Cloud accounting software program Xero Ltd (ASX: XRO) reported its first-half results for 2025 today. For H1 FY 2025, Xero reported a 25% increase in revenue to $995 million, a fraction below analyst estimates. As Xero reports in New Zealand dollars this article will refer to NZD unless otherwise noted. You can review previous coverage of Xero here.
The Australia and New Zealand markets both recorded double-digit revenue growth. The Australian business, in particular, benefited from price rises beginning in July, with H1 revenue up 27% on the prior corresponding period (pcp).
Xero’s progress in the international market remains a real challenge.
While international revenue grew by 25% on the pcp, subscriber growth was only 11%, even excluding the removal of idle subscriptions. This is a similar growth level to the mature ANZ market, which I think is disappointing given Xero’s low market share in North America. On the results conference call, Xero CEO Sukhinder Singh Cassidy reiterated her confidence in Xero’s international expansion plans, highlighting regulatory tailwinds in the UK, and the recent restructuring in the USA.
Xero continued its free cash flow growth with the company reporting an impressive $209 million in operating cash flow, growing 96% compared to the prior year. Prior to today’s results, Xero has had a strong share price run, up around 34% over the past 6 months. There continues to be significant optimism about the company’s growth, and the continued cash flow growth has been welcomed by the market. It is worth noting that in the prior two years, the first half cash flow has exceeded the second half of the previous year. But this wasn’t the case this time around, perhaps indicating the result isn’t as good as it could have been.
Xero grew its gross margin to 89%, showcasing its product stickiness.
While far from the best measure of profitability, EBITDA grew 51% to $311 million. Encouragingly, Xero reported H1 FY 2025 profit after tax of $95 million, up a whopping 76% on the pcp. Diluted earnings per share increased to $0.62 from $0.35 in the prior period.
Net subscriber additions dropped significantly due to a program announced in H1 2024 to remove long-idle subscriptions. These subscriptions were a small percentage of Xero’s overall subscribers and their removal had minimal effect on revenue. If we exclude the removal of the idle subscriptions, Xero grew net additions a subdued 6% to 4.1 million.
While the 9% reduction in subscribers (arising from the aforementioned removal of idle subscriptions) did boost ARPU, the company also put up prices. As a result, ARPU grew 15% to $43.08. the removal of the idle subscriptions, ARPU grew 15% to $43.08.Any way you look at it, subscriber growth is slowing, but While subscribers may be slowing, average revenue per user (ARPU) continues to accelerate.
Xero’s Operating Targets & Rule of 40
It’s difficult to miss when it’s in the headline result, but Xero hit its rule of 40 target with the metric coming in at 43.9%.
Xero is using the metric as a guide for business quality. We’ve previously covered the various definitions of the rule of 40. In Xero’s case, the company calculates it as the sum of constant currency revenue growth and free cash flow margin. Xero calculates free cash flow by accounting for net cash flow from operating activities minus investing activities (excluding acquisitions and investments). This isn’t exactly true free cash flow, although the excluded items (such as lease repayments) aren’t material, and the company’s definition of the measure is useful.
CEO Sukhinder Singh Cassidy has made it clear that Xero needs to see improvement in subscriber growth as well as continued ARPU expansion.
A goal that was previously flagged was the improvement in profitability and a reduced operating expense-to-revenue ratio. For FY24, that target was exceeded and came in at 73.3%. H2 of 2024 was particularly strong, with the ratio landing at 68%. The ratio has continued to trend in the right direction, and despite the drop of 71.2% in H1, Xero has maintained its full-year target of 73%.
However, it is worth noting that capitalised expenditure for the half was up 29% compared to the prior period, although it did reduce as a percentage of revenue. If this ratio continues to decrease, it could undermine the positive signal transmitted by the improved expense-to-revenue ratio.
Xero Churn and the Impact of Increasing Prices
From 1 July, 2024 Xero moved to simplify their plan offering, sparking outrage amongst users.
Despite the outrage, Xero’s churn remains flat at around 1%. Is it a sign that the product is difficult to live without? Or is there more to this story?
Back at the beginning of July Xero announced they would begin the migration of pricing slowly. The result was that existing Xero customers would not receive a further price increase this financial year (July 2024 to June 2025). The original plan was to migrate all Xero customers by March 2025 to the new pricing plans.
