Treasure Chest | Jul 27 2021
This story features XERO LIMITED. For more info SHARE ANALYSIS: XRO
FNArena's Treasure Chest reports on money making ideas from stockbrokers and other experts. Will Xero's stellar growth in accounting software start to wane? Beyond FY22, brokers appear to be lining up on opposing sides
-Subscriber growth or revenue per user: one may have to give
-Xero's recent price increases considered a step in the right direction
-Will Australasian growth start to decline materially beyond FY22?
By Eva Brocklehurst
Subscriber growth may be booming in the US but are there clouds on the horizon for accounting software supremo Xero Ltd ((XRO))? Brokers are lining up on opposing sides in terms of the outlook beyond FY22.
Macquarie makes a comparison with QuickBooks Online, which ten years ago took the North American market by storm. That company impressed with 38% subscriber growth over that decade but this was not without a sacrifice. Over the same period average revenue per user (ARPU) from the online business declined -42% in aggregate.
Xero experienced 38% growth in North American subscribers in FY17-20 along with a -25% decline in ARPU. Hence, Macquarie expects over the next ten years Xero's growth in North America will either moderate or ARPU within the region will need to continue declining.
Moreover, Macquarie's analysis shows that lifetime value (LTV) growth is not equal across jurisdictions. Net lifetime value (LTV-customer acquisition costs) of an Australasian subscriber is worth more than double that of an international subscriber.
In other words, growth in international subscribers, though valuable, is lower quality and accrues less value than an incremental Australasian customer.
The reality is the bulk of incremental value generation has been, and will continue to be, driven by Australasia, the broker asserts, and Australasian growth is expected to remain robust over the next year and then decline materially.
Macquarie has come to the same conclusion that UBS came to a while back. UBS is also positive about the outlook because of the structural tailwinds and strong execution by management but considers the stock well above levels of risk/reward that can be justified.
Xero's decision to increase prices in Australasia and the UK was welcomed by Citi, particularly as the new pricing did not include any additional items. The broker believes this reflected the company's confidence in the outlook in those markets. The prices are effective from September 23, 2021.
In the UK, starting plan pricing increases by 20% and standard plans by 8%. The standard plan price increases by 4% in Australia and premium plans by 4-9%. This was also the first price increase in New Zealand in three years, with all plans up by 3-5%.
After the company announced these price changes, that were larger than expected, Ord Minnett allowed for an increase in ARPU for the second half of FY22, believing Xero has made a step in the right direction to obtain a better yield from the subscriber base. Most of the gains are likely to be reinvested. Still, Ord Minnett retains a Lighten rating.
Not so Morgan Stanley, which takes a diametrically opposite view to Macquarie, UBS and Ord Minnett, emphasising the market is recovering faster overall and there continues to be strong take-up of additional products and services.
The higher investment in R&D that was flagged in recent results means Morgan Stanley does not lift earnings estimates over the short term, out to FY24, but expects higher earnings in the medium term.
Morgan Stanley believes launching into new markets and new partnerships with financial partners in existing markets will drive the Xero business as well as the take-up of new products. There are also regulatory catalyst that may deliver a strong impulse to take up the company's product.
On the downside, the broker acknowledges competition could result in failure to increase market share while a more competitive opponent could emerge from industry consolidation in Australia. There is also the prospect that offshore markets fail to gain traction and result in increased cash burn.
In terms of the regulatory catalysts, Macquarie also assesses Australia's drive for electronic invoicing will bring future demand forward, but result in slower growth beyond FY22. Penetration of the Australasian market has also increased to 53% of small-medium enterprises so the broker envisages growth rates will need to moderate over the coming years.
In summary, the short term growth story is intact but Macquarie finds it hard to justify current valuations and downgrades to Underperform. FNArena's database has three Sell ratings, one Hold (Citi) and one Buy (Morgan Stanley). The consensus target is $119.50, suggesting -16.9% downside to the last share price. Targets range from $81 (UBS) to $137 (Morgan Stanley).
See also, Xero Ramps Reinvestment on May 18, 2021.
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