Article from the AFR:

Xero's cash mountain suggests a major deal is on the horizon

Yolanda RedrupReporter

Nov 25, 2020 – 4.01pm

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A billion-dollar acquisition could be in the works for cloud accounting software giant Xero, with its cash pile swelling to more than $1 billion after the issuance of $US700 million ($951 million) in convertible notes.

While the company intends to use some of the proceeds to buy back almost $US300 million of existing notes, this will leave the $18.7 billion business with more than $NZ1.26 billion ($1.19 billion) in liquid assets, based on its financials for the year to September 30 (including a $150 million undrawn standby facility, but excluding its October purchase of fintech Waddle).

Xero chief executive Steve Vamos has more than enough cash to make a major acquisition. Louise Kennerley

Xero chief executive Steve Vamos told The Australian Financial Review the rationale for the raise came back to the company's core mission – "to reach more customers around the world with the benefits that cloud accounting can provide".

While Mr Vamos would not detail how much of the raise would go towards potential acquisitions versus "general corporate purposes", he outlined strategic priorities which would guide any future deals.

"We talk about being global ... extending the markets we operate in and expanding the size of businesses we serve," he said.

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"Then like we did with Waddle, we're extending the services we provide and the applications that are part of the Xero platform. There's a whole lot of adjacent areas.

"Then around capabilities, we're exploring future opportunities around how to take the use of applications and the customer data that comes from that and turn it into insights that can be used proactively and predictively."

The cashed-up company's vision is to be a platform for small business which provides more than just accounting software, but also interconnected services around payments, invoicing, payroll and more and, increasingly, predictive insights based on their data.

It has already started utilising artificial intelligence to provide more value to its users. During the pandemic the company launched a cash flow forecasting tool which analyses a user's data and suggests actions they could take to manage their cash through the COVID-19 period.

The convertible notes, which are being offered via the Singapore stock exchange, have an initial conversion price of $US134.72 per ordinary share, representing a conversion premium of 35 per cent.

The notes will mature on December 2, 2025, unless earlier redeemed, repurchased or acquired.

Morningstar analyst Gareth James said prior to issuing the convertible notes the business already had a mountain of cash, and he was struggling to envisage how it would be deployed.

But he said it wasn't hard to find billion-dollar companies which could be of interest to Xero.

He said any potential acquisitions would be geographic (buying up users in an existing market like the US or a new country) or fitting with its platform play and be in an adjacent area like Waddle, which is a cloud-based small-business lending platform.

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"Xero has already gone into the payments route, so some kind of clever software which makes its better in some way [would make sense], or some technology that's new and innovative that other people don't have," he said.

"It's been building out its M&A team pretty aggressively, hiring Damien Tampling [in May 2019] and I see loads of advertisements for jobs."

On the back of the announcement about the convertible notes, Xero shares were down almost 4 per cent to $130.50 in afternoon trade.

Yolanda Redrup writes on technology from our Melbourne newsroom. Connect w