Xero announced that if you are a customer who will see the same or a lower price, you will move to a new plan in October 2024 and gain the benefits of any new features. If the subscription you were on was going to see a price increase under the new plan, you would not be migrated until July 2025. If a customer chose to move you would be subject to a new pricing plan.
Kicking the churn can down the road?
Perhaps the change in churn (if any) may not be fully seen until the September 2026 reporting period! Or, could we see APRU continue to grow?
Not only has the price increase been delayed, but there has been significant discounts on offer to fend off competition in the battle for new subscribers.
Switching accounting software is incredibly time-consuming and a headache for business owners. While there are services that can migrate files to new providers, the effort to learn a new program can be onerous and often the last thing business owners want to deal with.
Xero’s Remuneration Report
Xero is incorporated in New Zealand and is subject to New Zealand law. Companies subject to Australian law are required to have an advisory resolution to shareholders at the Annual General Meeting that the Remuneration Report be adopted. This law does not apply to Xero. At this year’s AGM Xero voluntarily put an advisory resolution to its shareholders. Despite the vote not being binding, the negative feedback was clear, with only 77.54% voting for the adoption of the remuneration report.
Xero noted in its May annual report:
“Xero has become a global organisation with offices in more than ten countries, and generating more than 40% of its revenue from outside of Australia and New Zealand. We have found that the remuneration structures of most ASX-listed peers, which are domestic corporations or international businesses managed from Australia, have not been appropriate to secure the talent and experience required for some of our most senior roles that have an international remit. It is important that we adjust our frameworks as required to ensure that we can attract and retain the talent required to successfully execute on our global strategy.”
“Sukhinder Singh Cassidy was appointed by the Board as CEO, replacing Steve Vamos on 1 February 2023. The CEO has a much higher weighting towards variable pay compared to the former CEO, with equity in particular, making up a significant proportion of target total remuneration.”
Despite the increase in weighting towards equity (which should align with shareholders), not all shareholders were on board, perhaps partly because share-based compensation for H1 2025 did increase by 49% compared to the prior period. Or perhaps it relates to Xero chairman David Thodey who was listed in an AFR article back in March amongst Australia’s highest-paid directors.
Xero’s Financial Position & Outlook
Xero’s balance sheet continues to be strong. It holds cash and short-term deposits of $1.9 billion and net cash of $468 million. During the period, Xero successfully priced US$925m 1.625% convertible notes due 2031 to bolster its flexibility to refinance Xero’s existing convertible note liability and access additional capital on highly attractive terms.
Other than the previously mentioned operating expenses ratio and development costs, Xero management tends not to provide forward guidance. This is wise because it avoids the risk of missing guidance and damaging the market’s confidence in management.
Notably, CFO Kirsty Godfrey-Billy has decided to depart Xero after nine years, including more than six as CFO, and will step down as CFO on 31 March 2025. Generally speaking, a CFO departure would be considered a negative sign. However, given Godfrey-Billy’s tenure, and the change of CEO, it is not that surprising to see a transition.
Is There Value in Xero Shares?
From a standard valuation point of view Xero continues to defy gravity.
It’s a high-quality business model. Its sticky product and pricing power is clearly appreciated by the market. Not only that, but it is one of the few large high-quality tech businesses listed on the ASX. This means it receives torrents of capital from fund managers desperate to find sustainable growth.
At the time of writing, Xero’s share price was up 6.67% to $172.33. This corresponds to a market cap of over $26 billion! If we crudely assume Xero replicates H1, in H2 and records a full-year EPS of $1.24 (AUD $1.12), it would result in a trading multiple of around 154 times earnings.
That said, if Xero can improve its margins from around 10% to around 20% over the long term, whilst maintaining decent revenue growth, it could easily grow into its valuation within a few years. Therefore, while it clearly has plenty of optimism in the share price, I think the optimism could well be justified. I did reduce my holding somewhat at lower prices, prior to these results. While the share price is up around 20% since we covered the FY 2024 results, I remain a happy shareholder and will continue holding at least some of my shares.
Disclosure: The author of this article Nick Maxwell owns shares in XRO. The editor Claude Walker does not own shares in XRO. Neither will trade XRO shares for at least 2 days following the publication of this article. This article is not intended to form the basis of an investment decision and is not a recommendation. Any statements that are advice under the law are general advice only. The author has not considered your investment objectives or personal situation. Any advice is authorised by Claude Walker (AR 1297632), Authorised Representative of Ethical Investment Advisers Pty Ltd (ABN 26108175819) (AFSL 343937).
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