
3,500
20,000
15.0%
3,000
2,500
15,000
10.0%
2,000
1,500
10,000
5.0%
5,000
1,000
500
UK
Mar-20
Mar-19
Sep-19
Mar-18
Sep-18
Mar-17
Sep-17
Mar-16
Sep-16
Mar-15
Sep-15
Mar-14
AU
Sep-14
Mar-13
NZ
Sep-13
Mar-12
Sep-12
Mar-11
Sep-11
XRO US
Current penetration (RHS)
Mar-10
XRO UK
Sep-10
XRO AU
# of small businesses (LHS)
Mar-09
XRO NZ
Sep-09
0
0.0%
US
Proprietary customer indicator
Given the importance of customer acquisition, we have developed a proprietary indicator
model to better estimate and project customers. This should provide greater visibility on
the potential acquisition of customers over the coming six months. Refer to page 12.
Funding:
Cash on hand is cUS$190mn. To date, XRO has raised US$270mn of funding, largely
from insiders and specialised SaaS investors. In October 2013, XRO completed its largest
raising to date, a US$150mn raise (at a premium) from US/NZ investors, including existing
investors Matrix and Valar Ventures. A full list of XRO’s capital raisings are provided in the
Appendices. For more info on the latest raise click: video and release.
Risks and catalysts
Extreme risk: As with any technology company at the outset of taking on global
markets, at a time of a vast technological shift, the future is most uncertain. While
we are positive on XRO’s potential prospects, one must exercise due caution and
be realistic that an investment in XRO is highly speculative and only for investors
with a high risk tolerance. Investors should pay particular attention to the Risk
section of this note.
Risks include, but are not limited to: i) competition from incumbents; ii) internet security;
iii) execution; iv) managing growth and geographical spread; v) key man risk; vi) service
pricing; and vii) market risk with the potential for significant short-term stock price volatility.
Catalysts: Feedback from the current pan-US road show to accountants; 1H14 results (21
November 2013); FY14 results (April 2013); and ongoing product updates (such as the
roll-out of US payroll and inventories over coming months).
Market Daily
18
06 November 2013
Overarching tenets
Despite its strong record to date, XRO is very early in its evolution compared to its
potential opportunity set. XRO is essentially a concept stock with disruptive technology. In
looking at XRO’s prospects for success, we are guided by five broad tenets. If these prove
incorrect this could have a significant effect on our view:
1) Cloud shift: Why the cloud can succeed
We see multiple advantages of cloud accounting and cloud migration as highly likely. We
believe that cloud accounting could almost fully displace legacy accounting software over
the next decade. For small businesses, we see this as analogous to internet banking
versus counter banking. Conversely, the supposed advantages of desktop/legacy
accounting (security/ speed/ control/ access/ robustness, etc) are becoming less
compelling. As in the early years of internet banking, much of these appear to be
overplayed and will likely lessen as a critical mass move to the cloud. There are several
examples of highly sensitive organisations/businesses moving to the cloud, such as the
US federal government, healthcare, aviation. We note that recently the inevitability of a
cloud shift has started to be acknowledged by incumbents, most obviously INTU and
recently Sage, MYOB. We also believe the eventual TAM for cloud accounting is larger
than desktop, given lower start-up/service costs, ease of use and mobility features. Cloud
accounting can go deeper into the SB market – c40% of XRO’s customers come from no
previous accounting software.
2) Cloud turbulence: Cloud migration could be a time of great disruption
The period of migration to the cloud could be a time of great disruption to the accounting
software industry, and could be the first real challenge to INTU’s incumbency over the past
two decades. As businesses and accountants migrate to the cloud, they might consider
alternatives, some for the first time in 20 years. The small “test market” of New Zealand
proves two points: the likelihood of cloud migration and also the disruptive impact that a
start-up can have versus an incumbent (MYOB in NZ).
3) Cloud natives: The cloud is led by ‘cloud natives’ – a paradigm shift
Pure-play cloud companies seem to have the edge. Most successful companies in the
cloud were start-ups on a cloud platform. Examples include Salesforce, Workday and
Netsuite. Incumbents face challenges in migrating legacy revenue streams, UI and coding
from desktop. The rules of success appear to be relatively different in the cloud, which
have proven difficult for incumbents. These include: lightness of product features (“pareto”
products), design-led cloud philosophy, thriving eco-systems, “social” customer feedback
loops, online marketing, viral network effects and the mega-trend of mobility.
4) Cloud grab: A one-off opportunity to take market share
At this point in time, we see Xero as having a lead in innovation; native cloud product, ecosystem; philosophy of accountant relationships; and GTM (go to market) strategy. Our view
is that XRO is best to capitalise on these advantages before they dissipate. XRO is best to
rapidly acquire customers before incumbents attempt to replicate what they have done.
We believe XRO is best to seize the opportunity and continue to invest heavily in R&D,
and establish partnerships with accounting firms. We see a moment in time opportunity to
succeed on a global scale, rather than short-term profitability in much smaller markets.
Against this, we see XRO’s US$150mn capital raise completed in October 2013 as crucial.
5) Cloud incumbent: In the cloud, XRO is the incumbent
While wider incumbent market positions are of course highly relevant, we also believe it is
important to consider the competitive landscape in the cloud itself. XRO is the innovation
leader of cloud accounting globally, and has already proven more successful in cloud
penetration for two of its individual markets (both NZ and AU) than any competitor it faces
globally has achieved in its own market.
Market Daily
19
06 November 2013
Background and company description
We regard XRO as a global disruptor and arguably the “Apple of Accounting”.
Xero (XRO.NZ/XRO.ASX) is an emerging global leader in cloud accounting, with solutions
for small businesses and their advisors. The company was founded in 2006 and is duallisted on the New Zealand Stock Exchange (listed June 2007 with a NZ$55mn market cap
including NZ$15mn new capital) and Australian Securities Exchange (listed November
2012). XRO’s current market cap is NZ$4.2bn (US$3.5bn).
XRO is an emerging global
leader in cloud accounting
for SBs
XRO was founded by current CEO Rod Drury (previously sold AfterMail [email archiving
software] to Quest Software in 2006 and Glazier Systems to Advantage Group in 1999)
and Hamish Edwards, formerly the owner and CEO of a small- and medium-sized
enterprises accounting business, Openside. The concept from the outset was to create
‘beautiful accounting software’ that ‘delights’ customers.
XRO has over 220,000 paying customers in 100+ countries. Most of those are in XRO’s
four key markets: New Zealand (40%), Australia (37%), the UK (14%) and the US (c4%).
XRO also operates a ROW product which is sold directly off its website. XRO’s global
headquarter is located in Wellington and the company operates country HQs in Melbourne
(AU), Milton Keynes (UK) and San Francisco (US). The accounting software is delivered
as a software as a service (SaaS) model, with organisations paying a monthly
subscription, normally by credit card. XRO hosts customers’ data in the cloud via major
IaaS suppliers such as Rackspace. Using employees as a rough proxy, XRO has a sweetspot of 1-20 employees, but serves businesses with up to 100 employees.
XRO has a global footprint
and delivers accounting
solutions via a SaaS model
Major investors include Valar Ventures (participated in four rounds of investments; San
Francisco-based tech VC, non-US investment only, backed by Peter Thiel, cofounder of
PayPal/early investor in Facebook/LinkedIn, Yammer); Craig Winkler (cofounder of MYOB,
the leading AU/NZ incumbent accounting software); Matrix Capital Management (Bostonbased, concentrated investment style, with a particular focus on SaaS and disruptive
business models) and Sam Morgan (founder of TradeMe, NZ’s eBay equivalent).
XRO has a range of
specialist technology
investors
Board: We see a high calibre and experienced board, with ample strategic vision to
navigate XRO’s rapid growth and global opportunity set. At the recent AGM, the board
gave a clear outline of its progress and risk mitigation across XRO’s four key pillars:
Performance, Capital, Capability and Culture. Overtime, further US board appointments
might be possible after the first US director, Craig Elliot (co-founder of Pertino Networks in
Silicon Valley, former CEO of Packeteer, personally recruited by the late Steve Jobs to
work at Apple) was appointed in 2012.
People: We regard CEO Rod Drury as a visionary in the new global cloud era. While Mr
Drury’s strategy and execution has been central to XRO’s success to date, we regard one
of his greatest feats as building a strong and increasingly global team of talent around him.
The global management team includes senior personnel from Google, Microsoft, and
XRO’s key competitor, Intuit. We see the most important benefit of XRO’s US$150mn
capital raise as the ability to further grow its global team, including most importantly some
key hires that can best execute its GTM strategy in the US. XRO has 500+ employees
(from 247 in July 2012) including 100+ in the US.
Culture: As with any innovation company, we see XRO’s ability to attract and retain top
global talent as paramount. XRO’s developers and sales people have managed to grow
the company at a rapid pace despite being a relatively small team by global software
standards. In NZ, XRO is known as a high energy culture and a preferred tech employer.
This culture seems to have emanated in other markets. We see XRO as creating an
innovative global team environment that would be considered best practice in Silicon
Valley. XRO has flat/open lines of communication and is an avid user of social enterprise
tools. We believe XRO will be able to continue to attract global talent through opportunity,
autonomy and culture. Also a number of initiatives help attract talent, such as XeroLabs (a
similar concept to GoogleLabs) and share-based incentives.
Market Daily
20
06 November 2013
These three short videos are an efficient way for investors to understand XRO’s product
and distinct communication / marketing style:
■ Xero Touch: The mobile app for Xero
■ Xero overview
■ The single ledger
Figure 7: Xero dashboard and Xero mobile apps
For more product information refer to Xero website or Xero’s video channel.
Market Daily
21
06 November 2013
Valuation
DCF valuation (subject to DCF valuation risk warning and comment below)
Our primary valuation methodology is a discounted cash flow (DCF) valuation. XRO is a
‘concept’ investment, which is very early stage of its evolution relative to the scale of its
potential opportunity. Thus we acknowledge that our valuation range is necessarily very
wide. Our model gives us the ability to run multiple scenarios depending on various
outcomes for each individual market, depending on assumptions around various adoption
cycles and market share. Not surprisingly, the critical valuation driver is the degree of
success in the much larger US market. Some of these scenarios are shown below.
