Xero (XRO: ASX
), the provider of cloud-based accounting software for small to medium enterprises (SMEs), could be nervous about how fast September is approaching. Why? Because September marks the end of the government’s JobKeeper payments.
And while the Prime Minister hasn’t ruled out providing further support to businesses around the country, once the JobKeeper supplement is cut off, September could spell trouble for many SMEs in Australia. This, in turn, would have a knock-on effect on Xero’s business.
Xero and COVID-19
In its recent FY20 full-year report, Xero disclosed that COVID-19 had already impacted the company in the early stages of FY21. But the full impact of this is unknown.
Although the government has completed a review into the JobKeeper payments, the findings won’t be released until the third week of July.
Short-term pain
According to its FY20 report, Xero has 914,000 subscribers in Australia. These Australian subscribers contributed $320 million to the company’s total revenue. Unfortunately, a number of these Xero customers in Australia will struggle to stay solvent over the next 12 months as the real financial impact of COVID-19 hits home.
The good news for Xero and its shareholders is that the company has a global strategic focus, with an increasing footprint in the United Kingdom and North America. Nonetheless, COVID-19 is a worldwide pandemic, so the impact on businesses is not limited to Australia and Xero’s overseas customers will also be feeling the pinch.
Xero will suffer some short-term pain as its new subscriber rate slows, and some existing customers are potentially lost. However, the company remains in a strong position financially with net cash of $111 million and positive free cash flow of $27.1 million.
Long-term gain
The company reported a total of 2.285 million subscribers worldwide in its FY20 results. Of these, 467,000 were acquired during the year. While this growth rate may stall in the short term, Xero should continue to grow as the global economy recovers, and more businesses move towards cloud accounting.
As discussed in a recent article by Rask Media’s Owen Raszkiewicz, Xero has a customer lifetime value (LTV) to customer acquisition cost (CAC) ratio of around 6x. In simpler terms, for every $1 that Xero spends to attract a customer to the product, the company receives ~$6 in return from that customer.
The strong balance sheet and LTV-to-CAC ratio of 6x leaves Xero with room to spend more on acquiring new subscribers. If Xero were to use this strategy, it could prevent the company’s subscriber growth rate from dropping over the short term.
So what’s the verdict?
Even though Xero will experience a slowing of its growth, I believe the company remains in a strong position over the long term.
With the strong tailwind of businesses switching to cloud accounting behind it, and governments using both monetary and fiscal policies to drive new business growth globally, Xero is well-positioned to take advantage of these factors.
As history has taught us, economies will continue to grow, and new businesses will continue to open, leaving Xero with more opportunity to acquire new customers and increase profits.
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Disclosure: At the time of writing, Jack doesn’t own shares in any of the businesses mentioned.
