Is AI Nemesis Or Opportunity For Xero?

Australia | 10:00 AM

Xero's latest presentation addressed central concerns around AI monetisation, disruption and a stronger growth outlook for recently acquired Melio, but markets globally are in the grip of collective AI disruption angst.

• Xero moves to settle investor jitters, upgrading Melio's growth outlook
• Multiple levers to grow Melio earnings beyond customer acquisition 
• Embedded infrastructure offers major AI disruption moat, but fears persist
• Zero valuation ascribed to Melio offers re-rating potential

By Danielle Ecuyer

Valuations don’t matter until they do, and narratives don't matter until they do!

Fear consumes software stocks from agentic AI displacement

Software-as-a-service companies are being whitewashed with the same paint as a global narrative fuels a stampede out of software stocks, largely indiscriminate of any differentiation in technology advantage or barriers to entry, and driven by a growing fear around AI disruption.

Xero ((XRO)) is one of many companies being thrown out with the bathwater as valuation multiples compress.

As Stephen Innes of SPI Asset Management observes, “Artificial intelligence stopped being framed as a margin accelerator and started being treated as a structural threat. The fear was no longer about missing upside. It was about owning businesses whose economics might be rewritten by the very technology they helped popularize.”

Against this backdrop, Xero’s management used this week's AI and Melio product demonstration to outline several reasons why AI monetisation could instead act as a catalyst for a re-rating,

From a timing perspective, some may lament the presentation occurred just twenty-four hours before Anthropic unveiled a new legal tool, reported by the FT as promising to “automate contract reviews, compliance workflows and legal briefings”.

That announcement helped trigger an out-sized global sell-off in software stocks, reinforcing fears that AI is now disrupting itself by shifting from model provision to application delivery.

Xero's Melio presentation addresses growth concerns

Macquarie highlights a growing disconnect between the market’s reaction to cloud SaaS stocks and the on-the-ground reality outlined by Xero’s management.

Central to that disconnect is Melio. The large US-based acquisition (US$2.5bn plus potentially an extra US$0.5bn) has brought a payments-led workflow platform that materially extends Xero’s cloud-based accounting proposition and is now expected to achieve adjusted earnings (EBITDA) break-even on a monthly run-rate basis in 2H28.

This is significantly sooner than prior guidance and expectations and implies more robust gross profit dollar growth than previously assumed. This is significant news given the scale of the acquisition and its strategic importance to Xero’s longer-term ambitions in the US.

Macquarie notes management has indicated the bulk of Melio’s fixed cost investment is complete, paving the way for operating leverage as incremental gross profit flows through.

On conservative assumptions of no operating expense growth over the next three years, Melio would generate FY28 gross profit of around NZ$176m, approximately 46% above Macquarie’s initial forecasts, which were explicitly described as conservative at the time.

UBS expects total payment volumes for Melio to grow at a compound annual rate of more than 40% from FY26 to FY28, underpinned by Melio-only users of more than 15k per annum, higher attachment rates across Xero’s accounting subscriber base, and increased share of wallet.

At the core of Melio’s earnings strategy is a focus on growing gross profit dollars through deeper customer usage, improved product mix and operating leverage, rather than relying solely on customer acquisition.

Management is actively encouraging customers to move beyond basic bill payments into more complex workflows, including liquidity management, real-time cash flow visibility, card usage and international payments.

These “higher-value rails”, as brokers describe them, naturally lift take rates and gross profit per customer.

UBS forecasts take rates to advance to 82.5bps by FY29 from 51bps as customers increase usage of "premium" payment types which has been reinforced by UBS evidence lab survey. The results showed SMEs are expecting to increase usage of higher margin products (instant payments, virtual cards) and lower usage of low margin payments like cheques.

Historical cohort data supports this approach. Macquarie notes around two-thirds of gross profit growth per direct customer has historically been driven by take rate expansion and mix shift, with the remainder coming from higher payment volumes per customer.

This allows Melio to grow earnings materially even without strong customer growth, reinforcing confidence in the path to profitability.

Citi highlights this dynamic in recent results. While 1H26 total payment volumes declined -3% year on year, partly due to the exit of the QuickBooks channel following Xero’s acquisition, Direct revenue grew 56% year on year.

Take rates increased to 66bps and spend per customer rose 25%, despite direct subscriber numbers falling by -17k. Direct payment volumes still grew 4% over the period.

The data illustrates management’s willingness to trade lower-volume, lower-margin activity for stronger unit economics.

Can Melio's syndicated channel drive growth?

Melio’s business is split between Direct customers, acquired through Xero or Melio-branded channels, and Syndicated customers, acquired via partners, primarily banks and financial institutions, where Melio’s technology and workflows are embedded inside the partner’s product.

In the Direct model, Melio controls pricing, product design, payment mix and the customer relationship. In Syndication, the partner owns the customer, while Melio earns revenue through revenue-sharing, fixed fees or net revenue arrangements.

Management’s presentation leaned heavily into the growth levers Xero can directly control, notably Direct payment volumes and take rates. Brokers see this as a deliberate and conservative choice. While syndication was a key strategic rationale for acquiring Melio, it is inherently lower visibility, with long bank decision cycles and uneven revenue ramps.

This caution is reinforced by industry developments. Capital One’s acquisition of Brex highlights a trend toward banks internalising cards, payments and spend management capabilities rather than outsourcing to third-party embedded platforms.

Citi also notes Fiserv’s strategic reset toward favouring more internally developed solutions, after historically partnering with specialists like Melio to deliver high-value SMB workflows.

Macquarie remains positive on syndication as offering longer-dated upside potential. Management expects the customer mix between Direct and Syndicated to remain broadly unchanged, with 1H26 at around 63% Direct and 38% Syndicated.

Importantly, Macquarie is upbeat on Melio’s ongoing partnership with Fiserv, noting major banks such as US Bancorp have gone live on Fiserv’s CashFlow Central product powered by Melio.

These arrangements are described as “high calorie” revenue streams.

In cases where Melio does not process the payment itself, it earns high-margin net revenue with minimal variable cost, creating the potential for meaningful operating leverage as volumes scale.

However, this upside is not required to meet current guidance.