We primarily focus on DCF
valuation. Our range is
naturally wide, depending
on adoption outcomes for
each market
As an alternative valuation methodology, we use a forward revenue multiple, calculated in
2017 in order to incorporate the critical US market ramp-up where XRO is only just
starting. The revenue multiple is based on observed peer multiples, and is discounted
back to present value.
In setting our valuation and therefore target price, we risk weight the probability of each
scenario. Our probabilities reflect our assessment of how market dynamics could evolve,
i.e. our assessment of success probability is forward looking and dynamic. We will
continue to monitor and change our probability weightings over time to reflect XRO’s
traction or a lack of traction in each market.
We risk weight the
probability of each scenario
Figure 8: Summary of valuation scenarios
US scenario
UK/AU scenario
US Traction (Base)
Base
US Blue Sky
Base
US Success
Base
US Low
Base
US Low
UK sub/AU base
US Low
UK base/AU sub
US Fail
Base
Probability-weighted valuation (spot)
Probability-weighted valuation (12 month)
Potential upside to current share price
Customers
FY20
4,302,507
7,003,778
5,653,143
2,276,555
2,026,625
2,033,680
1,601,237
Penetration
FY20
12.0%
19.6%
15.8%
6.4%
5.7%
5.7%
4.5%
Valuation methodology (spot)
DCF
Rev mult.
Composite
$/sh
$/sh
$/sh
$43.48
$45.60
$44.33
$75.55
$81.29
$77.85
$58.50
$63.44
$60.48
$20.96
$18.92
$20.15
$18.52
$16.92
$17.88
$19.33
$17.50
$18.60
$13.50
$10.11
$12.14
$40.74
$42.25
$41.34
$45.06
$46.73
$45.72
36%
41%
38%
Probability
%
35%
10%
20%
10%
10%
5%
10%
100%
We believe XRO will be successful in each of its existing markets, including, most
importantly, the US. Our probabilities are thus skewed that way, for example, a 65%
chance of some success in the US and downside scenarios which include success in NZ
and at least a degree of success in UK and AU. This view is based on our perception of
XRO’s prospects in each market, which has been derived from our analysis of the
competitive landscape; product differentials; commentary by key industry influencers;
conversations with various management / analysts / market participants; and other
dynamic competitive forces in each market.
However, the probabilities outlined below are naturally subjective. Given the early stage of
the adoption cycle, there is much scope to be wrong in our assessment, particularly to the
downside given our positive view. But by outlining our valuations for different scenarios,
this will hopefully give a framework that enables investors to assign their own probabilities
to each scenario to formulate their own valuation.
Naturally, the extremely wide range of valuation outcomes underpins the reality that
XRO is a high risk investment, both to the upside and downside.
Our composite spot valuations for each scenario are based on a 60% weighting for our
DCF valuation and a 40% weighting for our revenue multiple valuation. Our 12-month
target price is a roll-forward of our probability-weighted spot valuations.
Market Daily
22
06 November 2013
Multiples approach
We also include revenue multiples in our assessment of valuation. While revenue
multiples are not normally our preferred valuation technique, we acknowledge their
predominance in early-stage tech companies and particularly US-based SaaS companies
given the typical absence of earnings in early years.
Figure 9: Comparable companies
Com pany
Code
Xero
Workday
Textura Corp
NetSuite
ServiceNow
Marketo
Demandw are
Cornerstone
Salesforce.com
Ultimate Softw are
Concur Tech
athenahealth
Akamai Tech
RealPage
Jive Softw are
Synchronoss Tech
Responsys
Constant Contact
LivePerson
Digital River
XRO
WDAY.K
TXTR.N
N.N
NOW
MKTO.O
DWRE.K
CSOD.OQ
CRM.N
ULTI.OQ
CNQR.OQ
ATHN.O
AKAM.OQ
RP.OQ
JIVE.OQ
SNCR.OQ
MKTG.OQ
CTCT.OQ
LPSN.OQ
DRIV.OQ
Price Market Cap
US$
US$m
24.96
75.35
37.89
98.68
53.81
33.44
49.40
45.55
53.96
152.04
104.30
137.16
45.09
23.99
10.35
33.85
15.93
26.12
9.21
17.78
3,183
13,073
933
7,370
7,361
1,266
1,513
2,342
31,833
4,232
5,846
5,101
8,067
1,847
717
1,358
802
801
498
609
Average
Median
Weighted Average
Rev CAGR
FY12-15
EV/Revenue
FY13
FY14
FY15
Price/Earnings
FY13
FY14
96.5%
49.0%
n/a
30.7%
33.3%
n/a
35.2%
28.5%
26.1%
20.8%
23.6%
25.0%
15.5%
19.6%
34.8%
n/a
16.5%
3.4%
27.5%
n/a
92.4
44.8
24.8
17.4
17.0
14.3
14.0
12.3
11.0
10.1
10.3
9.0
4.8
4.7
4.1
3.7
3.5
2.4
2.4
0.9
50.9
27.5
15.5
13.4
11.7
10.9
10.3
8.7
8.4
8.2
8.1
6.9
4.2
4.0
3.3
3.1
3.0
2.2
2.1
0.9
26.3
18.2
9.9
10.5
8.6
8.4
7.7
6.3
6.5
6.7
6.6
5.5
3.7
3.3
2.8
2.7
2.5
1.9
1.8
0.9
n/m
n/m
n/m
390.3
n/m
n/m
n/m
n/m
n/m
103.9
121.3
133.4
22.7
40.7
n/m
25.7
105.4
36.0
48.7
31.1
n/m
n/m
n/m
352.6
449.2
n/m
n/m
n/m
159.3
82.2
85.9
99.8
20.9
32.0
n/m
20.4
74.4
27.7
35.0
32.5
n/m
n/m
196.9
183.6
145.1
n/m
363.2
124.5
103.0
63.2
66.5
75.3
18.4
22.5
n/m
17.1
56.9
22.4
27.9
27.1
30.4%
26.8%
29.8%
15.9
10.3
18.1
10.7
8.2
12.2
7.4
6.5
8.7
102.8
76.3
52.0
119.9
78.3
128.5
99.1
66.5
81.6
FY15
Source: Reuters, FNZC estimates; XRO price above from 4/11/13 close price
DCF valuation – Important note and risk warning
Your attention is drawn to the fact that the above DCF valuation and projections of the future
performance of XRO reflect various assumptions exclusively by the author of this report,
which may or may not prove correct. Some assumptions inevitably may not materialise, and
unanticipated events, unknown risks, uncertainties and other circumstances will likely occur.
Therefore, the actual results achieved during the period of the projections shown will vary
from those projected. The valuation will also vary from that presented, and such variations
may be material. Such factors include, among other things, the following: general economic
and business conditions; competition; regulatory or administrative changes affecting the
business; the timing and amount of the company’s capital expenses; general cloud
accounting industry trends and pricing; a lack of cloud adoption; any security breaches; third
party failures; FX risk; unexpected operations difficulties and other factors, many of which
will be beyond the control of XRO. First NZ Capital Securities Limited and Credit Suisse
make no representation or warranty, express or implied, as to the accuracy or completeness
of the DCF valuation or the information or assumptions on which such valuation is based or
derived from, and nothing in this report shall be deemed to constitute such a representation
or warranty. Recipients of this report must carry out their own analysis and are cautioned not
to place undue reliance on such forward-looking information.
Market Daily
23
06 November 2013
The following chart plots revenue multiples for the peer universe against revenue growth.
Also, we show our base case for XRO’s revenue growth relative to the peer universe’s
average and range of revenue growth.
Figure 10: Enterprise value / NTM revenue multiple versus FY14-16 revenue growth
Enterprise Value / 12Mth Forward Revenue
50
XRO Spot Val
45
y = 43.049x - 3.3519
R² = 0.8883
40
35
XRO Current
30
25
WDAY
20
N
15
NOW
ULTI CNQR CSODDWRE
CRM
AKAM
ATHN
RP
JIVE
CTCT
LPSN
MKTG
10
5
0
0%
20%
40%
60%
80%
100%
120%
Revenue Growth
Source: Company data, Reuters, FNZC estimates
Figure 11: XRO revenue growth vs SaaS peers
Figure 12: FY14 revenue growth (SaaS companies with
FY14 more than US$50mn revenue)
120%
100%
100%
80%
80%
60%
60%
40%
40%
20%
20%
0%
0%
FY12
FY13
Peer - Upper Quartile
FY14
Peer - Lower Quartile
Market Daily
FY15
FY16
Xero
24
06 November 2013
Peer analysis
Most valuation focus among SaaS peers centres on revenue multiples, with the multiple
used broadly dependent on revenue growth. What sets XRO apart from its peers is that if
it succeeds on its plan over the next three years it could offer one of the highest revenue
growth rates in the SaaS sector. For the reasons given in the next section, we believe
XRO’s revenue growth could re-accelerate during 2015-16. We see XRO’s AU and UK
markets as growth engines which are starting to gain real traction as they move from the
‘innovator’ to ‘early adopter’ stages of the adoption cycle. By then XRO will also be some
way down the track in the much larger US market. So we see XRO as having a long
runway. We will provide further details on comparable SaaS companies in later notes.
XRO could offer one of the
highest revenue growth
rates in the SaaS sector
Within the peer universe, our analysis indicates that only two companies maintained
similar growth rates to XRO once they surpassed US$50mn of revenue. Those two were
Salesforce (CRM) back in 2005-06 and Workday (WDAY) from 2012 to present. Both have
become leaders in the SaaS space, with a market capitalisation of US$31.5bn and
US$13.0bn, respectively.
Overall, we do acknowledge that XRO’s valuation represents extreme risk after recent
performance, and allows little room for disappointment. However, we believe the market
could be surprised how quickly XRO gets traction globally and the eventual scale of its
customer base. And in a success case, we believe that XRO could potentially be worth
multiples of its current valuation. The upside and downside risks to valuation are wide.
Market Daily
25
06 November 2013
Proprietary customer indicator
Given the importance of customer acquisition, we have developed a proprietary model to
better estimate and project customers. This should provide greater visibility on the
potential acquisition of customers over the coming six months. We will publish updates to
this indicator over time. Please contact us if you require more regular readings of this
indicator.
