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Xero and AI

The biggest debate in the office came about because of my $100 billion number as an end-game market cap. In some sense that is the big-hairy-audacious-goal (BHAG) for any putative tech giant.
But in this case thinking about how you get there explains it pretty well and also explains to some degree what the company needs to do.
Xero currently has about a million customers paying on average about $400 per year each. We pay a bit more mostly because we transact some of our business in foreign currencies and as we add optional features we would expect to pay more still. We would expect revenue per customer to grow over time and think $600 is not unrealistic. At least some of the customers become bigger over time. We know one 200 person business who runs the entire thing on Xero. Their next transition would typically be to Oracle accounts - but they do not feel this is necessary.
To get to $100 billion in market cap you probably need $15 billion in revenue at some point. Even that is fairly expensive at 7x revenue - but most of the tech giants trade at about 7x revenue.
At $600 per customer that means you need 25 million customers. To get to my BHAG Xero needs 25 million customers. It needs to be 25 times bigger.
My first cut was simple. Xero has the bulk of the market in New Zealand - its home market - and about a third of the market in Australia. It has a small market share in the UK and a tiny market share in the US. Australia is about 2 percent of the world - and so Xero could - if it got to this market share globally - be 50x bigger.
It is a superior product, mission critical and sticky. This seemed plausible to me.
Then one of my staff members pointed out that there are less than 6 million incorporated businesses in the US. And sure this doesn’t count sole-traders but it does make my 25 million customer target seem hard.
This of course led to a debate. How is it possible to have a million customers mainly in Australia and New Zealand (very small countries economically) and there only be a target market of about 6 million customers in the US.
The first answer was the one alluded to above which is that Australia and New Zealand both have value added taxes which means that everyone with any private business has to file regular tax statements and the vast bulk of them use software to comply. This will apply in Europe too. Xero should have gone to Europe before going to America.
The second answer (which I would love to confirm) is about the structure of the US economy versus countries without large pools of low-income labour. In the US there is a vast pool of labour at approximately $10 an hour which is lightly skilled. Many businesses work out how to leverage an entrepreneur’s talent through using dozens of these people. The average restaurant in America is much larger than the average restaurant in Sydney - and leverages one executive chef over many staff. By contrast this low-income labour pool barely exists in Australia - and of consequence I suspect the average small business is smaller and there are many more of them. Australia, not America is a land of thriving small businesses (at least by number).
I suspect the same is true in Europe. Indeed in Europe in many jurisdictions there are penalties for businesses getting too big. France for instance has different labour laws for companies that employ more than 50 people rather than less than 50 people and many businesses deliberately stop growing under that threshold. My guess is that the market is again relatively bigger in Europe than America . Just because there are more potential customers.
In all cases it leads me to the conclusion that Xero has focussed its energy wrongly (on trying to grow in America) rather than going to countries where it is a natural fit.
Done well though I think there are 25 million customers out there to win. Whether they can do it - that is yet to be seen.

Xero and AI

I am hardly privy to the software design decisions of Xero but they clearly have their eye on this. They originally wrote Xero so that it ran in Microsoft server hosted on Rackspace. They re-wrote it so its backbone is Amazon Cloud Services. This was a non-trivial task - and I think they did it because Amazon has a much better artificial intelligence as a service offering (either direct or third party). They did it for the AI.
The trick here is to get really big fast. If you get big fast. When you do you will have more data and you will win the AI race.
At the moment Xero is the world leader in cloud based accounting software and records more than a trillion dollars in transactions per year. This is a race that Xero can win.
Xero's management issues
Rod Drury who founded Xero and was CEO until recently was a talismanic software genius whose heart and lifestyle was in Hawkes Bay New Zealand.
Now Hawkes Bay may be one of the nicest places in the world to live - but it is not the centre of anything that matters. He was both the inspirational genius and the limiting factor to growth.
The company was listed in New Zealand, hardly the world's most tech-driven market. And when they moved the listing it was to Australia and not to the NASDAQ.
This stock has always been cheap relative to the US SAAS companies. Take Ulimate for instance - a well run company with a vision far less expansive than Xero. The market cap is about double. This is typical.
Xero run the business to be cash flow break even. They are proudly (just) EBITDA positive. The mantra here is to grow as fast as possible subject to the constraint that they do not run out of cash. Which seems a sensible enough mantra - but given the prize is so big why not grow faster?
A Silicon Valley CFO (say a former tech investment banker at Goldman Sachs) would have hyped the stock, listed it on the NASDAQ, raised a bucket-load of cash with the minimum possible dilution and used the cash to grow even faster. Not doing this is the first thing that the company has done wrong.
The second thing they did wrong was target the USA before they targeted Europe. The USA alone amongst OECD countries does not have a value added tax. It has much less software penetration and the usual selling channel (sell to the accountants who then sell to their clients) was not as easily open.
Moreover going to the USA wakened the only credible long-term competitor.
Instead they should have gone to Europe first. Europe has compliance problems coming out of its ears. It is a natural market for a software product that solves them. And it has a weaker competitor in Sage.
They should have produced Xero in multiple languages. They went to the US without a Spanish language version which seems stupid if not insensitive.
And Quickbooks Online is opening in France - a completely natural market for this product.
There is no reason why Xero should cede the natural markets of Western Europe to the Americans. Hop to it I say.
Hope in the management change
Rod Drury has recently resigned as CEO of Xero.
It is not normally great news for a tech company when the talismanic founding genius leaves. But in this case he might have done the right thing.
You see Xero has appointed a genuine internationalist, Steve Vamos, formerly a senior executive at Microsoft.*
Steve will do certain things much better than Rod.
- he will run the administrative side of the firm a lot better - he is a MUCH better people manager and will hire stronger direct reports
- he will be much better at running the US subsidiary
- he will run a global organization much better
- sales and marketing will strengthen
And he will do somethings much worse
- he has not demonstrated product vision in this area
- he is not a life time accounting expert
- he will understand customer need a lot less well
If Rod can stick around as the product visionary this will work very well as a transition. Steve can cover all of Rod's (considerable) weaknesses and not lose Rod's (also considerable) strengths.
The CFO is also changing and this is unambiguously good news. The old CFO was way too parochial. The biggest weakness of Xero was its financial clout to go with the global potential of the company. The company really needs a first-tier Silicon Valley CFO. I think they are going to get it.
Are they going to get this done? I think so - but they will probably wind up being a nice second player to Intuit because they have not gone fast enough. You can own either stock but the upside is far more considerable at Xero.
I bought my stock at under half the current price. It is not that cheap anymore - trading at 16 times trailing revenue and 11 times forward revenue. If the stock quadruples its revenue you will probably win quite nicely owning it - but I am not looking for a quadruple. I am looking at a path to global significance.
I think they might yet do it. It is far from written in stone - but it is as far as growth tech stocks go - a pretty good