Xero’s XRO fiscal 2025 earnings before interest, taxes, depreciation and amortisation (“EBITDA”) increased 28% to NZD 638 million. The company reported a 23% increase in revenue on the prior year, or 20% in constant currency. The result was driven by growth in average revenue per user (“ARPU”) of 15%, while subscribers grew by 6%.

Why it matters: The result was in line with our thesis for the company, with saturation fast approaching in Australia and New Zealand, while international is struggling to grow profitably. Growth is increasingly driven by the company pulling short-term levers, such as price hikes in ANZ.

  • Subscriber growth in New Zealand, where the company originated, slowed to just 4%, from 7% the prior year. Australia, the company’s largest market, is fast following suit, with subscriber growth declining to 9%, from 13% the prior year.
  • ARPU growth was 10% in ANZ, and 20% in international. The removal of a number of idle subscribers during the year skewed combined ARPU growth by 400 basis points and overindexed on international. We estimate price hikes contributed the vast majority of underlying ARPU growth across the group.

The bottom line: We raise our fair value estimate for narrow-moat Xero by 3% to AUD 94.50 per share, representing the time value of money. At current prices, Xero’s shares screen as expensive and not reflective of a company struggling to maintain profitable growth.

Big picture: We view Xero’s ANZ business as having an economic moat based on network effects. Equally though, we believe Xero is up against a similar economic moat in its international business, especially in the US, where Intuit reigns.

More spending to go to replace churned customers, leaving fewer resources available for growth

We expect Xero’s near- and medium-term strategic focus to revolve around rationalizing its areas of investment, especially against a backdrop of normalizing demand for business software.

After the onset of the covid-19 pandemic, new business creation levels spiked while business failure rates plummeted, which we believe provided a temporary tailwind for business software.

In response to this tailwind, Xero’s nearly tripled its total expenditure on product design and development. However, we see little evidence of returns on these investments. Xero today operates mostly in the same markets as it did a decade ago. Therefore, we believe investments in country-specific adaptations of its products do little to explain the 10-fold increase in total expenditure on product design and development over the period. We also don’t see compelling evidence of returns on investment into new features and functionalities. New Zealand, Xero’s most mature market, should reflect increased average revenue per user, or ARPU, if new features and functionalities were valued by customers. Instead, the New Zealand market has only seen low-single-digit growth in ARPU over the past decade, leading us to believe Xero’s small and midsize enterprise, or SME, customers value simplicity, not features and functionalities.

Xero’s investments in sales and marketing in its international markets have also seen diminishing returns since the onset of the pandemic. Xero’s international customer acquisition costs, or CAC, per subscriber have grown by over 50% since the onset of the pandemic and are three times greater than its Australia and New Zealand markets. Although the lifetime value, or LTV, per international subscriber is still three times CAC, and CAC payback remains under two years, Xero’s overseas expansions have seen widely differing degrees of success over the past decade. Whereas Xero has successfully made inroads into the United Kingdom—where we estimate it is capturing around a third of new businesses created—in the United States, Xero’s market share continues to hover at just 1%.

Xero bulls say

  • Xero holds a dominant market position in Australia and New Zealand, where its business is supported by network effects.
  • Xero has successfully made inroads into the UK, where it is capturing around a third of new businesses being created.
  • Under new leadership, Xero has renewed focus on fiscal discipline.

Xero bears say

  • Xero’s customer base of SMEs is low-quality, due to the segment’s inherently high business failure rates. This will require constant spending into sales and marketing to replenish churned customers.
  • Xero has been unsuccessful at making inroads into North America, where it holds just 1% market share.
  • Xero has a chequered history when it comes to fiscal discipline, especially in product design and development.

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company’s future cash flows, resulting from our analysts’ independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.