We have developed a
proprietary model to better
estimate and project
customers
When back tested, the outturn of this proprietary model has been reliable. The accuracy is
demonstrated in the chart below that plots our indicator versus actual customer acquisition
by XRO. Due to being small scale/early stage in the US, data are yet to be meaningful
there. However, we expect this approach to be possible once XRO achieves critical mass
in the US. That said, while this should improve visibility, there is a real chance that
customer acquisitions could deviate quite significantly from our forecasts for a number of
unforeseen reasons.
Figure 13: AU customers
Figure 14: UK customers
40,000
100,000
80,000
30,000
60,000
20,000
40,000
10,000
20,000
0
Mar-11
Sep-11
Mar-12
Actual Customers
Sep-12
Estimated Customers
Market Daily
Mar-13
Sep-13
0
Mar-11
Sep-11
Mar-12
Actual Customers
Sep-12
Mar-13
Sep-13
Estimated Customers
26
06 November 2013
Seizing the opportunity (TAM)
We estimate the total addressable market (TAM) for XRO’s existing four markets below.
The NZ market is at the frontier of adoption of cloud accounting. We see this as a function
of a relatively agile/innovative business sector; a modern/consolidated banking system;
network effects of a small population; and being a home market to XRO, the leading
innovator globally for cloud accounting.
We estimate a TAM of
11.4mn customers across
XRO’s four markets (a
US$4.2bn TAM)
Accordingly, we use the NZ market as a proxy for cloud accounting adoption in other
markets. Our primary approach to estimating TAM in the AU/UK/US market is to apply the
same level of penetration that XRO has of NZ small businesses. We see this as a pragmatic
approach to measure how popular cloud accounting could be. XRO was listed in 2007, but
NZ customer rates only really started to pick up in 2012 (from Sep-11A: 7% to Mar-14e:
22%). So, cloud migration can happen over a relatively quick period, and we see no reason
why that can’t occur in analogous developed markets, such as AU, the UK, and the US.
■ Scenario 1: To be conservative we first look at XRO’s current NZ penetration (FY14e
= 22%). This equates to a TAM of 8.0mn customers across XRO’s four markets. For
simplicity we use XRO’s current ARPU in each market, this equates to US$3.0bn TAM.
■ Scenario 2: To show a more probable scenario, we look at a NZ penetration level that
we are confident of XRO achieving within five years (32% or 145.6k customers, which
compares to FY14e: 102k / 1H14: 85.5k / 1H12: 30.6k). This equates to a TAM of
11.4mn customers across XRO’s four markets. This equates to US$4.2bn TAM.
We see this as a pragmatic approach to measure how popular cloud accounting could be.
After calculating TAMs, we then look at different customer outcomes depending on
different levels of market share, as shown in the following tables. The columns refer to
various market shares for AU/UK at the top of the column. The rows refer to various
market shares for the US at left.
Figure 15: Scenario 1: XRO global customer count at various XRO market shares based on 22% penetration for the
sector (‘000 customers) – market share scenarios shaded
AU
UK
US
US
US
US
US
US
10%
20%
30%
40%
50%
40%
20%
1,124
1,774
2,424
3,075
3,725
60%
20%
1,214
1,864
2,514
3,164
3,814
80%
20%
1,304
1,954
2,604
3,254
3,904
40%
40%
1,317
1,967
2,617
3,267
3,917
60%
40%
1,407
2,057
2,707
3,357
4,007
80%
40%
1,496
2,146
2,797
3,447
4,097
40%
60%
1,510
2,160
2,810
3,460
4,110
60%
60%
1,599
2,250
2,900
3,550
4,200
80%
60%
1,689
2,339
2,989
3,639
4,290
40%
80%
1,703
2,353
3,003
3,653
4,303
60%
80%
1,792
2,442
3,093
3,743
4,393
80%
80%
1,882
2,532
3,182
3,832
4,482
80%
5,675
5,765
5,854
5,868
5,957
6,047
6,061
6,150
6,240
6,253
6,343
6,433
Figure 16: Scenario 2: XRO global customer count at various XRO market shares based on 32% penetration for the
sector (‘000 customers) – market share scenarios shaded
AU
UK
US
US
US
US
US
US
10%
20%
30%
40%
50%
40%
20%
1,605
2,533
3,461
4,389
5,317
60%
20%
1,733
2,661
3,589
4,517
5,445
80%
20%
1,861
2,789
3,717
4,645
5,573
40%
40%
1,880
2,808
3,736
4,664
5,592
60%
40%
2,008
2,936
3,864
4,792
5,720
80%
40%
2,136
3,064
3,992
4,920
5,848
40%
60%
2,155
3,083
4,011
4,939
5,867
60%
60%
2,283
3,211
4,139
5,067
5,995
80%
60%
2,411
3,339
4,267
5,195
6,123
40%
80%
2,430
3,358
4,286
5,214
6,142
60%
80%
2,558
3,486
4,414
5,342
6,270
80%
80%
2,686
3,614
4,542
5,470
6,398
80%
8,101
8,229
8,357
8,376
8,504
8,632
8,651
8,779
8,907
8,926
9,054
9,182
Market Daily
27
06 November 2013
Four aspects give us confidence that this approach is robust, and if anything could actually
understate the eventual TAM. (1) Some small businesses in NZ use cloud accounting from
other providers (mostly MYOB), but we have only used XRO’s penetration to approximate
penetration for the industry. This is because reliable data across the cloud accounting
industry are unavailable. (2) We believe the advantages of cloud accounting and its
superiority over desktop accounting are sufficient that in time it will almost fully displace
desktop accounting. This is not fully reflected in our 32% projection. (3) We believe that
due to low set-up costs, ease of use, efficiency and mobility advantages cloud accounting
could more deeply penetrate SBs than desktop accounting ever has. XRO estimates 4050% of its current customer uptake is from SBs that previously didn’t use accounting
software. That said, cloud accounting adoption is still early stage, so there are naturally
uncertainties at this juncture as to the eventual TAM. (4) We assume no growth in the
number of SBs, which will naturally evolve over time.
While 80% may seem a very high market share, we have shown this given that is the
approximate market share of INTU in traditional accounting software in the US.
In addition, XRO might eventually pursue other sizeable opportunities outside the existing
four markets. We believe XRO would most likely start with Canada (TAM c1.5x AU, or
c960k customers); followed by South Africa and English-speaking Asian markets.
Market Daily
28
06 November 2013
‘TAMplification’: Higher growth for longer
XRO is the inverse of most large tech companies, which tend to start in the US, building a
strong domestic brand, before embarking on a global strategy. XRO is already the leader
in SB cloud accounting in NZ, AU and UK markets, and recently built out its team to take
on the US market where it is reaching the end of its start-up phase.
XRO’s evolution and progression of markets has a pronounced consequence for its
revenue growth. If XRO does indeed prove to be successful in these larger markets, we
believe XRO could achieve 70-100% revenue growth for some time as it gains traction in
progressively larger markets. Given that XRO is a concept investment, at very early stage
relative to its potential global opportunity, revenue growth is likely to be the primary driver
of valuation over the next couple of years. Revenue growth is a proxy for the ultimate
scale and profitability of the company.
XRO could achieve 70100% revenue growth for
some time as it gains
traction in progressively
larger markets
The US has roughly 64 times larger total addressable market (TAM) than XRO’s original
NZ market. XRO has already amassed substantial penetration in NZ (c20%) since 2007.
In that time, XRO has materially enhanced and refined its product offering and go to
market strategy (GTM). Conversely, XRO is just getting underway in terms of sales in the
US (<c0.1%). But XRO, currently valued at cUS$3bn market cap, is no start-up company.
XRO has the funding to amplify a team that is already well-resourced to take on INTU,
including former INTU and Google execs. XRO already has a ‘largely completed’ US
product in the market, but a full service offering will finally ‘complete’ and ‘ship’ with US
payroll in a matter of months. This is the end of the beginning for XRO in the US.
XRO has perfected its product and GTM strategy in the NZ and AU market. These smaller
‘test’ markets, particularly NZ, appear to be the most advanced cloud accounting markets
globally – certainly among XRO’s target markets. This is a function of XRO’s proactive
initiatives in its home market, reasonably fast adoption cycles and a more consolidated
banking system that has more progressive information technology.
The small but adaptive NZ market has given the opportunity for XRO to develop a
compelling offering “under the radar” of global incumbents.
XRO can largely transfer the “core offering” of the product to small businesses and
accountants to new markets. Meanwhile XRO’s GTM strategy appears to be transferable
to other markets; XRO is already gaining traction with the UK and US accounting
channels. The product offering and GTM combined give us confidence that XRO can
replicate its success in much larger markets. This is explored further later in the Markets
section.
The sequencing of XRO’s entry into markets results in a continued amplification of TAM.
XRO is going after progressively bigger markets, as shown in the following chart, which
also shows XRO’s current penetration in each of those markets:
Market Daily
29
06 November 2013
XRO has progressively entered larger markets
Figure 17: Number of small businesses and current penetration in XRO’s markets (000s)
25.0%
35,000
30,000
20.0%
25,000
15.0%
20,000
15,000
10.0%
10,000
5.0%
5,000
0.0%
XRO NZ
XRO AU
XRO UK
# of small businesses (LHS)
XRO US
Current penetration (RHS)
XRO’s customer acquisition amplifies with larger markets
Figure 18: Projected XRO customers by market (000s)
5,000
4,500
4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
NZ
UK
Mar-20
Sep-19
Mar-19
Sep-18
Mar-18
Mar-17
Sep-17
Mar-16
Sep-16
Mar-15
Sep-15
Mar-14
AU
Sep-14
Sep-13
Mar-13
Sep-12
Mar-12
Sep-11
Mar-11
Mar-10
Sep-10
Mar-09
Sep-09
0
US
Market Daily
30
06 November 2013
The effect of amplifying TAMs is best shown from the example in NZ and AU. The
following chart shows the progression in market penetration of XRO in its two first markets.
We compare penetration ramp-up after each country reached 1%. NZ is shown from Mar09 to Mar-14, and AU in Sep-12 when it reached 1%. XRO has already gained decent
traction in AU, and we include 12m of future projections. AU is currently tracking similarly
and in fact a touch ahead of NZ penetration before the “NZ tipping point” where NZ
experienced its highest rate of absolute growth (Mar-12 and Mar-13). The x-axes in the
following three charts refer to the number of quarters from 1% penetration of the TAM in
each market.
