The growth opportunities for technology companies stand out from most industry sectors in the current low growth environment. We keep a tab on technology players that are the real disruptions of their respective industries rather than frivolous silicon valley ideas.
When we first started out investing in shares, the lack of technology companies on the ASX was the primary reason we shifted our focus from the Australia large cap (ASX 200) to US equities. The US is the primary listing location for all mature silicon valley startups. Hence you have to go where the opportunities are.
Australia recently became a hotbed of startup listing, primarily through a reverse merger into small-cap mining stocks past their time. The list of growth shares on the ASX has been increased overtime, with BNPL shares being the latest group of innovators in the market’s favor.
Investment Thesis
Xero (ASX XRO) is one of the only true exponential growth stories that we have seen in US-listed technology players like eBay, Google, Paypal and Apple for a time.
Xero is an accounting bookkeeping software with MYOB being the primary competitor. Rather than the traditional software distribution model of a user buying a license to use each software version, i.e., Windows (95, 2000, Vista, Home and 7).
XRO adapts a Software as a Service model (SaaS). The user purchases a subscription license with a monthly payment per user. The underlying software and functionality are upgraded and supported with limited front-end major jumps in versions requiring additional fees.
From the business perspective, the revenues can be considered an annuity as long as the churn rate or the rate at which customers discontinue the subscription remains low. The strength of the platform can provide increasing economies of scale and support long-term growth.
Xero Dividend Yield
Key Risk
Xero is not an obscure idea, and the growth story has been priced in the company share price for most of the period it has been listed. XRO share price today has priced in a certain level of expectation that the current growth pace will continue. The company can be considered a high-risk investment due to the uncertain realization of its potential. This means the investors’ profile that would buy this stock would be different from those that buy say Telstra shares ASX. The typical profile will fit the growth or momentum investors.
We currently do not hold a position, but it is a space we are keenly watching. The critical risk is the execution of global expansion is hindered by existing UK and North American competitors. Stronger than expected competition and by not having the first-mover advantage it had in Australia with a SaaS model poses a significant headwind.
Another area we are keeping an eye out for is the ability to support the current cash burn rate. The goal of management is to ensure that the ANZ cash flow will provide internally generated capital to invest its international expansion plans. The worst case is if the rate of cash burn requires an equity raise to support the growth.
If the share price pullback due to the broader market, it is an idea that we are willing to add to the portfolio. Until then, we will be watching from the sidelines.