Jenny Ruth: Did quitting the NZX pay off for Xero?

Xero chief executive Steve Vamos alongside founding director Rod Drury. Photo / File

COMMENT:

As the Australian stock exchange operator prepares to launch an "Aussie Nasdaq" next month, an index featuring Xero as its largest stock, it seems a good time to assess whether departing the NZX paid off for the accounting software company.

When announcing the shift on November 9, 2017, Xero founder Rod Drury said it was part of a bid to "attract strategic global growth investors who own significant stakes in other global platforms that we now consider peers and who are under-represented on our share register currently".

Increasing liquidity, getting Xero shares included in the major ASX indices and increasing analyst coverage were other drivers.

Some of those aims have been achieved, with the number of analysts covering the stock rising to about 15 from four or five.

Having seen some of this research coverage, I'm not convinced that its quality has improved but it's undoubtedly true that the number of customers getting broker research on Xero will have increased exponentially.

Milford Asset Management portfolio manager Sam Trethewey, who unsuccessfully campaigned for the NZX to force Xero to poll shareholders on the move, said the depth of analysts' coverage "is a lot lower".

But Xero is now included in the S&P/ASX 100, ASX 200 and ASX 300 indices - key positioning to attract passive and other index-hugging funds.

And the share price has jumped from NZ$34.05 the night before it announced its intention to delist from NZX to more than A$86 last week.

Trading patterns ahead of the decision suggest volumes on the ASX were unlikely to have increased naturally to the level required for index inclusion.

In 2017 through to November 9, there were 15.3 million Xero shares worth A$3.66 billion traded on the ASX but 42.7 million shares worth $10.81 billion traded on the NZX.

Fisher Funds portfolio manager Sam Dickie said average daily ASX trading is now 631,000, nearly double the combined ASX and NZX figure of 365,000 in 2017.

"Liquidity improvements and index inclusions feed on themselves. That would not have happened if Xero didn't delist from NZX," Dickie said.

In the two years before delisting, Xero shares traded at an average enterprise-value-to-sales ratio of about seven times and that has now doubled.

However, Dickie said a revenue upgrade muddied the waters. Before Xero delisted, analysts expected revenue of NZ$868 million in 2021, and that's now NZ$942m.

"Some of the re-rating and liquidity improvement would have happened if it hadn't delisted," he said.

"But I am convinced that not all of the re-rating would have happened if it had stayed listed in NZ."

Dickie said following Xero's example wouldn't work for other NZ companies.

"I think Xero is a genuine global high-growth company that was being held back by liquidity and was trading at an unjustified discount to global peers. I don't see many other NZ companies in that bucket."

Milford's Trethewey agreed that the move probably improved liquidity but argued liquidity would've improved in any case.

"The underlying performance of the company has been incredibly strong. In terms of shareholder returns, we think it would've produced much the same."

Trethewey points to other NZX-listed stocks that have gained support from international investors.

"It has impacted on the depth and offshore interest in the local market," and Xero could probably have achieved the same results but kept an NZX listing.

Private wealth firm JB Were's latest annual survey of foreign ownership of NZ shares found offshore ownership eased 1.7 percentage points to 37.7 per cent in the September 2019 year, due to a fall in Australian participation, but was at the same level as in 2017.

Xero made a strategic decision to leave the NZX. Photo / File

Excluding Australians, offshore interest actually rose modestly, "demonstrating that the appeal of the NZ equity market continued to resonate well with investors further abroad".

Long-time Xero-watcher Craigs Investment Partners analyst Stephen Ridgewell said Xero's market valuation reflects performance. "It was clearly moving towards breakeven and replicating its successful model in Australia and NZ in the UK, even if the US was still struggling."

Xero shares were trading at a slight premium to its US software-as-a-service peers on November 8, 2017 "and that premium has remained relatively consistent over the past two years".

As for analyst coverage, he notes Fisher & Paykel now having 12 analysts and A2 Milk having 14, even with an NZX primary listing. "I think the coverage and liquidity arguments are somewhat moot."

A Xero spokeswoman said that while Xero's register five years ago included a sizeable proportion of offshore investors, they tended to be US-based technology specialists and early stage capital investors, notably Paypal co-founder Peter Thiel.

Foreign shareholders now tend to be mainstream fund managers, particularly from North America and Britain.

Xero also said New Zealand ownership almost halved from about 40 per cent of the register before leaving the NZX.

However, that's likely to be a function of the rising value of Xero shares causing local fund managers to reweight their holdings, rather than any disenchantment with the Xero investment case.

The ASX will launch its S&P/ASX All Technology Index on Feb. 21.