Xero’s Bold US Play

This story features XERO LIMITED. For more info SHARE ANALYSIS: XRO

The company is included in ASX50, ASX100, ASX200, ASX300, ALL-ORDS and ALL-TECH

Xero’s largest acquisition to date has potential to fast-track its expansion in the US.

-Xero acquires payments platform Melio in the US
-Potential to fast-track Xero’s accounting expansion
-Transaction aligns with management’s 3-by-3 strategy
-Risk-reward payoff compelling, says Morgan Stanley

By Mark Woodruff 

Last month, global cloud accounting SaaS provider Xero ((XRO)) delivered interim results featuring a stronger-than-expected performance from its International segment, reinforcing management’s commitment to expand in the US market.

While revenues in Australia and New Zealand proved slightly below market expectations, offsets were provided by ‘beats’ in the UK and US.

Management also stated an ongoing ambition to “Win the 3 by 3 strategy” by improving Xero’s offerings for the three most critical jobs for small businesses –accounting, payroll, and payments– in its three key markets.

Across Australia and New Zealand, the UK, North America, and some Southeast Asian markets, Xero provides accounting plus business services to small enterprises and their advisers.

Morgan Stanley noted the 3-by-3 strategy was progressing well, as evidenced by 11% year-on-year subscriber growth to 400,000 in FY25.

Delivering on its ambition, management on Wednesday announced a bold -$3.9bn (US$2.5bn) acquisition of US business-to-business (B2B) payments platform, Melio, marking Xero’s largest transaction to date.

Morgans is on board with the deal, seeing it as a smart step to help spark product innovation and beef up Xero’s North American offering. By bringing together digital payments and core accounting, the platform is expected to become even more appealing to small businesses.

Management backs this up with research showing 60% of North American customers want their accounting and accounts payable fully integrated.

Founded in 2018, Melio provides cloud-based payments solutions tailored to US small-to-medium enterprises (SMEs), supported by a 600-strong team and investors such as Fiserv and Shopify.

As noted, Xero’s aim is to integrate accounting and payments into a single platform, with management anticipating a boost to group revenue of more than 100% by FY28 and a greater than ‘Rule of 40’ by that time.

Jarden at this point can only arrive at 39.3% for this metric after combining its forecasts for revenue growth of 19.4% plus a free cash flow margin of 19.9%.

Ord Minnett highlights management’s target equates to at least NZ$4.2bn for FY28, well in advance of prior market expectations of around NZ$3.6bn. The broker’s FY28 revenue forecast is now NZ$4.4bn once cost savings and revenue benefits from Melio are captured.

The transaction will assist Xero in controlling more of the economics in the US by directly owning one of the core 3-by-3 jobs-to-be-done, highlights Citi.

Melio provides syndication capability through its white-label platform and embedded payments infrastructure, which allow partners, including financial institutions, accounting platforms, and software providers, to offer Melio-powered payments services under their own brand.

Analysts at Citi believe Melio’s syndication capabilities and embedded relationships with banking partners could help fast-track Xero’s core accounting expansion in the US. The broker considers the banking channel a particularly effective route to acquire small and medium business (SMB) customers.

Despite the strategic rationale, some analysts caution over the steep acquisition price and Melio’s history of substantial losses.

Jarden estimates the deal will result in approximately NZ$4bn of goodwill, prompting questions about whether building similar functionality in-house could have been materially more cost-effective.

Execution risk is also cited due to the merging of two businesses, software stacks, and corporate cultures.

Macquarie disagrees, suggesting the greater risk for Xero resides in failing to execute on its US growth ambitions, rather than short-term earnings accretion or dilution over the next six to twelve months.

This broker considers the Melio acquisition reinforces the company’s 5-10-year growth narrative and holds a high conviction in Xero’s longer-term outlook beyond 12 months.

While upcoming brand re-investment may weigh on short-term margins, any share price weakness from increased costs should be seized upon as a buying opportunity, as far as Macquarie is concerned.

Investors may get their opportunity, as Citi anticipates initial share price weakness given the high acquisition multiple and dilution to free cash flow margins.

