Accounting software company Xero (XRO) has launched a $200m share purchase plan (SPP). Shareholders can purchase up to $30,000 of Xero shares at a price no higher than $176.00 per share. The offer follows Xero’s US$2.5m purchase of Melio, a leading US small and medium (SMB) bill pay platform.
The Melio Acquisition
Melio is a leading platform that enables easy to use accounts payable workflows and a wide choice of payment methods. The acquisition represents a calculated bet by Xero on the future of integrated business finance, targeting the massive US small business market. Melio serves over 80,000 U.S. small businesses, processing more than $30 billion in payments annually and generating $187 million in annualised revenue.
The platform addresses a critical pain point: approximately 78% of US SMBs place high importance on having accounting and payments software offerings integrated.
Melio also distributes its platform via syndication partners such as Fiserv and Shopify, potentially giving Xero access to millions of US SMB customers for its accounting software.
The acquisition aligns with Xero’s “3×3 strategy,” which focuses on three priority markets (Australia, United Kingdom and the US) and three key product areas (Accounting, Payroll, and Payments). By uniting these capabilities, Xero aims to create a comprehensive financial ecosystem for small businesses, directly challenging market leader QuickBooks.
Xero’s US revenue will treble with the acquisition to US$235m. It expects the combined business to significantly accelerate US revenue growth and more than double Xero’s FY25 total group revenue by FY28.
While Melio is currently loss making, it has been growing revenue at a compound annual growth rate of 127%. The acquisition has been priced at a multiple of 13.4 times annualized revenue, or 9.7 times revenue after expected revenue synergies.
Funding
The US$2.5bn (A$3.9bn) acquisition of Melio is being funded as follows:
- A$1.85bn placement of shares to institutions at A$176.00 per share (completed);
- Approx A$550m placement of Xero shares to existing Melio Shareholders;
- New debt funding of approx. A$600m;
- Existing cash on the balance sheet of approx. A$950m; and
- This share purchase plan (up to A$200m).
Share Purchase Plan
The share purchase plan allows retail shareholders to invest up to A$30,000 per shareholder, with shares priced at the lower of $176.00 or a 2% discount to the volume-weighted average ASX trading price of Xero shares during the five days up to the SPP closing date. The $176.00 is the same price institutional investors paid.
Participation is entirely voluntary, and shareholders may apply for parcels valued at $1,000, $2,500, $5,000, $7,500, $10,000, $12,500, $15,000, $20,000, $25,000 or $30,000.
The SPP closes on Monday 21 July at 5.00pm. In the event of oversubscription, Xero may elect to apply a scale back.
What the brokers think
The major brokers are supportive of the acquisition. While noting the high price being paid and that it will be earnings dilutive in the short term, they see it as being aligned with the Company’s strategy and strengthening the company’s position in its key growth market, the USA.
Paraphrasing Morgan Stanley’s latest research report, FN Arena wrote:
“The broker sees a “very large” opportunity for the company in the small and medium business (SMB) market, noting the SMB accounting software market is immature.
The analyst reiterated there’s strategic merit in the acquisition of Melio as it will further enhance the company’s strategy by bringing together accounting and payments into a single platform”.
A precis of Macquarie’s analysis: “Macquarie highlights Xero’s Melio acquisition is a US-based payments platform that provides digital accounts payable and receivable solutions focusing on the SMB market. It also has exposure to accountants and bookkeepers with revenue from transaction fees.
The analyst explains Melio offers Xero US subs growth, and the US payments market is a “large” revenue opportunity with a total addressable market of US$29bn. The risk in the medium term, Macquarie stresses, is the inability to achieve US growth.
Melio is also believed to be under-monetised, so it can generate growth with lower incentive pricing for more volume expansion. There is scope for margin expansion from higher-margin syndication, states the broker, and subscription revenues.”
All the major brokers currently have “buy” recommendations on the stock. According to FN Arena, the consensus target price for Xero is $213.67, about 22.6% higher than the last ASX price of $173.83. The range of target prices is a low of $200.00 from Ord Minnett up to a high of $235.00 from Morgan Stanley.
Our view
The USA is Xero’s key growth market. While there are opportunities to increase margin and revenue from adjacent products in the Australasian market, further increasing market share of its base accounting platform will be difficult. Substantive revenue growth can only come from offshore.
In the USA, Xero has struggled to make significant headway against Quickbooks. This acquisition propels it into a different orbit and allows it to offer a more compelling product to SMB customers. It looks to be the right product set and Melio has a distribution footprint that can be leveraged.
Like all acquisitions, the challenges will be around execution. For shareholders, this is a bit of a “leap of faith” acquisition, but Management has the track record to warrant backing. While the acquisition price is full, this is a revenue play rather than a cost play, and if Xero can pull it off, shareholders will be handsomely rewarded.
In the short term, we don’t expect to see share price appreciation (in fact, the shares could come under pressure) simply because of the new supply of shares from the institutional placement and from this SPP. So, investment in this SPP should be from a long term perspective.
Xero remains one of our core information technology stocks. This SPP is worth backing.