The cloud accounting supremacy war in Australia

There are three big players in Australia’s accounting software market: MYOB, Intuit and Xero.

The battle for supremacy in the cloud accounting market has taken a renewed vigour with MYOB confirming details of its IPO this month.

The companies compete for dominance in a huge market: every business needs to keep track of its accounts and these companies make that simple. They remove the need for book keepers and allow businesses to make invoicing and cashflow management decisions on the run through desktop and mobile apps.

They’re all jostling for market share and are not shy when it comes to criticising rivals, in public and behind the scenes. Earlier this year, a representative of one company handed Business Insider a sheet of paper comparing pricing and features with a competitor. It was off-the-record – the representative said “this didn’t come from me” – and we’ve decided not to publish the information, but it’s worth mentioning because it shows the type of tactics in play.

Xero boss Rod Drury came out swinging this month, saying he wouldn’t recommend the MYOB investment to his mother and questioned why key details had been left out of the prospectus.

The accounting – or more precisely, book keeping – industry has been blown wide open by cloud services like Xero and Intuit. Incumbents – in Australia, that’s MYOB – have been racing to build out their own offerings, maintain market share and raise between $AU831.7 and $AU833.8 million based on an indicative price range of $3–$4 a share in its IPO.

While all this is going on Xero has evolved from a tiny New Zealand-based startup to spending about $250 million on developing software. The company last year had more than 400,000 paying customers across 180 countries, processing about $240 billion in transactions and 95 million invoices.

US giant Intuit has also rolled into the Australian market, a move some described as combative. Intuit Australia’s MD Nicolette Maury said she found statements like that “amusing”.

Maury said the accounting software industry was being significantly disrupted but there was still room for growth.

“The industry is shifting… and that changes the game for everyone and I think we’ve seen that over the last few years, that’s the reason Intuit is investing so heavily in Australia,” she said.

In the past 12 months Intuit has grown its Australian team to 60 staff and made two acquisitions including PDF data extraction company Invitco, which automates extracting information from bills and entering the data in accounting software as well as practice management software provider Fifo.

“We’re open to acquisitions and it’s a path that we go down on a regular basis,” Maury said.

A well-placed industry source told Business Insider there was a recent high-level meeting between MYOB and Intuit although neither MYOB CEO Tim Reed nor Maury would confirm or deny this. But MYOB has reportedly asked fund managers to value MYOB in line with Intuit, which has a market cap of over $27 billion.

MYOB is valuing the company at an enterprise value of between $A2.34 and $A2.69 billion, or 14.5 to 16.8 times forecast EBITDA for the coming financial year.

Now Melbourne-based investment firm Evans & Partners analyst Peter Stamoulis has done his own calculations to figure out who is dominating the cloud accounting market in Australia and New Zealand.

First, average revenue per user (ARPU) and the long term valuation (LTV) of each company’s customer.

As the table below shows, MYOB secures more revenue per unit compared to Xero, but it also has a higher churn rate. With higher margins, MYOB’s LTV is also higher however Stamoulis expects over time Xero’s will also increase as it improves gross margins.

Source: Evans & Partners.

Xero is yet to turn a profit and according to Evan Lucas of IG Markets, the share price of $23.72 “is more down to future expectations rather than current operations and shareholders are going to have to wait until FY17 on current estimates to see NPAT turning positive”.

With an IPO ahead, MYOB is expected to list at between $3 and $4 a share. IG’s grey market is betting the price will land somewhere around the $3.4 mark, equalling a PE ratio of around 15 times forecast 2016 earnings.

In his report, Stamouslis says while MYOB is the largest accounting software provider in Australia and New Zealand, Xero is the biggest cloud accounting company. MYOB has 116,000 cloud subscribers compared to Xero which has about 320,000 across Australia and New Zealand.

“Xero’s net customer additions over the past 2 reported periods are >2x that of MYOB’s cloud subscriber growth. By this metric, Xero is winning the race for market share across the cloud offering,” he said.

As a result, global incumbents, including MYOB and Intuit, have responded by allocating significant investment to building their own cloud-based offerings and communities both through acquisitions and internal development. It has made for a battle of epic proportions as incumbents with their cashed up coffers, established networks and strong brands muscle up against new entrants like Xero, which invested more than $250 million building its cloud platform from scratch.

Much like what happened in search when Yahoo underestimated small newcomers like Google, cloud-accounting’s incumbents have also been investing heavily in building out their own competing solutions.

Last year MYOB’s board approved a $40 million program to develop cloud technology. It’s part of a plan to spend $100 million over three years on developments in automating data entry, including bills and invoices, improving mobile experiences, collaboration, payments and banking.

“What we’re trying to do is really focus on mobile moments, one, two or three minute experiences that largely mean that the accounting is done,” Reed said.

But the Evans & Partners note highlighted a lot more money will be required to fund sales and marketing activities to ensure it can compete in the “land grab” for cloud customers.

“The short-term solution for SaaS companies is not to peel back cost growth in preference for earnings and margin expansion, but rather focus on customer acquisition and reaching significant scale to deliver a more profitable and sustainable longer term earnings profile,” the report says.

These charts show the numbers.

Source: Evans & Partners.

Despite making ground on the cloud front, Stamoulis warned MYOB had a long term risk of around 700,000 active but not paying customers and 384,000 paying desktop subscribers transitioning off the legacy software. It’s this point which Xero has repeatedly pounced on, claiming “thousands” of former MYOB users have transitioned across.

Reducing customer churn is important in the cloud space because users have a higher lifetime value compared to the desktop market. According to the report, MYOB’s annual churn across its cloud customer base is around 17% while Xero’s annual churn is between 11-13% in Australia and New Zealand.

Intuit is a dominant player and has undergone a significant shift in its user mix as the chart below shows. Globally QuickBooks Desktop and QuickBooks Online has 328,000 and 683,000 users respectfully. Management is targeting about 2 million Quickbooks Online users by FY17 of which about 25% will come from existing desktop users.

In an effort to push more of its users into the cloud MYOB will release an online collaboration platform this quarter. MYOB Portal enables accountants to transfer documents securely to clients.

“I am extremely proud of where MYOB is today and what has been achieved in a relatively short period. Three years ago we had not yet taken our flagship SME solution AccountRight into the cloud. Now we are in the cloud across all areas of our business,” Reed said.

“Cloud accounting now makes up 67% of our new registrations, up from 48% the same time a year ago and 24% the year before,” Reed said.

This chart from a recent MYOB investor presentation shows transitioning customers to the cloud materially changes their lifetime value. It explains why accounting software companies like MYOB are throwing all the resources they can at building out solutions and securing cloud market share.

MYOB is aggressively trying to shake off its desktop legacy. Reed refers to “legacy opportunities,” because those desktop clients are potential paying cloud customers.

So far, there are no plans to retire support for the desktop product.

“In any technology business there does come a time where you’ve got to stop support for the legacy platforms because it does become too expensive to run the old and the new,” he said. “We stop support of software that’s more than three years old… we’ve made the decision that it’s not 2015 and it’s not 2016.”

Quite clearly, Intuit, Xero and MYOB will focus on reducing their churn rates and aim to improve customer acquisition and retention rates as they jostle for the overall leadership title.

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