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In an era of fake news, it’s getting more difficult to separate fact from fiction. Yet it’s imperative we do so because the consequences for being deceived can be enormous.
Unpacking Xero’s slowdown
The Xero Limited (ASX: XRO) share price is dropping after the business released its FY22 first half result.
Xero is one of the world’s largest cloud accounting businesses, with subscribers all over the world.
Xero’s HY22 result
The cloud accounting business reported that operating revenue increased by 23% to NZ$505.7 million.
The average revenue per user (ARPU) rising by 5% to NZ$31.32 helped grow the operating revenue.
Turning to other financial metrics, the annualised monthly recurring revenue increased by 29% to NZ$1.13 billion. The total lifetime value of subscribers rose by 61% to NZ$9.94 billion.
The gross profit margin increased again, rising 1.4 percentage points to 87.1%.
Xero’s EBITDA (EBITDA explained) fell by 19% to NZ$98 million. In HY21 it made a net profit of NZ$34.5 million, but this reversed to a loss of NZ$5.9 million. The free cashflow sank 88% to NZ$6.3 million.
Investing for growth
During the 2021 calendar year, Xero was being careful with its spending in the difficult economic and pandemic environment.
But it has now returned to pre-COVID spending. Total operating expenses increased as a percentage of operating revenue to 83.4%.
It has increased its spending on marketing to win new subscribers and increase brand awareness in a number of markets.
Product and technology investment in the period continued in line with Xero’s long-term ambitions including core accounting and platform enhancements. Product and development costs increased 51% to NZ$166.8 million, representing a third of operating revenue – similar to the second half of FY21.
Also, Xero continues to invest in people. Excluding acquisitions, Xero’s number of full time (equivalent) employees rose 22%.
Subscribers
Xero’s subscribers grew by 23% to 3 million, with total net subscriber additions of 272,000. Net subscriber additions for the six months were 62% higher than last year’s additions.
Australia ended with 1.24 million subscribers, with 124,000 net subscriber additions.
New Zealand ended with 480,000 subscribers, with 34,000 net subscriber additions.
The UK ended with total subscribers of 785,000, with 65,000 net subscriber additions.
North America had 308,000 subscribers, with 23,000 net additions.
Finally, the rest of the world (ROW) ended with 201,000 subscribers with 26,000 net subscribers. Xero is seeing strong progress within its South Africa business, which is scaling a large base of subscribers. Meanwhile, Singapore also is being a strong performer.
Strong tailwinds for Xero (and the share price)
The cloud accounting business aims to be the world’s most insightful and trusted small business platform. It’s going to keep investing in product development and partnerships.
Xero management noted that there are multiple drivers for cloud-based software adoption: digitisation of tax compliance, innovation of financial services and an imperative for small businesses to prepare for the future.
It’s going to keep investing the cash it generates for more growth and drive shareholder value.
Xero is a great business, I think it’s one of the most compelling businesses on the ASX. However, I’m not exactly sure what a fair price is for the business in this environment where interest rates may or may not be about to take off. High-growth business valuations can be impacted by interest rate changes.
I’d be happy to buy a parcel of Xero shares today, and accumulate more on price weakness and/or continuing success of Xero’s growth.
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