Figure 19: XRO’s penetration in NZ/AU after reaching 1% penetration (number of half
years (HYs) from that time) (actuals and 2014e only)
30.0%
25.0%
20.0%
15.0%
10.0%
5.0%
0.0%
1
2
3
4
5
6
7
8
9
10
11
12
Number of HYs after reaching 1% penetration
NZ
AU
We believe a tipping point is imminent in AU where XRO has achieved sufficient scale to
achieve a virtuous cycle of brand awareness for accountants and small businesses. This is
further amplified by XRO’s efforts to realise network effects, which we see as a real
strength (see later sections on Network effects). XRO also recently launched its first
above-the-line advertising campaign in select suburbs in Australia.
In valuation terms, AU is dwarfed by the potential scale of the US market. However, we
believe that AU and UK adoption will have a significant bearing on valuation. We believe
the market will watch closely as a proxy or leading indicator of potential adoption rates in
the US.
We show the equivalent adoption rates in absolute rather than percentage terms. Given
AU has around five times as many small businesses than NZ, over the same time period,
this naturally results in a much steeper adoption curve in an absolute sense (chart
overleaf). This is a precursor to what can happen if XRO succeeds in UK and the US.
Market Daily
31
06 November 2013
Figure 20: XRO’s customer numbers in NZ/AU after reaching 1% penetration (number of
HYs from that time) (000s of customers; base case)
160
140
120
100
80
60
40
20
1
2
3
4
5
6
7
8
9
10
11
NZ
AU
We assume similar ramp-ups in each market. However, we are less aggressive in our
assumptions in the UK and the US given that XRO will face more competent and better
resourced competitors there (Sage and Intuit).
Figure 21 shows our projected penetration ramp-up from the same starting base of
penetration.
Figure 21: XRO’s penetration in NZ/AU/UK/US after reaching 1% penetration (number of
HYs; base case)
35%
30%
25%
20%
15%
10%
5%
0%
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
NZ
AU
UK
US
Market Daily
32
06 November 2013
Chart 22 shows penetration ramp-up over time, reflecting the different starting points and
time to gain traction in each market. Given NZ started first, this gets to a more stable rate
quicker. XRO started in AU and UK at similar times, but for a number of reasons AU
gained traction earlier. We do note though that more recent releases from the company
have indicated that XRO is just starting to gain material traction in the UK.
Figure 22: XRO’s customer penetration by market (%, base case)
40%
35%
30%
25%
20%
15%
10%
5%
AU
UK
Mar-20
Sep-19
Mar-19
Sep-18
Mar-18
Sep-17
Mar-17
Sep-16
Mar-16
Sep-15
Mar-15
Mar-14
Sep-14
Mar-13
NZ
Sep-13
Mar-12
Sep-12
Mar-11
Sep-11
Mar-10
Sep-10
Mar-09
Sep-09
0%
US
Overall, our analysis leads to the following customer number projections. These show our
expectation that customer uptake could accelerate as XRO gains traction in larger
markets.
Figure 23: XRO’s customer numbers by market (000s of customers; base case)
3,000
2,500
2,000
1,500
1,000
500
NZ
UK
Mar-20
Sep-19
Mar-19
Sep-18
Mar-18
Sep-17
Mar-17
Sep-16
Mar-16
Sep-15
Mar-15
Mar-14
AU
Sep-14
Sep-13
Mar-13
Sep-12
Mar-12
Sep-11
Mar-11
Sep-10
Mar-10
Sep-09
Mar-09
0
US
Market Daily
33
06 November 2013
Stacking the markets on top of each other, we expect phased amplification of TAM to lead
to continued steep growth in total customer numbers, reaching 4mn+ in 2020. Obviously,
cloud accounting is very early stage in the adoption cycle, so the eventual outcomes will
be markedly different. Nonetheless, the existence of a much later stage market in NZ
gives us much more confidence in our projections than would otherwise be the case.
Figure 24: XRO’s total customer numbers (000s of customers; base case)
5,000
4,500
4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
NZ
UK
Mar-20
Sep-19
Mar-19
Sep-18
Mar-18
Mar-17
Sep-17
Mar-16
Sep-16
Mar-15
Sep-15
Mar-14
AU
Sep-14
Sep-13
Mar-13
Sep-12
Mar-12
Sep-11
Mar-11
Mar-10
Sep-10
Mar-09
Sep-09
0
US
This in turn is likely to lead to high revenue growth being maintained for a longer period of
time. The following chart isolates different combinations of markets. For example, the top
line shows XRO in all markets (base case) and the bottom line if XRO were only to grow
revenue in NZ. Naturally, multiple streams of growth from increasing scale of market
results in a high level of growth. By comparison, our SaaS comp universe has average
revenue growth of 26% FY14-16E (including only US$50bn+ revenue companies).
Figure 25: Revenue growth (with different markets included)
140.0%
120.0%
100.0%
80.0%
60.0%
40.0%
20.0%
0.0%
2012
2013
NZ
2014
NZ/AU
2015
NZ/AU/UK
2016
2017
2018
NZ/AU/UK/US
Market Daily
34
06 November 2013
By comparison, even in a market still some way from maturity, revenue naturally declines
from a doubling each year when one market is considered in isolation (in this case XRO’s
initial market of NZ where it has quickly amassed penetration). For the record, we still
expect XRO to continue to add healthy levels of revenue in the NZ market in absolute
terms (Figure 26). It’s just that as with any single market this eventually leads to much
lower revenue growth in percentage terms.
Figure 26: Revenue growth from NZ alone (NZ$ ’000)
100.0%
8,000
90.0%
7,000
80.0%
6,000
70.0%
5,000
60.0%
50.0%
4,000
40.0%
3,000
30.0%
2,000
20.0%
1,000
10.0%
0.0%
2012
2013
2014
2015
NZ Revenue (000s)
2016
2017
2018
2019
2020
NZ Revenue growth (%)(RHS)
Finally, given that XRO to date has tended to particularly appeal to early adopters and
new business start-ups, we expect XRO to be particularly successful at capturing
customers during the early stages of each adoption curves. This is one of the reasons that
gives us particular confidence on the trajectory for XRO’s next 18 months.
Market Daily
35
06 November 2013
Market overviews
The following table summarises XRO’s major competitors in SB cloud accounting globally.
The three major incumbents in each geography are Intuit (US), Sage (UK) and MYOB
(AU/NZ). XRO has already amassed sufficient market share to oust MYOB (established
1991) to become the dominant brand in the NZ cloud market. We believe the NZ market,
with the emergence of XRO, is a small and innovative ‘test market’ that shows the
potential for small businesses and their accountants to collaborate in the cloud. We expect
other markets to follow.
Incumbents: We rank the incumbents’ capability in the following order: 1) Intuit; 2) Sage;
and 3) MYOB. We see INTU as considerably ahead of the other two. We believe XRO
already has an unassailable lead in AU and we are confident on the UK. Outside of the
US, we believe XRO currently has a first-mover advantage in the clear and a competitive
edge. In the US, we see XRO as having the lead in innovation, and a real chance of
success if it can execute its GTM strategy. However, globally XRO will need to move fast
and remain fully funded to capitalise on its lead. XRO faces large incumbents whose future
prospects are likely to depend on their strategic response to the cloud.
Small players: While we see potential for niches to emerge, we see little risk at this
juncture of any non-incumbent / smaller player overtaking XRO in any of its four markets.
There is no emergent smaller player with sufficient funding. So we see the battle in XRO’s
four markets as being between XRO and the three incumbents.
Figure 27: Key competitors
Small business
Primary markets
product (if not
core focus)
Customers
(‘000s)
Desktop/*Cloud
APIs for cloud
Monthly pricing
product
(as at 14 Oct 2013)
300+
NZ$49 Medium
Comments
NZ$29 Small
NZ, Australia, UK
211
and US
See note
$64 Large
Incumbents
Total: 5,100 small
US
QuickBooks Online
businesses
US$12.95 Simple
33
c500* (QB Online)
UK, France, Spain
and Germany
Australia and NZ
Sage One
AccountRight Live
and LiveAccounts
6,000 Total
c15* (Sage One)
US$39.95 Plus
£5 plus VAT Payroll
18
£10 plus VAT Accounts
£5 plus VAT Cashbook
$23 ex GST LiveAccounts
Total: 1,200
Cloud: not
US$26.95 Essentials
20
disclosed
$21 ex GST AR Live Basic
$37 ex GST AR Live Std
$56 ex GST AR Live Plus
Clear market leader, recently
more focussed on cloud;
considered XRO’s main
competitor
Considered laggard in cloud
versus XRO and Intuit
Transitioning to cloud not well
received, AR Live is not a true
cloud product
Minors
Accounts Hosted
Australia and NZ
(previously
Total: 600
QuickBooks)
Lost QuickBooks brand and
NZ$42.50 Premium*
releasing Reckon One to
*Available after first 12mths
Unclear (include
US, Canada
NZ$33.50 Standard*
Free (invoicing, accounting and
non- paying
personal finance)
customers
compete with XRO
Underlying product free but adsupported; payroll and payment
are paid services
Formed a partnership with the
Not available publicly, must
AICPA to help CPA firms and
submit a quote request
businesses adopt cloud
US
6
UK
30
35
US$20
UK
20
71
£18 plus VAT
computing in 2009
Acquired by IRIS Software
Group in October 2013
£9 Micro
UK
10
11
£19 Expansion
£39 Connect
Source: Company data
Market Daily
36
06 November 2013
US: Biggest opportunity and best competitor
The US market clearly dwarfs all others (c4.3 times the size of UK/AU/NZ combined). In
the US, XRO goes up against its most competent, innovative and aggressive competitor,
Intuit (US$20.2bn market cap). USA is XRO’s biggest challenge and biggest opportunity.
Competitors
■ c29mn small businesses in the US.
■ INTU is the clear leader in the US for SB accounting products with its QuickBooks and
QuickBooks Online products. INTU’s has around 80% share of the legacy US market
(desktop accounting software).
■ Given the predominance of INTU, and a lack of credible smaller players, we focus
entirely on INTU when looking at the US market dynamics.
