Perhaps it’s ironic that I write this assessment of Xero’s 1H18 results at 10,000m above the Pacific Ocean, on my way to Intuit’s #QBConnect 2017. But 15 hours without kids, work, social media or Stranger Things 2 distracting (well at least 3 out of the 4), is a great opportunity to sit and analyse last week’s results and announcements (whilst listening to the new Gang of Youths album), then get some sleep #winning.
The Yays in order of Wow factor
- Delisting from the NZX. Wow, didn’t actually see that coming. To the Kiwi patriots who might be a little disappointed, rest assured we Aussies know how you feel with our poster child tech. company Atlassian listing on the NASDAQ rather than the ASX! The logic behind the move for $XRO is actually pretty sound when you look at it without emotion, from a shareholder’s perspective (and not from the perspective of NZ brokerage and IRD revenues lost). In short: consolidating Xero’s listing on the ASX should improve liquidity for shareholders as a result of attracting greater investment from mainstream investors, particularly increasing interest from the world’s 4th largest investment pool (the Australian Superannuation industry), through inclusion in more indexes such as the ASX 100.
- Customer Lifetime value per subscriber (LTV) increased 15% (12% in constant currency) to NZ$2,306 adding more than $1 billion in total subscriber LTV in the past 12 months. It is perhaps this number that excites me the most as an investor in Xero and the broader SME B2B tech space.
- Xero has put in place a $100 million stand-by debt facility which it says “will improve the company’s overall liquidity position”. I’d personally be lobbying for the board to be actually using debt not just as a “rainy day” stow away… they could very easily leverage debt in the next few years, whilst the growth opportunity is great and debt is cheap and the Xero balance sheet remains relatively clean when compared to every listed competitor worldwide!! Surely Rod and board, if you got a wad of cash at say 5% (more likely better) you could return a LOT more for that investment than 5%…? Particularly given the next point! That said, if you can continue to grow without debt, and this proposition isn’t traded off by more watering down of shareholder funds through more capital raising nor slowing the rate of growth, then KUDOS to you. And this seems to be the language being used – self-funding. Reinvesting free cash flows… Lets keep a close eye on growth to hold them to account (see the next section below)!
- Customer LifeTime Value (LTV) vs Customer Acquisition Cost (CAC) has moved very noticeably to the positive this calendar year.
Just to reinforce my point 3 above, if you can get a 6.3X return on the cost of acquisition, perhaps using cheap debt to fund continued, aggressive growth makes some sense…?! Sure, it’s a tricky line to tread, when do you need to trade off growth for profit? My response is, I hope the trend outlined below, is NOT caused by the desire to make a profit, but rather just seasonal blimp (or a hangover from the desire to announce 1m customers in March…).
Heys
- Subs Growth
Whilst on the surface subscriptions continued to grow, for the first time ever, the 6 month subscriber growth rate sank below 20% (by a fair margin too, down to 15.8%).
This is a worrying trend in the 6 month growth rate line. I thought it worth comparing to Intuit for those that jump in and say, hey but as you get bigger, of course the growth % will slip:
To add some perspective to this comparison:
- Outside the US, Xero added 146,000 subs in the 6 months to September 30 vs Intuit adding ~130,000 in the 6 months to July 31 (including both QBo and QBSE subs and to be fair to Xero, at probably less than half the ARPU and a fraction the LTV by my estimate).
- Inside the US on the other hand…Xero North America improved marginally adding 18k net new subs (c.f. 15k last half and SPLY) representing a 1% increase in half year % growth from 19 to 20%. When benchmarked against Intuit to put Xero’s competitive environment in North America into perspective: Based on the the 6 month’s to July growth rate for Intuit, it took less than 9 days for them to acquire the same number of subs in the US, as Xero acquired in the US and Canada in 183 days…
Worryingly, on raw numbers, growth rates shrank from highs of 173k net new subs in 2H17 to 164k in 1H18. This is THE most disappointing thing, I personally found hidden in the detail of the results.
The Rest Of World number is probably most disappointing to me. SE Asia and Africa have got to be significant “next big market” opportunities and yet growth slowed in both % and raw number terms (8k vs 10k and 34% vs 21%, 2H17 vs 1H18). All the talk of the numbers of people showing up to roadshows in these markets, just isn’t translating as quickly as I’d hoped to subs. Let’s hope the aggregator focus starts to pay some dividends in these markets soon, before other players work out how to scale there.
OKS
EBITDA positive… this was expected… many investors were in fact hoping for that elusive term NET PROFIT… I am unconcerned by the Net Profit or lack thereof, given the trajectory of growth (still north of 30% annual growth despite my concerns above), status of margins and churn as well as consideration of the remaining accessible TAM … I do make a side point, never let the use of EBITDA (over net profit) fool you with software companies. The DA is actually important to watch, as it represents REAL limited life investments that went the way of the balance sheet which ultimately need to be accounted for in the P&L… a near-future post on MYOB flagged here…note comparatively Xero has possibly the least DA drag on the future P&L to worry about of any similar company!
Cash flows from operating activities were positive at $6.1 million for the half-year from an outflow of $13.4 million in the same period last year, and a lot more in the preceding decade.
Google search is one factor sure, but how about subs growth in the UK? To use Xero’s own words “Market adoption of cloud expected to accelerate with digitisation of U.K. SME initiatives”. When? 29% growth last half vs 19% this half (48k vs 41k in subs) raises an eyebrow… That said, I can’t be too harsh…this is reflective of previous year trends (2H seems to trend higher vs 1H). Also, by my estimate the UK is the most competitive market worldwide for Cloud Accounting tech and yet Xero seem to be consolidating market leadership. Hence this is an OK not a Hey…
Australia through EOFY matched last year’s 1H growth with 68k net new subs. That’s OK, not setting the world on fire, but pretty good in a maturing market.
Concluding remarks
All in all, how can you criticise a company that is competing very well on a global stage for the world’s second largest market (outside the consumer market). Adding north of a billion dollars in LTV (that’s $1,000,000,000 and north of 60% improvement) in just 1 year, an attractive investment doth make.
Given the potential size of the TAM, the key #watchthisspace eye on whether they have switched to a self-funding focus too early. Whilst Intuit with its QBo platform seems unconcerned by profit from the cloud accounting market in the near-term, I ponder whether trying to be profitable at this moment in time is wise. I’m hoping for truth in the stated aim to reinvest profit for continued market growth. I’m also acutely aware that the growth numbers aren’t where I, many investors nor Xero themselves would be “giddily happy” with the trend over the last 6 months…
Now back to those Stranger Things 2 episodes I downloaded in my Netflix app from the Qantas lounge….
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