Bitesize: How to value Xero with Rask

Alec: [00:00:07] Welcome to Bitesize on Get Started Investing In this series, we feature some of our favourite lessons, quotes and moments from the podcast. If you'd like to listen to the full episode, we've included the link in the show notes. 

Bryce: [00:00:23] So we're here to understand. The valuation of zero. And we've spoken about a couple of key metrics here. Subscriber numbers, prices, you know, Ren has spoken about revenue growth. If you can, I guess, clearly sort of take us through the process that you would go through to try and get to a valuation for zero, knowing that it's not profitable yet. So some of the valuation methods are going to work. How do you and what are the assumptions that you're looking at to create a valuation? 

Owen: [00:00:53] Yeah, sure. So that this is the simplest way to model any type of subscription business is the number of subscribers multiplied by how much they pay you gives you revenue. Right. Because it's like customer numbers multiplied by how much they pay gives you the sales rights pretty straightforward. So then all we need to do is we need to have a sense of how far subscribers can grow, like how big can it get in each market, which they tell us they have an estimate of like 4 million potential customers in Canada, for example. And these are small businesses. And then you go, okay, well, how much can I charge at the moment? You'll see in Australia there's about 50 to 60 bucks, but it scales depending on the number of employees. And if you add on to blah, blah, blah, blah. But if you think about that, like what you can see is you can see different pricing levels over time as well. So you would expect that as businesses grow, they start to pay more. And then even though it's not profitable, we can start from just those two numbers, we can start to get a sense of the value because we know how much revenue it's got, how much it's making in sales. And so we could say, you know, price to sales ratio if you want to go down that path because it's still growing, you could say, I don't know the exact number off the top of my head, but size zero is like ten times sales that in the company's worth according to the market price, ten times the annual sales of the business. But you could say, well, I think it's going to grow sales, you know, further. And I think ten times is a reasonable price to pay, then, you know, that's probably going to go up in time. What I do is I take the the number of subscribers multiplied by the price, and then I just feed that straight into my own income statement. So just like you would say in the annual report, I just put this extra step on top of it, if you like, where I'm just trying to predict what might happen in the future. So you've got total subscribers, and I do have it on the video version, but total subscribers. And then I look at, well, how big can I grow in those marketplaces like Canada, UK, Australia? And then I basically just get to that revenue line and I make some assumptions about the profit margins. Then from there you just do a profit margin and you get down to cash flow.

Alec: [00:02:56] So we're not going to talk through the details of the spreadsheet because that probably doesn't translate over audio. But let's just ask some questions to unpack sort of how you think this business goes into the future, because as we spoke about on the last episode, the real where the rubber hits the road where the best value was separated from the average value isn't in their ability to build a spreadsheet. It's in their ability to accurately assess a business's prospects. So first question: When do zero become profitable? 

Owen: [00:03:27] I'd say in the next two years. Okay. Yeah. So we're recording, we're recording this let 2022 but it is in 2023, I would say before 2025 it will be profitable. Yeah. And you can actually say this is interesting. So this is I initially bought this a long time ago just this year. And this company and my assumption at the time is this if Xero wanted to, it could cut its marketing budget in half and be instantly profitable. 

Bryce: [00:03:53] Well, we hope you enjoyed that bite size. Now, if you're a beginner to investing or you have been doing this for a while and you're ready to take your next step, why don't you try out one of our online courses? We've built these in partnership with Rask to help you learn about the nitty gritty of investing in shares. From beginning to dividend, we've got two courses on offer. The first is out get started investing introduction course. It is free and the second is out Value Investor program, which is highly rated and gets you under the cover of value investing.

Alec: [00:04:26] And that course comes with plenty of downloadable resources as well. You can do your own discounted cash flow or DCF analysis. You can research ASX or global companies using free and premium analyst tools. There's investing checklists. There's so much more here.

Bryce: [00:04:42] It's a super comprehensive, great course. So don't miss out on our special offer until the end of June. You can save $100 on the Value Investor program by using the code EOFY. That's EOFY for $100 off. 

Alec: [00:04:55] Head to equitymarkets.com/online-courses. If you didn't get that, the link is in the show notes below to find out more.