Figure 28: XRO’s US revenue versus customers (base)
Figure 29: US revenue versus US as % of global rev
1,400
3,000
1,400
80%
1,200
2,500
1,200
70%
1,000
2,000
60%
1,000
50%
800
800
40%
1,500
600
600
1,000
400
500
200
0
0
FY13
FY14
FY15
FY16
Revenue NZ$m (LHS)
FY17
FY18
FY19
FY20
30%
400
20%
200
10%
0
0%
FY13
FY15
FY16
Revenue NZ$m (LHS)
Customers '000 (RHS)
FY14
FY17
FY18
FY19
FY20
% of Global (RHS)
XRO in the US
■ XRO had 16,600 customers in the US/ROW as of 30 September 2013
■ 2,000+ accounting professionals have completed XRO training events – a key indicator
of growth.
■ Off a low base, US/ROW grew at 141% in 1H14, second only to its AU market. We
believe that the US is tracking just ahead of AU at the same market maturity.
■ XRO is just starting to gain traction in the US, ahead of the releases of US payroll (late
2013) and inventory (mid 2014) that will round out the core platform. A lack of inventory
to date has shut out at least 30% of the market for XRO.
■ Headquarters in San Francisco. Opened sales offices in New York, Los Angeles and
Denver.
■ 400 accountant professionals and XRO Partners just attended XRO’s inaugural
Xerocon (XRO’s annual conference).
■ Payroll to be released late-2013. Payroll is currently being demonstrated in XRO’s first
pan-US road show (Oct-Nov-13). Payroll proved to be a tipping point for AU adoption.
■ Software to enable conversion from QuickBooks desktop accounts has just released
and will also be demonstrated in XRO’s road show.
Market Daily
37
06 November 2013
INTU’s strengths
Despite our positive view on XRO, it is important to remember that INTU does have
significant advantages with its substantial brand equity, recognition and existing
relationships with accountants and accounting influencers. These points are selfexplanatory for an incumbent with such market dominance. The stakes are high and one
should not underestimate INTU’s power, ability and indeed its growing focus on the cloud.
We also acknowledge that INTU has a material advantage given its leading tax software,
TurboTax. XRO currently addresses US tax through its ecosystem add-on partners,
Lacerte and CCH, which does give it pan-US tax coverage. Integrating US tax would seem
to be an obvious strategy for XRO to consider at some point in the future.
However, five reasons we believe XRO could succeed in the US:
■ 100% pure cloud: XRO’s core accounting engine, evolved over seven years in the
NZ/AU market, is well placed to compete in the US cloud accounting market. A pureplay cloud-based platform is a real advantage versus INTU’s “converted” technology
stack which will require a degree of “refactoring” (time-consuming restructuring of the
existing body of code just to stand still). The current approach seems to be to improve
the form rather than the fundamental framework. We believe this will likely make
INTU’s platform more cumbersome to develop going forward.
Conversely, XRO’s platform was built from the outset in the cloud with open API. XRO
has already displayed a clear advantage in pace of innovation and coding. This will
further accelerate with its greater financial resources today.
Despite its apparent incumbent position, INTU has been much slower to fully commit to
the cloud, and its recent QuickBooks Online (QBO) refresh (branded “Harmony” QBO –
currently in beta testing) is its first real attempt to match XRO’s more elegant and userfriendly (Apple-esque) user interface (UI). It appears to try to mimic XRO’s design
principles, rather than being developed as a fully-integrated design-led philosophy from
the outset. That said, for now INTU does have the advantage in breadth of product with
QBO – albeit a less integrated collection of legacy products. We note that there is a
lack of legacy desktop software companies that have successfully led cloud migrations.
While INTU is undergoing substantial change management (the largest in at least a
decade) to transform into a more cloud-oriented enterprise, cloud is all that XRO does.
■ Culture of innovation: Imitation is the sincerest form of flattery. It is fair to say that
where INTU’s cloud strategy has improved over the past two years it is where it has
altered its approach to match XRO’s more closely. This is essentially a confirmation
that its own approach to the cloud has historically not worked. XRO is at the leading
edge of change in cloud accounting, with INTU following suit. We believe that one of
XRO’s core competencies is the ability to hear and indeed anticipate what customers
need and rapidly design/deploy those solutions. Having said that, we do acknowledge
that historically INTU appears to have a better reputation for innovation than some
incumbents in other software categories.
■ No installed base: In a cloud migration, an installed base is somewhat cumbersome
strategically. By switching customers to the cloud, INTU is potentially cannibalising its
own desktop base, reducing short-term revenue, and risking leakage to cloud
competitors, as customers go through a one-off transition. We believe as SBs move to
the cloud, they will consider other options, in a way they wouldn’t do if they were
merely updating to a new desktop software version. There is also the silver lining of
INTU starting to acknowledge and communicate the inevitability of cloud migration to
accountants and SBs. This should speed up cloud adoption among INTU’s substantial
installed base, at a time when XRO still has the lead in the cloud.
Market Daily
38
06 November 2013
■ Accounting partners: XRO has a proven, well-developed model of educating/
partnering/collaborating with accountants, whereas INTU has historically used
accountants in a more traditional reseller role. XRO has tuned this approach over
seven years. And it is transportable to the US market. XRO has an advantage in the
degree of integration between its accounting platform and its free ‘practice studio’ for
accountants. This is discussed further in the later section on accountants.
■ Ecosystem and add-ons: XRO has a proven, well-developed model of collaborating
with its add-on ecosystem. These benefits and INTU’s shortcomings there are explored
in the later ecosystem section. It is telling that INTU’s references to the “ecosystem”
are bundling its own product.
From a cloud perspective, INTU and XRO’s relative scale is very different. Despite its clear
head-start, INTU has been relatively slow to migrate customers into the cloud, particularly
outside the US. The data below show how INTU’s global growth in cloud flatlined over the
past year, and how we expect XRO’s global growth in FY14 to be 51% higher than INTU’s
was last year (XRO FY14e: 150k vs INTU FY13A: 96k). While we don’t forecast INTU, it is
not hard to see the potential for XRO to surpass INTU globally.
(global annual growth in customers, ’000s) (Mar y/e)
(global annual growth in customers, %) (Mar y/e)
300
200%
250
160%
200
120%
150
80%
100
40%
50
0%
0
2010A
2011A
2012A
2013A
XRO
2014e
2010A
2015e
2011A
2012A
2013A
XRO
QBO
2014e
2015e
QBO
Figure 32: INTU (QBO) vs XRO in cloud accounting (global number of customers, ’000s)
700
600
500
400
300
200
100
0
2009A
2010A
2011A
XRO
2012A
QBO US
2013A
2014e
2015e
QBO Non-US
Overall
It certainly will not be easy and will at best take several years. However, overall we believe
XRO has the competitive edge in cloud accounting and the established GTM strategy to
succeed in the US.
Market Daily
39
06 November 2013
AU: Growth engine #1
XRO is leading in cloud uptake over incumbent MYOB. XRO appears to have a clear
technological and user interface (UI) advantage versus MYOB’s solutions. We believe
XRO has the highest probability of success in AU versus its other larger markets. AU is
XRO’s fastest growing market and we expect AU to be XRO’s key growth engine in 1H15.
Competitors
Figure 33: XRO’s AU revenue versus customers (base)
700
250
Figure 34: AU revenue versus US as % of global rev
50%
250
45%
600
200
40%
200
500
150
400
35%
30%
150
25%
300
100
20%
100
15%
200
50
100
0
0
FY13
FY14
FY15
FY16
Revenue NZ$m (LHS)
FY17
FY18
FY19
FY20
10%
50
5%
0%
0
FY13
FY14
FY15
FY16
Revenue NZ$m (LHS)
FY17
FY18
FY19
FY20
% of Global (RHS)
Market
■ c2mn small businesses in Australia
XRO
■ 79,100 customers in AU as of 30 Sep 2013. In the year to 30 Sep 2013, AU was the
fastest growing market in both percentage and absolute terms, +143% YoY and 46,600
customers added (+89% and 99,500 for XRO globally).
■ Headquarters in Melbourne. Sales offices in Sydney, Perth, and Canberra.
■ XRO just commenced its first above-the-line ad campaign (#dobeautifulbusiness)
Competitors
Same competitors as NZ, except INTU which does not compete in NZ directly:
MYOB
■ MYOB’s AccountRightLive launched in October 2012 but is not a true SaaS solution
(see AU section).
■ MYOB’s LiveAccounts (discounted, pure cloud) is a product light on functionality.
Reckon/INTU
■ 18,000 Reckon Accounts online users in Australia and NZ.
■ Licensing agreement with Intuit concludes in February 2014 requiring a new product
launch, no longer use of the QuickBooks brand.
■ Reckon releasing Reckon One to compete with XRO. Currently in beta testing, and has
been delayed a year.
■ INTU directly entered the AU market with QuickBooks online. Limited impact so far.
Other: Saasu – quality product, but less ambitious business model and funding.
Market Daily
40
06 November 2013
Description
XRO has a tailwind of momentum in Australia, its key growth market currently. XRO has
quickly displaced MYOB as the clear leader in cloud accounting. MYOB was de-listed from
the ASX after Archer Capital (AU private equity firm) bought it in January 2009 for
A$560mn.
MYOB has 1.2mn total customers (predominantly legacy accounting software) across
AUNZ versus XRO’s 79,100 in AU (pure cloud) and 85,500 in NZ (pure cloud). In our view,
MYOB’s AccountRightLive “syncing” technology is somewhat outdated, a technology
hybrid between the desktop and the cloud. The product could be described as ‘cloud
wash’ (something made to look like the cloud, rather than a genuine cloud offering).
Syncing was an approach that INTU tried and walked away from several years ago. As
INTU’s CEO has said, “I think it comes down to what the next generation of customers
want. I don’t think syncing product will give it to them.” Also, MYOB’s LiveAccounts
(discounted, pure cloud) is a product light on functionality. In our view, from a cloud
offering perspective, it appears that MYOB lags XRO in functionality, infrastructure and
innovation.
We believe MYOB and XRO’s products will continue to bifurcate as XRO continues to lead
the evolution of cloud accounting and awareness grows in the marketplace through XRO’s
evangelising of the cloud. We believe it is only a matter of time before cloud-based
accounting services substantially displaces desktop-based services. This could cause
disruption in market leadership. We also note that MYOB’s debt loading will likely
constrain a business that really would likely require a significant reorganisation, a refresh
and injection of capital to succeed against a cloud-based service provider.
