Growth costs seen as risk

Questions are emerging about the heady success of cloud accounting company Xero as further huge expansion costs come at the expense of profitability.

While Xero's share price outperformed all comers on the stock exchange last year and it maintains a $210 million war chest, with eight consecutive losses behind, the massive expansion costs are causing concern.

Analysts do not see Xero booking a profit for at least two to three years, prompting several questions about where its value lies for shareholders, its capital requirements and its expansion costs.

Craigs Investment Partners has a consensus price target at $30 and maintain a ''hold'' recommendation, while broker Forsyth Barr has the 12-month target unchanged at $24.75 and the stock rated, unchanged, at ''underperform''.

Craigs Investment Partners broker Peter McIntyre said Xero had had a ''lofty appreciation'' in value. Its shares were up 259% from $12.80 a year ago to its recent 45.99 high, but its future was ''finely balanced''. Its market capitalisation was more than $4 billion.

''Growth is already factored into the share price but Xero needs to get revenues adjusted upward,'' Mr McIntyre said.

''The question is whether $210 million [current cash in hand] is enough to keep ahead of the curve of competitors, then give a boost to its operating cash flows ... where investors could then take heart that growth can continue,'' he said.

Forsyth Barr broker Haley Van Leeuwen said Xero's booking of a $35 million loss this week was as expected, noting customer growth was beyond 80%, revenue was up and strong growth was expected in Australia.

However, she believed Xero was a ''risky investment proposition''.

''There's no doubt that Xero has performed very well to date and has a great future.

''However, in our view, investors are not being adequately rewarded for the risks they are taking on,'' she said.

Mr McIntyre believed investors would not see a profit booked ''for the foreseeable future; two to three years at least'', noting management would be reinvesting back into the company's growth and expansion.

''The tech stocks can have the hype, show new customers and sales up, but the fundamentals eventually come back to revenue and profit, then the company providing income to investors,'' he said.

Ms Van Leeuwen said: ''As Xero needs to grow in the United States to meet its aspirations its costs will continue to outstrip revenues for several years yet.''

Mr McIntyre noted the US accounting sector was ''fragmented'' and Xero faced increasing competition, such as Australian-listed MYOB, which now better understood Xero and its targets and was ''making moves into its space''.

On the question of whether the $210 million war chest was enough to fuel growth, Mr McIntyre said it was possible Xero ''may at some time have to consider'' going back to the market for more capital.

''But they have got some big global players on the share register. They would be supportive of further capital raising, if requested,'' Mr McIntyre said of US institutional Blackrock, City Corp and Credit Suisse.

- simon.hartley@odt.co.nz

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