Xero CFO gives outlook for 2017 and beyond

Glenn Freeman  |  02/02/2017Text size  Decrease  Increase  |  
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Glenn Freeman: I'm Glenn Freeman for Morningstar. Xero, a software accounting firm, recently celebrated its 10-year anniversary. We invited the chief financial and operating officer, Sankar Narayan, into our offices to speak about the business and its outlook for the next 10 years. And also joining us is our Equity Analyst, Gareth James, who explains a little about how we assess the Xero business.

Sankar Narayan: So, if you look at what drives our P&L, we're making a lot of investments acquiring new customer. Last year, we added over 250,000 new small and medium businesses.

That's in the 12 months ending September. So, when you have such a high growth rate, when you acquire a new small and medium business, you actually have to make investments in the year in which you acquire the business.

And the business stays with us for a long period of time and you actually get revenues and margins in future years. So, in a funny way, the faster you grow, you have to make more investments that actually flow through the P&L.

Having said that, we have actually given guidance that we actually expect to be cash flow breakeven with cash on hand and most market estimates have it within two years.

Gareth James: At Morningstar, we value companies using what's known as a discounted cash flow approach.

So, what we do is we forecast cash flows for the business for the next 10 years at least and then we discount those cash flows back to a value today and that's how we arrive at the value for the company.

So, with Xero, we're not too concerned about the fact that they are loss-making currently. What we're more interested in is how the company is going to perform from a financial perspective over the long-term.

And we believe that the company is going to turn profitable within the next couple of years and then start generating cash for shareholders. And that's why we arrive at a positive value for the shares.

Sankar Narayan: We actually have a strong global footprint now. So, we started in New Zealand, established a strong market presence in Australia where we are the market leader in cloud accounting and in New Zealand as well. We went to the U.K. We've been in the U.K. for a few years and we have a leadership position there as well on the cloud in terms of software.

We started the U.S. a few years back and the U.S. business is building up and gaining momentum. And most recently, we started our offices in Singapore, that was within the last 12 months.

Gareth James: We think Xero's strategy makes a lot of sense because we see the software sector being increasingly globalized going forward. Now, the difference with Xero's strategy and some other companies that have failed with the global strategy is that a lot of the failures are due to companies which have gone overseas and acquired businesses and they've not necessarily fully understood what they are acquiring.

With Xero, it's quite different. They are pursuing an organic growth strategy. So, they very much know what they're getting into.

They are not investing significant amounts of capital and they don't run that risk that they're buying a business from somebody else who knows more about that business than they do and can therefore value their business more accurately.

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