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Commitment to growth boosts Xero's fair value

Roger Balch  |  05 Oct 2018Text size  Decrease  Increase  |  
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cloud computing xero accounting

Morningstar has increased its fair value estimate for narrow-moat rated cloud accounting software company Xero by 6 per cent to $25.50 on the back of its pledge to boost revenue.

The increase follows the Xero's (ASX: XRO) commitment to maintaining high-revenue growth rates via the issue of US$300 million worth of debt

Xero recently acquired Hubdoc - a website that helps organise financial documents - to add functionality to its platform and further acquisitions are expected, which, while they may prolong losses from an income statement perspective, are likely to maintain or accelerate high revenue growth rates.

The new debt takes the form of convertible notes which mature in 2023 with a coupon rate of 2.375 per cent a year, lowering Xero’s cost of capital. Note holders have the option to request repayment of the debt in Xero shares instead of cash at maturity, based on a stock price of about $65 a share in five years’ time.

The structure of the capital raising is complicated and involves the costly involvement of investment banks. There is also the possibility of shareholders being materially diluted in five years’ time if Xero has to effectively repay the debt by issuing shares.

On balance, Morningstar is reasonably comfortable with the transactions around the notes issue but would have preferred a pro-rata equity issue open to all shareholders.

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Current losses are an acceptable price to pay for rapid growth and Morningstar forecasts a maiden profit in fiscal 2019. The capital-light business model should enable returns on invested capital to comfortably exceed the weighted average cost of capital from fiscal 2019.

 

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Roger Balch is a Morningstar contributor

© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

is a contributor for Morningstar Australia.

© 2021 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'regulated financial advice' under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information, refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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