Out of AU, US and UK markets, we see AU as XRO’s highest chance of dominance. With
its debt burden and a lack of innovation, we see MYOB as the most exposed of the
incumbents. We also see Chris Ridd, XRO’s Australian manager, as a real strategic asset
to XRO, both locally and globally.
INTU’s direct entry into the AU market after dropping Reckon as a reseller appears to be
an attempt to hamper XRO in its key growth market. While we see INTU as a very credible
and competent competitor in the US market, INTU has historically struggled to grow
outside its North American base. We also note that XRO already has first-mover
advantage and strong momentum after gaining real traction in AU over the past 18
months.
We believe Reckon will struggle to enter the cloud accounting race from a standing start.
The launch of its new cloud product is imminent (currently in beta testing), but running
around a year late. We believe Reckon could lose market share to XRO and INTU.
We don’t see any credible minor companies in the Australian market. While Saasu is a
quality product, its business model, GTM strategy and funding put it far behind XRO in the
likelihood of domination.
Feature-wise, the introduction of AU payroll in May 2012 was a game-changer in adoption.
We expect the much anticipated rounding off of the product suite (inventory, purchase
orders, sales quotes and enhanced reporting) over the next year to similarly drive another
acceleration in growth, coupled with XRO’s first above-the-line advertising campaign
globally (#dobeautifulbusiness).
Overall, we are confident XRO will extend its lead in the AU cloud accounting space.
Market Daily
41
06 November 2013
UK: The surprise growth engine
While XRO hasn’t focussed on the UK in terms of communication with the market, we see
potential for it to surprise to the upside in FY15. We believe the UK is approaching a
tipping point of disruption. The incumbent Sage (£3.68bn market cap, US$5.94bn), so
dominant for desktop/hosted accounting software, has been surprisingly slow to react to
the cloud opportunity. Indeed, we share the view emerging in the UK market that the cloud
(and especially XRO) poses more of a threat than an opportunity for Sage.
Competitors
TAM
■ c4mn small businesses in UK and Ireland
XRO
■ 30,100 customers in UK
■ Headquarters in Milton Keynes, opened sales office in London mid-2013
■ ICAEW accredited
Competitors
Sage One (Sage’s cloud solution)
■ 12,000 total subscribers
■ Localised in Spain, France and Germany
■ Considered laggard to XRO and Intuit
QuickBooks Online, (Intuit)
■ 487,000 total subscribers, but only 32,000 outside the US. We estimate c10,000 of
these are in UK.
■ Operates in 160 countries, available in over 45 languages
■ ICAEW accredited
FreeAgent
■ 30,000 total subscribers (majority in UK)
■ Operates in 80 countries globally (minimal subscribers ex UK)
■ Available in English only
■ Ability to make the requisite investment for material growth could be limited
Other
■ Kashflow – acquired by IRIS Software Group in October 2013, a provider of accounting
and payroll solutions, leading to a joint subscription base of 60,000
■ ClearBooks – 10,000 subscribers, ICAEW & ICB accredited, appears to be in growth
phase off a low base
■ Twinfield – struggling, uncertain future within CCH
■ Crunch – c4,000 subscribers
■ e-conomic – struggling in UK
Market Daily
42
06 November 2013
The following chart (derived from market research conducted by XRO in the UK) shows
how the UK is approaching a tipping point, with more than 50% of accounting practices
now either already using the cloud or intending to move to the cloud. The adoption by
accounting practices has proven in NZ and AU to be a clear lead indicator for customer
acquisition.
Figure 35: Cloud tipping point in the UK
Practices
already using
cloud
28%
0%
Not using or
intending to
move to cloud
45%
Intending to
move to cloud
27%
20%
40%
60%
80%
100%
Source: Company market research
The following chart shows XRO’s 1,200 accounting partners in the UK. XRO’s partnership
programme is a clear leader in the UK, with more active participation and collaboration
with the accountant channel.
Figure 36: Affiliated accounting practices for each product
Xero
724
532
29
FreeAgent
161
e-conomic
181
21
Clear Books
98
Sage One
82
0
200
400
600
Certified Practices
800
1000
1200
1400
Uncertified Practices
Source: Company data; derived from online databases of accounting partners
Market Daily
43
06 November 2013
Figure 37: XRO’s UK revenue versus customers (base)
350
900
800
300
Figure 38: UK revenue versus US as % of global rev
25%
350
300
20%
700
250
600
250
200
500
200
150
400
150
300
100
15%
10%
100
200
50
100
0
0
FY13
FY14
FY15
FY16
Revenue NZ$m (LHS)
FY17
FY18
FY19
FY20
5%
50
0
0%
FY13
FY14
FY15
FY16
Revenue NZ$m (LHS)
FY17
FY18
FY19
FY20
% of Global (RHS)
Our initial observation of the UK market is that it appears to be approaching a tipping point
of disruption, led by XRO. Against several more established competitors, XRO has already
secured a slim lead to become the most popular cloud accounting platform for small
businesses in the UK. A critical lead indicator is that XRO has already managed to secure
1,200 accounting partners.
XRO appears to be gaining material traction and critical mass in the UK, which is roughly
twice the size of the Australian market. XRO started in the UK at a similar time as
Australia. However, the original uptake seems to have been slower than Australia due to
slower availability of bank feeds and perhaps a less innovative/more conservative culture
among accountants. Interestingly, XRO found in both NZ and AU that “tipping points”
tended to occur in the accounting profession once there was sufficient “safety in numbers”
moving to the cloud. In New Zealand, which is in a later stage of cloud accounting
adoption, for some accountants the decision to move to XRO has become a defensive
move of not wanting to be left behind.
While bigger than AU, we still expect the UK to lag in customer adoption for some time.
However, we expect the UK to start to become a second growth engine for XRO.
As mentioned, we are surprised at the languid response to cloud computing by the major
UK incumbent, Sage. Sage has apparently only secured 12,000 subscribers to its Sage
One product. We believe Sage faces some structural issues and lacks a response to
XRO’s disruptive strategy of effectively giving away accounting software to accountants.
We believe that XRO’s fresh starting point of collaboration with accountants, also gives
them the edge over Sage’s mixed relationship with the industry. Conversely, Sage has
historically approached accountants as another revenue stream for its practice
management software.
Far from being design or innovation led, Sage’s global strategy has been to patch together
piecemeal acquisitions. This is at odds with the inherent integration of true cloud solutions.
The UK has the most developed collection of smaller cloud accounting software
companies of the four markets and is the most fragment competitive landscape. It also has
the most able smaller pure cloud competitor that XRO faces internationally, with
FreeAgent. While FreeAgent is worth keeping an eye on, particularly if it is acquired, its
momentum seems to have stalled somewhat and it does not have the same access to
capital as XRO and the global incumbents.
Market Daily
44
06 November 2013
NZ: The perfect test market; the template
Intro
Given the small scale of the market, XRO’s growing domination and a gradual slowing of
growth as cloud adoption is later stage, the NZ market has little impact on valuation.
However, it is an important template: for the potential cloud accounting adoption cycle,
efficacy of GTM strategy and path to profitability.
Figure 39: XRO’s NZ revenue versus customers (base)
Figure 40: NZ revenue versus US as % of global rev
50
180
50
50%
45
160
45
45%
40
140
40
40%
35
35%
30
30%
25
25%
20
20%
15
15%
10
10%
5
5%
35
120
30
100
25
80
20
60
15
10
40
5
20
0
0
FY13
FY14
FY15
FY16
Revenue NZ$m (LHS)
FY17
FY18
FY19
FY20
0
0%
FY13
FY14
FY15
FY16
Revenue NZ$m (LHS)
FY17
FY18
FY19
FY20
% of Global (RHS)
Market
■ c455,000 small businesses in NZ
XRO
■ 85,500 customers in NZ as of 30 Sep 2013
■ Global headquarters in Wellington
Competitors
Same competitors as AU, except for INTU which does not compete in NZ directly
MYOB
■ MYOB’s AccountRightLive launched in October 2012 but is not a true SaaS solution
(see AU section)
■ MYOB’s LiveAccounts (discounted, pure cloud) is a product light on functionality
Reckon
■ 18,000 ReckonAccounts online users in Australia and NZ
■ Licensing agreement with Intuit concludes in February 2014 requiring a new product
launch, no longer use of the QuickBooks brand.
■ Reckon releasing Reckon One to compete with XRO. Currently in beta testing, and has
been delayed a year.
■ Small presence in NZ
Other
■ Saasu
Market Daily
45
06 November 2013
We see New Zealand as a perfect test market. XRO was able to develop and perfect its
core accounting engine, well away from larger markets and competitors. In this way,
XRO’s product has been able to develop “under the radar” before landing in much larger
markets with a well-developed product offering and proven GTM strategy.
NZ’s small population allows for rapid and collaborative interaction with influencers,
accountants and small businesses. This collaborative approach created a rapid feedback
loop which has enhanced product and GTM development. NZ tends to have an innovationfriendly business environment. NZ also has a history of innovation in banking technology.
It was used as an early test market for both internet banking and electronic point of sale
(EPOS) technologies.
The market structure, as with Australia, was previously dominated by the incumbent
MYOB. Since its launch in 2007, XRO has rapidly taken market share from MYOB. MYOB
was discussed in the previous section on the Australian market, similar themes apply in
NZ.
NZ has the lowest growth potential, a much smaller market with higher penetration of
cloud accounting. NZ recently slowed to 49% customer growth versus other markets at 99143%. Being later stage, NZ offers an insight into potential penetration for cloud
accounting in other markets. Indeed, we use NZ to project an upper limit in percentage
terms to determine the potential TAM in other geographies. Finally, we see XRO’s market
share in NZ its most entrenched and defensive.
Overall, NZ offers an insight into the size of opportunity for XRO. With XRO as a local
brand champion and dynamic agitator for change, we believe NZ is the most advanced
cloud accounting market globally.
ROW: Back of mind, for now
XRO reports customer numbers as USA/ROW of which we believe two-thirds could be the
US, with the country making up the vast majority of customer growth. We largely ignore
the ROW for now. XRO has the opportunity to potentially become multiples of its current
size in its existing markets alone. However, suffice to say that if the US market works, we
expect XRO to redeploy its well-developed new market playbook to enter Canada, South
Africa followed by English-speaking Asia and beyond. In a bull case (i.e. – XRO succeeds
in the US) ROW could eventually prove to be quite material (for example, Canadian
market alone is roughly 1.5x the size of the Australian market) while requiring relatively
little investment.
