Xero delivers record profit and makes its biggest acquisition to crack America
The accounting giant’s profit soars 42 per cent as it shifts focus to higher-value customers with its biggest US acquisition. But its shares have fallen as analysts raise some red flags.
Accounting software titan Xero has delivered its strongest profit performance in years as it pivots to higher-value customers over pure volume growth and makes its biggest ever acquisition to finally crack into the US.
Xero’s net profit surged 42 per cent to $NZ134.8m ($116.72m) in the six months to September 30, beating analysts estimates of $NZ132m.
Free cash flow, meanwhile, jumped 54 per cent despite a slight slowdown in the pace of net subscriber additions, signalling a new, more mature phase for the $23.16bn software-as-a-service provider.
Chief executive Sukhinder Singh Cassidy – one of the highest paid CEOs on the ASX – said the core of Xero’s success was its performance against a key industry benchmark, the so-called rule of 40.
This widely watched metric, which defines the health of a growing SaaS company, holds that a company’s revenue growth plus profit margin should be 40 per cent or more.
Xero reported a Rule of 40 outcome of 44.5 per cent for the half year, surpassing its 43.9 per cent result in the year-ago period. It has been focusing on delivering on this metric before it contemplates paying shareholders a dividend.
“Xero’s H1 FY26 results reinforce our ability to deliver as we continue to do what we said we would do, in line with our strategy,” Ms Singh Cassidy said. “We have continued to deliver above Rule of 40 outcomes and generate significant cash, underpinned by our disciplined allocation of capital.”
Despite the robust headline figures, Xero’s shares fell 9.03 per cent to $127.36 on Thursday as analysts raised concerns over the quality of the earnings and a slowdown in customer acquisition pace.
While it generated adjusted earnings before interest, tax, depreciation and amortisation of $NZ350.9 million, beating consensus, it was heavily reliant on an accounting decision to capitalise 47 per cent of research and development costs, effectively inflating the reported profit margin, according to analysts.
Citi analysts said normalising for this capitalisation would have resulted in a profit miss.
But Ms Singh Cassidy pushed back on the critique. “I don’t know that I would agree with that. We always anticipate capitalisation rates being higher in Xerocon halves, because we ship a lot of product.” She also pointed to broader efficiency gains.
For the full fiscal year, Xero management lowered its operating expense-to-revenue ratio forecast to approximately 70.5 per cent, citing internal efficiencies.
“Our OPEX guidance previously was 71.5, and it’s 70.5. That’s coming from operating efficiencies in the core business, a little bit of Melio, a little bit of forex, but mostly operating efficiency. So we’re going to keep looking at our underlying rate of efficiency, and it is improving.”
Xero struck its biggest deal, acquiring New York-based accounting platform Melio Payments for $US2.5bn in July, a move Ms Singh Cassidy labelled a “step change”.
The company’s growth strategy, which prioritises average revenue per user, led to a 15 per cent increase in ARPU to NZ$49.63. But this focus coincided with a 5 per cent decline in net new subscribers, who fell to 186,000 for the half-year.
Total subscriber growth over the year was 10 per cent, but the deceleration of momentum in key markets like North America and New Zealand prompted questions about the company’s ability to aggressively expand.
Ms Singh Cassidy clarified that the nominal ARPU figure was distorted. “I encourage you to look at the constant currency numbers, which were 10 per cent subscriber growth and 8 per cent ARPU growth, and then you can see it’s right in line with kind of what we sort of said about balanced growth.”
The Melio acquisition, which closed in mid-October, is a cornerstone of Xero’s strategy, designed to embed high-margin payment capabilities and help the company more than double its FY25 group revenue by FY28. Separately, Xero is advancing its proprietary AI platform, JAX (Just Ask Xero), an “AI financial super agent” intended to automate core accounting tasks, drive internal efficiencies, and enhance customer retention.
“I think that you would find that the majority of them (customers) continue to face an industry that is short of talent and long on tasks and a desire to move up the stack into advisory services. That is the macro kind of thesis of the category.”
She sees Xero as a partner in this shift, helping accountants move from “charging an hour for my time versus charging for my expertise.”
“We see potential for the share price to be weak on the softer than expected 1H result, with the EBITDA beat driven by higher R&D capitalisation,” Citi wrote in a note to investors.
“However, AMRR (annualised monthly recurring revenue) growth picking up and the reduction in OPEX ratio are positives, and we see potential for the share price to recover through the course of the day.”
Farhan Badami, an eToro analyst, said: “Xero’s latest results show a company quietly shifting gears”.
“While the ANZ (Australia, New Zealand) market remains its backbone, there is plenty of value offshore. The recent Melio acquisition marks a bold push into the US, Xero’s toughest yet most lucrative market. The deal is dilutive in the short term, but management believes it will double US revenue by FY28,” he said.
“Melio gives Xero access to tens of billions in payment flows and distribution through partners like Capital One and Shopify. This effectively turns accounting software into a financial hub, and if integration goes smoothly, it could transform Xero’s growth engine.
“The market has been sceptical, and one can argue for good reason. Shares retraced from their highs of A$196.52 on June 24 following the Melio announcement, and the near-term margin pressure is real. That being said, I do believe if you look past the next six quarters, the strategic logic becomes clearer. Xero has a track record of delivering on guidance, and they’re on a mission to build a platform that is too valuable and too embedded for customers to leave.”
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