Xero, the cloud and bubbles

Radio New Zealand’s business editor called me up last night and asked me what I thought of the company Xero, which has seen its share price soar over 500 per cent in the last year. 

Screen Shot 2013-11-07 at 1.07.27 PMThe accounting software company today became the second most valuable listed company by market capitalisation behind Fletcher Building ($6.6B) before dropping back to third place behind Auckland International Airport ($4.7 billion). After hitting $41 today, Xero’s share price closed at $34.00, which actually saw it drop 9 per cent for the day. That sort of volatility comes with relatively low liquidity. Still, the company is worth $4.3 billion. That is a staggering endorsement of the business.

Xero is yet to turn a profit and it could be years before it does. It is growing quickly and expects 80+ per cent growth next year.

I’m not a financial expert, I’ve just covered the tech sector for a long time, including the last time New Zealand tech stocks saw massive increases in value and – the depressing aftermath. Here are some of the points I made to RNZ – I’m interested to know what the Sciblogs community thinks as many of you are involved in fast-growing science and technology businesses:

What’s driving the growth?

– This isn’t being driven by New Zealand investors, but by interest in the US and Asia where investors are used to having stocks like Xero as a part of the high-risk component of their portfolios. So it isn’t really out of the ordinary, its just unusual for the NZX, unprecedented for a tech stock here, in fact. New Zealand day traders may make money (or get burnt) going along for the ride, but this is primarily trading among companies scouring the world for the next big thing.

– The share value increase has really been driven by the repeated investments led by Silicon Valley investor and Paypal founder Peter Thiel, who led the latest $180 million investment round after previously injecting money in 2010 and 2012. Thiel is known for only investing in technologies and businesses he thinks can change the game – Paypal, LinkedIn, Facebook and Palantir among them. Someone with that track record investing a third round of funding in a company is going to generate a lot of interest and therefore investment from people following the thought leader.

– Thiel is a big believer in investing in people – as he has said, companies and technologies change, but people don’t – investing in good people is a smart move. Xero founder and CEO Rod Drury is a visionary leader who has mobilised a team to develop, design and market a great product. Thiel’s repeated efforts to top up Xero’s funding suggests he continues to think Xero has something special – and can scale up to deliver the type of returns he expects from an investment when it gains serious traction in the US.

Can Xero meet expectations?

– The big question is whether Xero can take significant market share off arch rival Intuit in the US. Less important but still relevant is how long it takes to get there. It now has money to pad out that journey slightly. Drury has said that if you conquer the US with a cloud service, you conquer the world. That is what he seeks and it is a huge uphill battle. But he knows that if he can convert customers the way he has in New Zealand, the UK and Australia, they’ll never go back to their old software. He has talked before about his goal of reaching one million customers on Xero – it doesn’t seem unrealistic given the growth Xero has experienced today and the fact that these types of services benefit greatly from the network effect as more people come onboard as users.

– Intuit isn’t standing still – it realises it has millions of customers on its creaking desktop platform and needs to take them to the cloud. It needs to do better in building the ecosystem that allows other applications to plug into its core products such as Quickbooks, making them more useful and valuable as a result. Intuit is aware of this, making acquisitions and doing deals to catch up, but it is behind Xero technically, which means the nimble competitor has a window to exploit and a simpler message to sell without the baggage of having to support legacy systems.

– Xero has done a really good job at innovating and treating its accounting software as a platform that others can plug into to provide important components it doesn’t specialise in, such as payroll and receipts. Recently it added document storage to Xero so a user can place all the important files managers and accountants need to see, in one convenient place.

Maybe a sector bubble but not a tech bubble

The NZX has seen a number of technology companies list this year – Wynyard Group (forensic and data analysis software), SLI Systems (search engine software) and Snakk Media (mobile advertising) among them. Most recently was GeoOP, a job scheduling and management tool that was founded by a former Xero executive Leanne Graham, and which is one of those apps that plugs into Xero, therefore making both of them more useful.

GeoOP listed less than two weeks ago and shares priced at $1 on listing quickly surged 138 per cent on day one. It’s share price closed at $3.17 today down 12 per cent for the day.

Apart from GeoOP, the new listings have made fairly conservative progress – not out of line with new companies in other sectors. They each have their own set of opportunities and challenges and it will take some time to determine their longterm potential. But enthusiasm for GeoOP is something else – it appears in part to have come from the buzz around Xero. These are both pure software as a service (SaaS) players pursuing the same type of business model and appealing to the same type of investors. Both have relatively low revenue and high valuations based on their share price.

How sustainable that share price is depends on whether investors believe Xero and GeoOP can get customers to adopt their disruptive technology in large numbers.

If there is any bubble here, it is in the specific New Zealand SaaS sector, which currently isn’t a crowded field on the NZX, but which could grow as others eye up the value gains Xero and GeoOP have experienced. Then we may seriously have a bubble – and some of these companies will fail, denting confidence and valuations. But we are not there yet – and with a healthy war chest of funds, it will be two – three years before we really know whether Xero’s North American adventure pays off.

In terms of whether there is a tech bubble in the US right now, there has been a lot of commentary on this, stoked further by the IPO of Twitter, which has been valued at US$18 billion. Not bad for a company that has racked up US$300 million in losses. But again, like Xero this is a company with disruptive technology, huge future growth potential and with cash to see it through for a while as it develops revenue models. Facebook’s revival of fortunes on the share market has given renewed confidence to investors eyeing up social network companies like Twitter.

I think that consumers will grow increasingly disillusioned with advertising – this is what has happened in the media space, where online advertising is failing to make up for the decline in print advertising as the media moves to the web. I’d rather be betting on Xero than Twitter.

The Business to business sector that Xero inhabits seems more sustainable revenue-wise because their customers are willing to shell out several hundred dollars a year for their services. The freemium consumer world is a different story altogether, where advertising can be the main source of revenue.

So, a bubble? I don’t think so here in New Zealand. The Xero story has  invigorated interest in the New Zealand tech scene which is a very good thing. There is more capital available than ever before and entrepreneurs taking inspiration from Rod Drury. Xero is a sort of special case because of the international interest, which wouldn’t be that out of the ordinary if Xero was a Nasdaq company. But the future of other fledgling SaaS companies that chose to list on the NZX will determine the success of this high-growth sector and whether some high profile failures will take the gloss of it.



One Comment

  1. George Slim

    Do you use Xero? It’s hard not be a belever if you do. I am not too well placed to speak about the competitors since I’ve never used them but Xero is ridiculously straightforward. When I worried to my accountant that he was trying to make me do my own accounts on Xero with only 3rd Form Commercial Practice from the 70s as a guide, he said, ‘over qualified.’

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