Xero to a million, but where to from here?
Xero’s milestone in racking up a million customers is a huge achievement worthy of a moment’s reflection.
It has proved founder Rod Drury’s original thesis that it is possible to build a global software company from New Zealand if you can gather a lot of capital and a bit of a buzz behind you.
But its shares have gone from being one of the most exciting to one of the most boring stocks on the NZX.
For a while in 2013, investors were finding themselves collectively hundreds of millions of dollars richer each time they opened the newspaper.
But now there’s no end in sight to the stalemate between the believers, and those who can’t understand how the loss-making firm can be worth more than $2.6 billion.
For the past three years, Xero shares have traded in an increasingly narrow band between $15 and $25, waiting for the thumbs up or down from the investment gods.
Meanwhile, shares in Intuit, which has kept its tight grip on the United States accounting software market, are trading near an alltime high after gaining more than 50 per cent over the same timeframe.
Sage Software, Xero’s main rival in Britain – the market which is key to Xero’s medium term growth – has seen a similar gain in its share price.
In Australia and New Zealand, MYOB is certainly holding its ground on the Australian stock market.
So is Xero still a good investment?
I like the clouding accounting software segment in general and believe all these firms could grow to become a much more important part of the economy.
Their real value lies not in the software they provide as such, but in the data about businesses that software collects.
It wouldn’t surprise me if in five years’ time all the cloud accounting firms were more than happy to give their software away for free, in return for businesses agreeing they could aggregate their trading data and details of their costs and expenses.
Instead of charging for their software, cloud accounting firms would be charging small businesses to benchmark their performance against their peers and to provide insights on what they could be doing better, using tools such as machine learning and data analytics.
The same ‘‘big data’’ could provide assurances and early warning signs about each small business’s performance and prospects to the likes of suppliers, creditors and potential buyers.
There are other reasons to be bullish about the sector, but it is the data opportunity that I think is the biggest.
The relevant questions then become:
Is the cloud accounting market best thought of as a global market, or a series of national markets? I think for the foreseeable future it will remain national.
How much of each national market does a cloud accounting firm need to capture to compete in that data market? I’d guess to have value in data, you certainly wouldn’t want to be less than a quarter of the size of your largest competitor.
And how many and which firms in each market will cut the mustard? Analysts agree Australia and New Zealand look like a two-player market. Suppliers other than Xero and MYOB lack the traction to make the switch to a data-driven business model.
MYOB added 79,000 cloud accounting customers in Australia and New Zealand last year while Xero added 167,000, but Xero doesn’t look capable of delivering a knock-out punch.
The situation in Britain is a bit harder to read, but Sage, Xero and Intuit look set to achieve ‘‘critical mass’’.
In the US, Intuit is consolidating in the cloud accounting market, with more than a 90 per cent share of new business.
Xero hasn’t pressed the button on any mass-marketing in the US – perhaps wisely given the scale of the challenge – and has instead relied on the kind of guerrilla and partnership-based marketing that has served it well in smaller markets.
It added 30,000 cloud accounting customers in North America last year while Intuit’s filings suggest it added about 800,000.
If Intuit could gain an effective monopoly in the business of aggregating and selling performance insights from small businesses in the US, that would be a phenomenal prize.
For that reason it would have to be my long-term growth pick in the cloud accounting space, despite its heady US$30 billion (NZ$43b) market capitalisation.
But that’s not to say Xero (NZ$2.6b), MYOB (NZ$2.4b) and Sage ($12.2b) might not offer good value to investors.
That may be especially the case in the medium term, given that you’d perhaps expect the US to be slower to embrace a more ‘‘cooperative’’ data-driven model for small businesses.