The core of the accounting engine is geographically neutral, with say 10% of new coding
required for localisation. Some additional elements outside the core such as payroll, tax
and reporting are much more localised. XRO is already set up for multi-lingual user
interfaces when required. Multi-lingual ability is an example of a common theme in XRO’s
early strategic decisions: XRO has typically chosen the harder/more expensive best-inclass options. Early investment makes it a true global platform.
Market Daily
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06 November 2013
Network effects
Overall, XRO has been particularly successful in developing network effects that lead to
potential for viral spread of its products once a critical mass is reached. That was the
experience in NZ once a tipping point of 5% penetration was reached (AU incidentally was
at 4% penetration in September 2013, with some states/cities someway ahead of that). A
key reason for XRO’s successful GTM strategy has been one-to-many marketing benefits
of empowering the accounting channel.
Key pillars of XRO’s GTM that benefit from network effects are:
1)
Empowering the accounting channel
2)
Leveraging the ecosystem
3)
Online invoicing
These both accelerate customer acquisition and lower sales and marketing costs.
Network effect #1: The importance of accountants
Central to XRO’s GTM and channel strategy is empowering accountants and
bookkeepers, who in turn provide “partner” endorsement. Rather than mere resellers, XRO
has successfully shown them how cloud accounting can provide tangible benefit to both
their practice and clients’ businesses. Themes include fixed-price billing and advisory
services. XRO also supplies cloud solutions for practice management that are fully
integrated with the client software. Around 60-70% of XRO’s sales are sold through
accountants and bookkeepers. We believe this is a powerful strategy, particularly given
that most accountants need some guidance on how best to modernise their practice and
transform into cloud-based solutions. Accountants then act as a gatekeeper to IT
accounting decisions for their SB clients.
XRO’s partner strategy is based on three stages:
1)
Recruit: reach out to accountants to attend introductory events
2)
Educate: host regular events to enhance the practice, transition their practice and
derive benefit for customers. Events also showcase new product features.
3)
Grow: help the partner to grow their cloud-based practice and realise benefits of
cloud.
This has proved a true win-win as partners grew their practices rapidly while XRO grew its
customer base.
XRO is unique in providing both small business and accountant tools on the same
integrated platform. This has disrupted incumbent accounting software providers, whose
solutions are either not integrated or only partially integrated. Also, this places a
substantial barrier to entry to small competitors, none of which have sufficient resources to
develop accountant tools that are not directly remunerated. This substantial upfront
investment has deepened XRO’s upfront investment, but leads to much greater customer
acquisition and disruption than otherwise.
Now that the upfront investment has been made, this will materially reduce future sales
and marketing operating expenditure. Accountants, once converted, provide a gateway to
their clients. The more clients and accountants convert, the greater efficiencies they
realise from cloud accountancy. This creates a “one-to-many sales” channel which makes
the economics of selling to SBs feasible. Almost all SBs use an accountant.
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06 November 2013
Conversely, there is typically no common link for other SaaS solutions with small
businesses. For example, for CRM – there is no common “customer relationship
professional” that stands between the SaaS provider and small businesses. Thus CAC
(cost to acquire a customer) is prohibitive to sell into small business and most SaaS
providers to date have focussed on the enterprise rather than small business. Therefore
XRO’s partnership with accountants provides a unique link into small business. Other
SaaS providers are now willing to “piggy back” onto XRO’s customer relationships via
XRO’s ecosystem (see following section).
Figure 41: XRO platform – the relationship between XRO’s SB and practice tools
Source: Company information
XRO perfected its strategy for the accounting channel in the NZ market, with its small,
collaborative and highly networked accounting industry. XRO followed this playbook again
in the AU market, a critical reason for its rapid success in a market with an established
domestic incumbent. And XRO is already well established with key influencers in the US
and UK markets. We see the free provision of cloud solutions for accountants as one of
the key strengths of XRO’s strategy and one of XRO’s most disruptive attributes.
XRO is starting to build traction with US industry influencers, such as trainers who convert
accountants to the cloud. This is a double network effect as influencers disseminate the
message to accountants who in turn communicate with their client bases of small
businesses. 400 accountant professionals and XRO Partners recently attended XRO’s
inaugural XeroCon event in the US. Below is an example of an interview with Michelle
Long of longforsuccess (accountant trainer, author, QuickBooks and cloud consultant) who
recently added Xero to the name of her 38,000 members LinkedIn group of “Successful
QuickBooks Xero Cloud Consultants”. The video includes the comment “accounting
professionals [in NZ] really are years ahead of [in the US] … it's really working well for a lot
of them.”
“Partner” Materials:
Video: connecting accountants to small business clients
Interview with US influencer Michelle Long
Overview: Benefits of Xero's partner program
Website: Partners section
Market Daily
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06 November 2013
Network effect #2: The importance of ecosystem
XRO plays well with other cloud add-on solutions. XRO’s open API was designed from the
outset and has always been free for add-on providers to hook into. The advantage is that
XRO embraces other companies’ innovation to deliver rich solutions for clients, in a way
that it could never do by itself. Essentially, XRO and its ecosystem are growing together,
and from a client perspective the sum total of solutions is much greater than XRO acting
alone. This is a unique advantage of cloud vs. desktop solutions. Depending on the client’s
business, they can pick and choose solutions from various providers that best meet their
demands. The key is how they integrate. No combination of desktop software packages
can offer that same breadth and certainly not the integration between solutions.
We see the degree of ecosystem growth as a critical differentiator between cloud
accounting competitors. A vibrant small business ecosystem has evolved around XRO.
With an accounting engine at the core, XRO is becoming a small business platform with
300+ add-on applications. This collaborative ecosystem provides a wide range of business
solutions for SBs and accountants. In return XRO realises referral benefits. The sales
teams for 300+ add-ons are indirectly promoting XRO when they promote themselves and
vice versa. Another virtuous cycle which effectively “clubs together” marketing spend.
Similar to XRO’s approach to accountants, its approach to ecosystem is true collaboration.
XRO provides a launch pad for small add-ons, designed by developers looking to provide
solutions for SBs. In a true win-win, XRO helps small add-ons by introducing them to
capital providers, providing introductions to help them grow into new international markets
and even occasionally co-habiting leased office space to add-on partners to provide
beachheads into new geographies.
A more familiar example of a successful platform of innovation is Apple’s iTunes. The
iTunes platform is provided by Apple but the ongoing innovation is effectively “crowdsourced” from a multitude of app developers.
Figure 42: Add-on application growth
350
300
300
250
200
150
113
100
45
50
1
5
2008
2009
14
0
2010
2011
2012
Today
As mentioned previously, XRO has managed to build a scale business that targets SBs, a
rare feat among its large cloud peers. XRO thus provides a unique SB “platform” for SaaS
businesses seeking to reach SBs. This in turn provides a virtuous feedback loop as those
SaaS businesses promote XRO by association.
Market Daily
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06 November 2013
The new rules of the cloud were obviously lost on INTU, who has failed to embrace the
ecosystem. Surprisingly, it has been slow to open its API and even attempted to use its
ecosystem as another revenue stream, by charging a fee for add-on partners to hook into
its QBO. By contrast, XRO treats its ecosystem as the real win-win that it is. XRO’s API
integration team is known for being best in class among add-on developers versus difficult
and time-consuming integrations with its competitors. Not surprisingly, XRO’s ecosystem
uptake and popularity has far surpassed INTU. And XRO is even further ahead of both
Sage and MYOB.
The utility of the ecosystem is best demonstrated by the example of a modern retailer
triangulating three cloud solutions: Xero (accounting); Vend (point of sale); and Shopify
(ecommerce). Click here: video: example of retailer "stitching together" cloud ecosystem.
Network effect #3: Online invoicing
Online invoicing is a useful product feature which also accelerates XRO’s brand awareness
via a network effect. These tend to work well once a tipping point of “critical mass” of XRO
customers in a particular market is reached, whereby there are multiple interactions between
XRO customers who effectively help “evangelise” the new technology to non-XRO
customers. We believe that XRO is close to such a tipping point of adoption in AU.
While the creditor has full control of branding, online invoicing has three clever features
that improve collection and/or virality: 1) the debtor has the option to “pay now”; 2) rather
than sending a PDF, customers send a hyperlink which brings debtors straight into the
XRO environment – giving XRO greater control and allowing debtors to see how easy it is
to send invoices themselves. If they are also a XRO customer they can immediately sync
the draft invoice. From a debtor perspective, this helpfully allowing customers to see the
debtor has viewed the invoice – no more “lost in the mail” excuses; and 3) debtors can
immediately sign up and get a free trial version of XRO, including the details of the invoice
they just received, without leaving the invoice.
Video: online invoicing
Similar to online invoicing, we expect XRO to develop further banking tools to enable the
payments to be made seamlessly between XRO clients and suppliers. Just in NZ alone,
XRO processed 15.4mn invoices worth $25bn in the year to August 2013. We see the
potential for XRO’s banking interaction to drive further virality. XRO will increasingly move
to the centre of payments between SBs and their suppliers, who are often SBs and
therefore potential customers.
Figure 43: Banking 2.0
Source: Company information
Market Daily
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06 November 2013
Risks – not insignificant
Extreme risk: As with any technology company at the outset of taking on global
markets, at a time of a vast technological shift, the future is most uncertain. While
we are positive on XRO’s potential prospects, one must exercise due caution and
be realistic that an investment in XRO is highly speculative and only for investors
with a high risk tolerance. Investors should pay particular attention to the Risk
section of this note.
Risks include, but are not limited to: i) competition from incumbents; ii) internet security;
iii) execution; iv) managing growth and geographical spread; v) key man risk; vi) service
pricing; and vii) market risk with the potential for significant short term stock price volatility.
Key risks:
■ Risk of incumbent dominance: We see INTU and other incumbent accounting
software providers as the biggest risk to XRO. XRO faces established, large
incumbents in each of its markets. These incumbents have established selling
channels for traditional software models. Out of the three major incumbents we regard
INTU as by some way the most capable, innovative and resourceful. We believe the
risk posed by MYOB in AU/NZ is much less. There is a risk incumbents can quickly
develop attractive cloud accounting solutions and leverage off their brand equity,
incumbent relationships and product depth to halt XRO and other cloud challengers.
