XROLF - Xero: Superior International Growth But Also International Competition

2023-04-04 14:40:54 ET

Summary

• The company’s international segment revenue (43% of total) consisting of North America, the United Kingdom and Rest of the World has higher revenue growth (44%) compared to its home market ANZ.
• This is as the company's subscriber penetration in the ANZ segment has reached 54% while its penetration in international markets is only at 1%.
• While Xero’s penetration in the largest market in the world (North America) is only at 1%, the company faces stiff competition from Intuit and other competitors.

In this assessment of Xero Limited ( XROLF ), we reviewed the company's investor presentation, which emphasized the long-term potential of its International segment. Consequently, we conducted an analysis of the company's growth across geographic segments, building on our prior assessment that revealed the superior growth of its international divisions over its ANZ home market segment. Furthermore, we conducted a comprehensive examination of the company's subscriber and ARPU growth across different geographical regions.

International Segment Growth Superior to ANZ Segment

Source: Xero, Khaveen Investments

The table above shows the operating revenue across geographical locations. The geographical segment breakdown is Australia, New Zealand, the United Kingdom, North America and the Rest of the World. We obtained our 2023 estimates based on Xero’s prorated H1 results.

Based on the table, its home market (ANZ) is a significant portion of its business, expected to represent 57.4% of the total revenue in 2023. Although both Australia and New Zealand are expected to grow at healthy rates of 21.8% and 11.9% respectively, we see that New Zealand has the biggest difference in growth rate (11.9%) compared to the total in 2023 (20.1%) and also the second-largest difference (22.9%) when compared to the total 9-year average (35.1%).

Looking at the international segment, the United Kingdom is the largest international market for the company, even bigger than New Zealand and it is expected to grow in line with the total for 2023. Both North America and the Rest of the World segments are showing below-average growth but the Rest of the World segment is expected to have a steep fall in growth from 84.7% in 2022 to 24.4% in 2023 based on prorated results.

Overall, its international segment had a higher average growth rate in the past 8 years in terms of revenue growth compared to its ANZ segment but had slowed down in the recent 3 years. Though, it is still higher than its ANZ segment.

International Subscriber Growth Opportunities

Source: Xero, Khaveen Investments

The table above shows the average number of subscribers per region from 2019 up till the forecasted value of 2023. We obtained our 2023 forecasted subscribers for the company based on its average half-yearly customer additions in the past 3 years. There is expected to be a slowdown in total subscriber growth, falling from 21% in 2022 to 18.9% in 2023.

In the ANZ segment, Australia is its largest market by subscribers not just within ANZ but as a whole. We expect it to show higher growth in 2023 (21.9%) compared to 2022 (21.3%) but is still growing at a rate below the average. New Zealand is expected to have the lowest growth rate in 2023 (13.6%) across all regions but growing in line with 2022 (15.3%). New Zealand also has the lowest average subscriber growth among all regions in the table though its ANZ segment is supported by the higher Australia segment average growth.

In the International segment, we expect all segments to grow at a rate that is below the one of the previous year as well as the average value. The United Kingdom is expected to fall from 20.4% to 17%, North America is expected to fall from 20.7% to 16.7% and Rest of the World is expected to show a decline from 37.3% to 24.5%. Rest of the World has the highest average subscriber growth rate among all regions and is well above its total company average, followed by North America and the United Kingdom.

Overall, the International segment has superior growth than its ANZ segment in terms of subscribers with a higher average growth rate. Except in 2023, its International segment subscriber growth had been higher than ANZ in all years.

Source: Xero, Khaveen Investments

However, based on the company’s presentation, its penetration rate of subscribers of the total TAM is highest for the ANZ segment at 54.2%. Conversely, its penetration rate is lower for the UK, North America and the Rest of the World segments. For the International segment overall, we calculated its penetration rate to be only 3.6% which we believe indicates its growth opportunities for its international segment in addition to the much larger TAM of the ANZ segment. Moreover, we believe the biggest growth opportunity is in the North American region as it has the largest TAM and only a 1% penetration rate.

Higher ARPU Growth for International Segment

Source: Xero, Khaveen Investments

The table above shows the annual revenue per subscriber (ARPU) for each region from 2018 up till the forecasted value of 2023. The values are obtained by taking the revenue for each region and dividing it by the average subscriber number for the region.

We expect the overall ARPU growth in 2023 to be muted but in line with the 8-year average. For the ANZ region, overall growth is expected to be flat at –0.1%. Australia is also exhibiting a flat growth rate of –0.1% whereas New Zealand is showing a slight decline with a growth rate of –1.5% in 2023 compared to a growth rate of –0.7% in 2022.

The International growth rate (2.4%) is expected to be above the company’s overall growth rate in 2023 (1%). This is mainly due to the 2.7% in North America and the 2.6% in the United Kingdom. We see the Rest of the World segment to have muted growth at –0.1%. The Rest of the World segment had the highest average ARPU growth and is almost the company’s overall ARPU growth. In contrast, North America’s ARPU growth has a negative average growth rate and its ARPU is also the lowest among other regions.

Overall, the company’s international segment has a lower ARPU than its ANZ segment but a slightly higher average growth rate than ANZ. In comparison, subscriber growth for Xero was significantly higher and was its main growth driver rather than ARPU growth as discussed earlier.

Risk: High Competition in North America Segment

We believe one of the risks of the company is the competition risk for its international segment. In our previous analysis of Intuit ( INTU ), we highlighted the company’s market dominance in the North American market which could pose a threat to Xero’s expansion into the market. Furthermore, the company’s ARPU for its North American segment is the lowest among all other geographic segments. Furthermore, from the previous point, the company has a low penetration rate of subscribers compared to its North America TAM. Thus, we believe these factors indicate high competition in that region.

Verdict

Source: Xero, Khaveen Investments

Overall, Xero's international segment has demonstrated above-average growth over the past eight years. Notably, based on Xero's investor presentation, we highlighted that the ANZ segment has the highest subscriber penetration rate at 54.2%, while the UK, North America, and Rest of the World segments exhibit lower rates, suggesting greater growth potential for the international division in terms of subscriber growth which is its main growth driver. Furthermore, the international segment exhibits a lower ARPU than the ANZ segment, but with a slightly higher average growth rate, thus further supporting its positive international growth outlook. However, we note the intense competition in the largest market, North America. According to TipRanks' analyst consensus, Xero has a price target of AUD 96.17 , implying an 8.2% upside. Given this outlook, we rate Xero as a Hold.

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