I'm currently debating buying more XERO FPO NZX (ASX: XRO) shares, despite the accounting software company already being one of my larger positions. I think that despite a seemingly expensive headline price, the company could be cheaper than it appears.
Marketing expenses
First, the company is investing heavily in sales + marketing and product development.
You can see here that Xero's spending on marketing and product development dwarf its operating loss. That is, the company is being intentionally run at a loss to gain market share. Purely for illustration, if Xero cut its marketing and development spending by 50%, it would be profitable and priced at approximately 58 times earnings.
So, although the losses look serious, Xero is vanishingly unlikely to go bankrupt. Plus, it has $325 million in carry-forward tax losses, so when it does become profitable, it won't pay tax for many years.
Long customer lives
Xero reports an average customer lifespan of 7 years. According to its calculations, the lifetime value of its customers is NZ$2.2 billion, or more than half its market capitalisation.
I think investors would be wise to keep a high degree of scepticism regarding these figures, if only because in 2010 Myob Group Ltd (ASX: MYO) probably had similar figures and Xero has subsequently eaten most of its lunch. The world changes quickly but even so, Xero has a lot of value already built into its business via its customers, and the customer base is largely untapped. Xero could create new products to sell to its customers, for example.
So, Xero is a lot more valuable than it appears. The question is if it can continue growing sales enough to earn a nice return for shareholders. So far it has been, although the numbers for international customers are substantially worse than ANZ ones:
There is a full definition in the annual report (pg23) for interested readers. For now just know that, in addition to growing total customer numbers, Xero also needs the numbers in the 'International' column to move closer to those in the 'ANZ' column, because ANZ subscribers are better in every way. Xero grew its subscriber numbers by 31% to over 1 million.
In summary, Xero is a) very unlikely to go bankrupt, b) a lot more valuable than it appears, and c) making good progress on both subscriber numbers and customer metrics, which are key to the company living up to its promise. I haven't decided if I'll buy more shares yet but I'm definitely keeping the ones I have.