There is also the risk of the emergence of a well-funded start-up competitor, although
at this juncture we see incumbents posing the greatest risk.
■ Market risk/risk appetite: Technology stocks have historically been particularly
volatile, and so has XRO specifically. After the recent share price appreciation (the
highest in the NZ market recently) there is risk of share price volatility. XRO is also
prone to general market risk. In particular, a reversal of global risk appetite could lead
to underperformance.
■ Internet security: XRO is a cloud-based service that transmits highly sensitive
financial data between the cloud and customer via the internet, which means the
service will be subject to constantly evolving cyber threats. Any direct security
breaches may undermine customers’ confidence and damage XRO’s reputation and
future revenue growth. There is also a risk to cloud uptake if there are any high profile
security breaches involving either their competitors in cloud accounting, or in the cloud
generally.
■ Managing growth: XRO is currently experiencing a period of high growth in New
Zealand and internationally. As with any disruptive technologies, growth rates are
particularly difficult to forecast. A significant slowdown in customer and revenue growth
would be detrimental to valuation. Threats include competitors (discussed above) as
well as general acceptance of cloud solutions. XRO must also ensure that it manages
its growth sustainably to ensure that it services its customers adequately, maintain a
high-quality product, controls costs and retains sufficient funds for future opportunities.
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06 November 2013
■ Geographical spread: XRO has some challenges running a global company from NZ.
XRO needs to rapidly build local human resources, while retaining communication /
coordination / culture as a multi-national organisation. However, to date, we have been
impressed by XRO’s global coordination through the use of social enterprise tools and
various other modern tools that mitigate the challenges of distance from larger
markets. Importantly, XRO is beginning to run some global functions from the US,
through some key appointments there.
■ Key man risk: CEO/co-founder Rod Drury has been central to XRO’s vision and
execution. XRO’s key man risk is mitigated by the growing capability of XRO’s
management team, which we expect to further grow with further key US appointments
over the coming year after the US$150mn capital raise.
■ Failure to attract/retain key personnel: XRO is still at an early growth stage and is
participating in a new market for SaaS products. Accordingly, this makes XRO
particularly vulnerable to management and key personnel departures. XRO must retain
key personnel as well as attract new talent to ensure it continues to be innovative and
to implement a solid growth strategy. We believe XRO’s capital raise will help mitigate
this risk.
■ Pricing: There could be a risk that incumbents aggressively cut pricing to attempt to
beat off new pure cloud competitors and defend their position. We believe this could be
difficult for incumbents to pursue as a strategy given they already face the challenge of
revenue decline from cloud cannibalisation. There could also be a long-dated risk to
pricing once cloud accounting becomes mainstream and maturity eventually sets in.
■ Failure to innovate: XRO must remain innovative to ensure that it is competitive
against the much larger incumbents in the international markets. XRO must remain
innovative in their service offering as well as their marketing and supply channel
strategies.
■ Third party risk: XRO uses a number of third party providers for essential services,
most notably for hosting. A failure by one of these could affect XRO’s ability to service
its existing customers, which could also have an impact on further customer
acquisition. While XRO’s API add-on ecosystem brings many benefits, these third
parties also represent some risk if there is a failure. A failure by an add-on could have
collateral impact on XRO, decreasing the combined utility of XRO and their partners,
and therefore decrease the attractiveness of using XRO. XRO has a certification
process for each of its ecosystem partners which mitigates this somewhat.
■ Exchange rate risk: XRO is currently expanding into larger markets in Australia, UK
and the US. International expansion means revenues and costs are denominated in
local currencies, exposing XRO to an ongoing increase in foreign exchange risk.
■ Funding: SaaS business models require substantial upfront spend, while recurring
revenues occur over many years. We expect XRO to be loss-making with negative
cash flows for several years. It still might be considered necessary for XRO to raise
further funds to seize the global cloud accounting opportunity. At this juncture, we
believe that there would be sufficient support, but there is risk that support could wane
and XRO is unable to raise the capital required to support its high growth rate.
Market Daily
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06 November 2013
Capital raisings
Figure 44: Capital raisings
Pre-IPO
IPO
Craig Winkler (MYOB founder)
Private Placement
SPP
Valar Ventures (Peter Thiel)
Valar Ventures, Sam Morgan, Sam Knowles & Craig Winkler, Institutions
SPP
Valar Ventures & Matrix Capital
Valar Ventures & Matrix Capital, Other US & NZ Investors
Total
NZ$ ’000
2,000
15,000
18,000
5,000
6,000
4,000
20,000
15,600
60,000
180,000
325,600
Date
Jul 2007
May 2009
May 2009
May 2009
Oct 2010
Feb 2012
Mar 2012
Nov 2012
Oct 2013
-
Disclaimer: External links
Throughout this note we give several links to videos and websites to help familiarity with
the XRO product. First NZ Capital and/or Credit Suisse give no assurances about the
material on those websites or in those videos.
Written permission to use all images and links/videos.
Market Daily
53
06 November 2013
Financials
Figure 45: Profit & Loss
NZ customers
AU customers
UK customers
US/ROW customers
Total customers
Revenue
Expenses
EBITDA
Depreciation
Amortisation
EBIT
Interest
Associates
PBT
Tax
NPAT
FY11
23,000
6,000
5,000
2,000
36,000
FY12
47,000
16,000
11,000
4,000
78,000
FY13
73,000
51,000
22,000
11,000
157,000
FY14
102,000
117,000
49,000
34,000
302,000
FY15
117,925
189,000
113,500
97,800
518,225
FY16
131,120
282,890
229,600
358,800
1,002,410
FY17
142,495
382,055
380,998
846,382
1,751,930
FY18
152,050
468,420
540,901
1,482,980
2,644,351
9,666
-16,864
-7,198
-207
-946
-8,351
880
10
-7,461
-26
-7,487
19,771
-26,491
-6,720
-320
-1,574
-8,614
612
208
-7,794
-110
-7,904
39,969
-51,407
-11,438
-1,130
-3,417
-15,985
1,838
0
-14,147
-296
-14,443
71,805
-103,535
-31,730
-1,804
-6,815
-40,350
4,319
300
-35,730
0
-35,730
137,847
-176,175
-38,329
-2,797
-11,196
-52,322
5,234
300
-46,788
0
-46,788
274,541
-305,567
-31,026
-4,812
-16,858
-52,696
3,213
300
-49,183
0
-49,183
553,324
-488,114
65,210
-8,000
-24,083
33,127
3,750
300
37,177
0
37,177
935,603
-672,774
262,829
-11,529
-33,613
217,687
7,138
300
225,125
-16,128
208,997
FY11
16,922
466
4,773
2,186
24,347
FY12
38,976
4,195
10,260
4,342
57,773
FY13
78,244
7,274
17,585
7,319
110,422
FY14
209,716
10,771
30,120
11,757
262,364
FY15
139,204
17,920
48,249
20,684
226,057
FY16
75,000
30,199
69,754
38,527
213,481
FY17
75,000
49,799
98,827
73,551
297,178
FY18
210,526
65,492
136,464
118,780
531,263
2,659
0
2,659
3,046
2,479
5,525
3,090
4,680
7,770
6,016
9,426
15,442
9,885
16,039
25,924
16,534
27,818
44,352
25,435
44,437
69,872
33,712
61,248
94,960
21,688
52,248
102,652
246,922
200,134
169,129
227,306
436,303
49,757
-28,047
-22
21,688
86,377
-35,951
1,822
52,248
150,022
-50,394
3,024
102,652
330,022
-86,124
3,024
246,922
330,022
-132,912
3,024
200,134
348,200
-182,095
3,024
169,129
369,200
-144,918
3,024
227,306
369,200
64,079
3,024
436,303
Figure 46: Balance Sheet
Balance Sheet
Cash
Property, Plant & Equipment
Intangible Assets
Other
Total Assets
Trade & Other Payables
Other Current Liabilities
Total Liabilities
Net Assets
Share Capital
Accumulated Losses
Other
Total Equity
Figure 47: Cash Flow
Cash Flow
NPAT
Depreciation & Amortisation
Working Capital & Other
Operating Cash Flow
FY11
-7,487
1,153
1,114
-5,220
FY12
-7,904
1,894
1,149
-4,861
FY13
-14,443
4,547
2,364
-7,532
FY14
-35,730
8,619
3,234
-23,877
FY15
-46,788
13,993
1,555
-31,240
FY16
-49,183
21,670
586
-26,927
FY17
37,177
32,083
-9,504
59,756
FY18
208,997
45,142
-20,141
233,998
Capex / Cap Dev
Other
Cash from Investing Activities
-3,059
-236
-3,295
-7,482
-1,077
-8,559
-12,220
-1,050
-13,270
-24,651
0
-24,651
-39,272
0
-39,272
-55,454
0
-55,454
-80,756
0
-80,756
-98,472
0
-98,472
Cash from Financing Activities
4,040
35,474
59,982
180,000
0
18,178
21,000
0
-4,475
16,922
22,054
38,976
39,180
78,244
131,472
209,716
-70,512
139,204
-64,204
75,000
0
75,000
135,526
210,526
Net Cash Flow
Closing Cash Balance
Market Daily
54
06 November 2013
Appendices
Figure 48: Investment in people (year to Aug-13)
Figure 49: Country contribution
66
69
4.3m
NZ
Product Development
6.2m
Customer Experience
-0.6m
AU
1.2m
Finance, Legal, HR,
Facilities and Internal IT
Country Leadership
Teams
0.2m
0.5m
UK
Platform
26
Marketing
43
19
12
ROW / US
Sales, Enablement and
Training
12
-4.0m
0.1m
-2.0m
-2.0m
0.0m
2012
2.0m
4.0m
6.0m
8.0m
2013
Figure 50: Investment delivering revenue growth
50,000
40,000
30,000
20,000
10,000
0
2008
2009
2010
Net Loss
2011
2012
2013
Operating Revenue
Market Daily
55
Sales & Research
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This publication is intended for distribution only to market professional, institutional investor and retail investor clients
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A Disclosure Statement is available on request, free of charge.
Copyright: First NZ Capital Securities Limited and its related companies, 2013. All rights reserved.

Market Daily, 6 November 2013

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