Sceptics Want Xero To Prove Melio’s Added Value

Australia | 3:11 PM

Despite strong underlying growth in the core accounting business, lower cost guidance and the general approval of analysts, shares in Xero fell after first-half results.

-Xero’s interim reveals strong growth for the core accounting business
-Operating expense guidance down, Melio aspirations confirmed
-Loss-making Melio to keep Xero's growth below Rule-of-40 level until FY28
-Re-rating likely requires tangible evidence of successful Melio integration and execution 

By Mark Woodruff

Cloud accounting software provider Xero’s ((XRO)) value proposition continues to resonate strongly across the A&NZ region, which accounts for over half of group revenue, but the key question remains whether this success can be replicated across the United Kingdom and North America.

Xero’s core accounting business delivered strong underlying growth in the first half, with faster-than-expected execution across several near-term growth initiatives. Gusto (payroll) went live ahead of schedule and the recent acquisition of digital payments platform Melio closed earlier than anticipated, with the US rollout slated for December.

Full-year FY26 operating expense guidance improved to 70.5% versus the previous 71.5%, and management reiterated longer-term aspirations tied to the Melio acquisition. FY25 revenue is expected to more than double by FY28 while maintaining “greater than Rule-of-40” outcomes.

Melio enhances Xero’s product suite, expands its payments capabilities, and will hopefully accelerate scale across the North American market.

Subscriber growth is gradually improving from a low base in the larger North American market, Morgans observes, while the UK’s mandatory ‘Making Tax Digital’ program is providing a structural tailwind.

Negative reaction to results

The recent sell-off in high-growth stocks like Xero has been broad-based, driven by rising bond yields, macroeconomic uncertainty, and a market rotation into value sectors.

Given the -28% share price fall since the Melio acquisition announcement in late-June, and the -11% decline in the four weeks prior to first half results, analysts at Jarden were surprised by the additional -9% drop after the release, noting it came despite solid operating momentum.

Ord Minnett believes investors reacted to higher-than-expected guidance for the operating expenses-to-revenue ratio, which was interpreted as implying roughly a -5% downgrade to FY26 earnings (EBIT).

Also, A&NZ’s lifetime value-to-customer acquisition cost (LTV/CAC) ratio declined to 10.7 in the period from 11.6 in the prior year.

While this is mathematically correct, Jarden notes the 8% rise in lifetime value per subscriber to $4,899 more than offsets the -17% deterioration in acquisition cost to -$458, underscoring continued efficiency in customer economics.

Although revenue recognition in the International segment was around 90% due to higher discounting, Macquarie explains the six-month discount period reduces subscriber lifetime value by only -0.8%, while effectively supporting subscription growth.

North America revenue 'missed' which RBC Capital attributes to weakness in Canada and ARPU discounting, given North America subscriptions were in line with expectations.

Despite the above real or imagined disappointments, Macquarie now has increased confidence in management’s ability to achieve its FY28 target of more than doubling sales.

In a more cautious take, Morgans believes it may take time for management to rebuild investor confidence in Melio’s strategic value and to restore Xero to Rule-of-40 growth levels.

Revenue, subscribers and ARPU

Xero’s growth is driven by both subscriber volume increases and rising ARPU via the introduction of new products and price rises.

The company’s cloud-based small business accounting platform, which brings together core business tools such as accounting, payroll, and payments, generates revenue primarily through recurring subscription fees.

Xero’s SaaS model is supported by an extensive ecosystem of third-party app integrations and bank connections, allowing small businesses and their advisors to manage finances and automate processes.

In the first half, operating revenue grew 20% year-on-year (18% in constant currency) to NZ$1.194bn driven by a combination of subscriber expansion and higher ARPU.

Total subscribers reached 4.59m, up 10% year-on-year, with net subscriber additions of 176,000 in the half versus just 26,000 in the prior period, which had been depressed by a one-off purge of long-idle accounts.

A&NZ delivered NZ$663.7m in revenue, up 17% year-on-year, with subscriber numbers reaching about 2.7m.

The International segment (which encompasses the UK, North America and Rest of World) grew even faster, with revenue rising 24% to NZ$530.5m as subscribers climbed to 1.9m.

ARPU expanded in both segments, especially internationally where higher-value offerings and price changes drove a 19% year-on-year increase in ARPU to NZ$54.08.

Group ARPU climbed to NZ$49.63 per month, a 15% increase reflecting price increases and uptake of higher-tier offerings. Australian, UK and New Zealand price rises within the half contributed more than 50% to this increase, Macquarie highlights.

Subscriber growth in A&NZ has remained steady over the past three halves, Morgans highlights, while the UK continues to record year-on-year improvement in subscriber additions. Management now also discloses US subscribers and revenue, and these operations continue to improve on an underlying basis.

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