Xero Demonstrates Improved Cost Discipline

We increase narrow-moat Xero’s XRO fair value estimate by 11% to AUD 60 per share with its new plan to reduce costs and focus on disciplined growth. Our fair value increase reflects a reduction in our ongoing cost assumptions, specifically for product design and development.

We appreciate Xero’s disciplined growth focus and willingness to make tough choices. The COVID-19 pandemic ushered a surge in demand for digital products and services, like Xero’s accounting software. And many technology companies hired aggressively, pushing up salaries, and arguably, increasing bloat.

Between fiscal 2019 and fiscal 2022, operating expenses more than doubled for Xero, driven primarily by 170% growth in product design and development costs. With demand normalising, new CEO, Sukhinder Singh Cassidy, has rationally cut costs. While potentially unpopular among employees, it bolsters her role as a steward of shareholder capital. Xero will lay off between 700 and 800 people, or around 15% of the staff.

We expect revenue growth to continue despite the cuts. While there is some logic to the idea that more labour improves output, we believe there are limits and sometimes success can breed inefficiency, especially when growth—and particularly employee growth—is fast. Adding more people to a problem can slow efficiency and progress. The layoffs are painful, especially for those directly affected. But in the longer term, we believe they will improve the health of the company and help return Xero to a path of efficient growth.