For the longer-term, Citi too views the deal as strategically positive, helping Xero achieve greater scale and providing a broader revenue base to amortise US brand investment.

Excluding the acquisition, management reiterated FY26 total operating expenses at around 71.5% of revenue, with a higher weighting in the first half, reflecting several one-off factors, including increased executive compensation.

Transaction details

The Melio acquisition follows a decade of limited success for Xero in North America despite substantial investment.

Morgan Stanley concedes the -NZ$3.9bn price tag is steep at 13 times FY25 EV/sales for a loss-making tech business, but views it as reasonable.

This broker anticipates near-term dilution to earnings and to Xero’s Rule of 40 performance and expects the deal will take more than three years to become EPS-accretive.

Still, the risk/reward trade-off is seen as compelling, with the transaction reinforcing confidence in Xero’s ability to generate meaningful additional shareholder value over the next two-to-three years.

CEO Sukhinder Singh Cassidy noted the payments space is too specialised for Xero to build in-house at scale and speed, positioning Melio’s established presence as the catalyst to transform Xero into a truly global software giant.

With 24m US SMEs yet to adopt cloud accounting, Singh Cassidy sees payments as the “seamless experience” to unlock monetisation at scale.

The acquisition marks a pivotal shift for Xero, reshaping its product strategy and financial model to compete with US players. The US market offers a significant opportunity, but it’s highly competitive, notes Morgan Stanley, with Intuit as a strong incumbent.

The purchase will be funded via a US$1.2bn institutional placement at $176 per Xero share (a circa -9% discount to Tuesday’s close of $194.21), US$360m in Xero scrip, a US$400m credit facility, and US$600m from existing cash reserves.

Management also announced a non-underwritten share purchase plan (SPP) of circa $200m at the lower of either the $176 placement price (per share), or a -2% discount to the five-day volume weighted average price (VWAP) of Xero’s shares up to and including the closing date of the SPP.

Preliminary numbers

Morgan Stanley notes the deal has not yet closed and therefore remains excluded from current forecasts.

The broker estimates Xero’s pro forma FY26 revenue would increase by 15%, from NZ$2.5bn to NZ$2.9bn, once Melio’s revenues are annualised. Earnings (EBITDA) are forecast to decline by -12% to NZ$692m.

Melio is expected to reach earnings break-even by FY28. To achieve EPS neutrality by then, Morgan Stanley calculates Xero must deliver NZ$102.5m in annual earnings synergies.

As March 2025, Melio had 80,000 customers, US$153m of revenue and an average revenue per user (ARPU) of US$250 per customer versus Xero’s North America ARPU at US$18 per customer, as highlighted by Wilsons.

Outlook

The bullish scenario for Morgan Stanley involves leveraging the Melio platform to reach the around 30m self-employed businesses where cloud penetration for accounting remains low.

Analysts at Wilsons believe the transaction will accelerate Xero’s US expansion while also enhancing scale and broadening capabilities across the entire business, over time.

Following the acquisition announcement, six daily covered brokers in the FNArena database keep their ratings unchanged. Four are Buy-rated, while both Ord Minnett and Morgans are dwelling in the space between Buy and Hold with Accumulate ratings.

While the average 12-month target price has eased to $211.50 from $212.80 since the announcement, most brokers are awaiting deal completion in late-2025. The average target suggests around 14% upside to the $184.85 closing price on June 26.

In the case of Wilsons (outside of daily coverage), earnings forecasts were left unchanged, but the analysts allowed for the increased cash and shares on issue from the placement. This broker’s target increased by 2% to $217.26.

Elsewhere, RBC Capital maintains an Outperform rating and raises its target price to $230 from $210, while also highlighting a new transaction-based revenue model could complicate forecasts and margin comparisons.

Jarden also raises its target to $207 from $197 and maintains its Overweight rating (also between Buy and Neutral).

Find out why FNArena subscribers like the service so much: “Your Feedback (Thank You)” – Warning this story contains unashamedly positive feedback on the service provided.

FNArena is proud about its track record and past achievements: Ten Years On

Click to view our Glossary of Financial Terms