Shares in accounting software provider XERO FPO NZ (ASX: XRO) took a sharp dive last week after the company announced an 81% increase in revenue, on the back of a 67% increase in paying customers.
Xero's losses after tax more than doubled to $69.5 million, apparently prompting some fears about cash burn and slimming market hopes of achieving profitability in the next year.
While shareholders were clearly disappointed, I believe that selling out of a company posting 81% revenue growth per annum might indicate a bad case of short-sightedness.
Net losses doubled, sure, but revenue also almost doubled and Xero is clearly getting bang for its buck with its extra spending on staff and marketing.
It may not be the right company for every investor, but Xero's situation could be the only time that doubling your losses is a good thing.
(Contributor Owen Raskiewicz covered Xero's results release in more depth here)
Xero's shares dropped nearly 10% on Friday, before recovering some – but not all – of their lost ground this morning.
Management is clearly hoping to continue Xero's explosive growth; with market dominance already established in three countries, the key will be capturing enough of the American market to fend off competition from MYOB Group Limited (ASX: MYO) and Reckon Limited (ASX: RKN).
MYOB can expect an underwhelming launch next month, according to one Foolish writer, but there's no escaping the fact that competition in the cloud software sector is heating up and Xero will need all its ducks in a row if it wishes to capitalise on its promise.
With MYOB and Reckon both rapidly expanding into the cloud software, or 'Software as a Service' (Saas) sector, two things will be vital to Xero going forwards:
- The ability to capture new customers
Xero looks to have this under control, as 67% growth in the total number of customers would appear to indicate.
94% growth in the number of US subscribers was particularly impressive and it appears Xero may have finally cracked that market. Shareholders will want to check that growth continues, but I see no major concerns here.
- The ability to keep new customers
With competition increasing in the cloud space, Xero will have to work overtime to maintain its customers and base of recurring revenue.
Competitors MYOB and Reckon might be a little behind the curve at present, but both are formidable and investors shouldn't diminish the potential risks from this sector.
One good indicator to watch for will be slimming gross profit margins – currently 70% – which could indicate Xero is having to compete on price in order to remain appealing to customers.
As contributor Owen Raskiewicz noted in his earlier article though, 70 cents in every dollar comes out as gross profit, and Xero's problems are very good problems to have.
