Brian Gaynor 's Opinion

Brian Gaynor is a Weekend Herald columnist.

Brian Gaynor: Xero gives business lesson in IPO boldness

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Entrepreneurs' timidity in raising cash hampering their chances of success

Rod Drury, founder of internet-based accounting software company Xero, has been incredibly successful in raising capital. Photo / Mark Mitchell
Rod Drury, founder of internet-based accounting software company Xero, has been incredibly successful in raising capital. Photo / Mark Mitchell

Xero's phenomenal share price performance is giving a strong message to New Zealand business.

That message is that not only do business people have to be extremely determined and focused, but they also need to raise sufficient capital through their IPOs to fund growth.

As well, they must be able to raise additional capital once they have listed.

Unfortunately, many of our entrepreneurs are timid and afraid of failure while also wishing to avoid any dilution of their shareholding.

As a result they raise too little through the initial public offering process.

Even though Xero still has a long way to go, Rod Drury has established an attractive business model for ambitious entrepreneurs, particularly those operating information technology or "software as a service" businesses.

Xero was established on July 6, 2006, as Accounting 2.0 Limited with capital of $1.5 million. The company's original directors were Drury, who owned 74.3 per cent and Hamish Edwards, with 20 per cent.

Drury had sold AfterMail, an email archiving software company, to Quest Software in the United States and Edwards was the former CEO of Openside, a chartered accounting consulting company.

The name was changed to Xero in November 2006, and $1.3 million of additional capital was raised in March 2007.

Xero registered its IPO prospectus on May 11, 2007, for the issue of 15 million new shares at $1 each. Before this, existing shareholders were issued 23.2 shares for every one share held.

This converted their capital contribution of $2.8 million into 40 million shares worth $1 each and none of these shares was sold through the IPO.

Thus the company had a sharemarket value of $55 million at the $1-a-share IPO price.

Drury couldn't have chosen a worse time to list. The global economy was starting its meltdown and the NZX50 Gross Index, which peaked at 4333 six days before the offer closed, was beginning a sustained downturn.

Investors were sceptical about Xero because the company had no operating revenue and a $15 million capital raising was far too small to launch a global software-as-a-service company.

Xero listed on the NZX on June 5, 2007 and its shares closed that day at $1.10 on light turnover. It reached a high of $1.14 four days later, but then drifted down as investors became increasingly concerned about the deteriorating world economy.

The stock hit a low of $0.68 in January 2008.

Drury was a worried man as potential customers were too immersed in their own financial problems to sign up to Xero and investors, many of them friends of the CEO, were losing money on their investment.

But he has never wavered in his determination to turn Xero into a hugely successful company.

Xero's sharemarket recovery began in early April 2009 when Drury announced a capital raising of $23.2 million at 90c a share.

The main subscriber was Craig Winkler, a founder and former major shareholder of Australian accounting software company MYOB, who subscribed $18 million.

The others were the Bank of New Zealand and two independent directors, including Sam Morgan.

This was a brilliant move as investors finally realised the extra capital gave the company a chance of achieving its global ambitions.

Its share price immediately shot up to $1.51 and then settled to the $1.20 to $1.40 range.

Drury's next big move was in February last year when he raised a further $20 million, at $2.75 a share, from Winkler, US investor Peter Thiel and two directors, Morgan and newly appointed chairman Sam Knowles.

A further $15.6 million was raised from existing shareholders, also at $2.75 a share.

Finally, in November last year, Thiel invested an additional $24 million and US hedge fund Matrix Capital Management put up $58 million. This represented $60 million worth of new shares and $22 million of existing shares, all at $6 each.

Drury, Winkler and co-founder Hamish Edwards sold 3.67 million shares to this placement, all at $6 each.

Xero's share price has been on a roll since that transaction. It closed at $10 on Thursday and rose a further seven per cent yesterday to close at $10.70.

At $10.70, the company is worth $1.254 billion even though it has annualised revenue of only $48 million and is still reporting large losses.

In early February, Xero said it had more than 135,000 customers around the world, giving the company a sharemarket value in excess of $9000 a customer compared with average annual revenue of $350 per customer.

Drury has been incredibly successful at raising new capital and creating wealth for investors, including himself.

Xero has raised $146 million in new capital since inception, and this is now worth $1.254 billion.

Drury has invested $1.1 million in the company and this is now worth $232.2 million, excluding the $9.5 million he has realised from the sale of 2.95 million shares since listing.

This puts him in Briscoe's Rod Duke class as far as wealth creation is concerned.

Drury's main attributes are his determination to succeed, his aggressiveness, ability to raise capital and willingness to dilute his shareholding.

Drury's shareholding has fallen from 44.8 per cent to 18.5 per cent since listing, yet the total value of his shareholding has risen more than nine-fold over the same period.

Unfortunately there are clear signs that some upcoming IPOs will be too timid in terms of the capital raised, partly because many entrepreneurs have a fear of failure and don't want to dilute their shareholding.

Investment bankers are talking about IPOs in the $10 million to $30 million range for companies with world-wide ambitions.

This is far too low, particularly as some of this new capital is the sale of existing shares by original shareholders rather than the raising of additional capital through the issue of new shares. This is a shame because Rod Drury has shown that investors are attracted to companies which support global ambitions with adequate capital resources.

It will be a major disappointment if upcoming IPOs raise too little new money to support the growth ambitions outlined in the prospectuses.


• Recent comments that the NZX is at a record high are clearly ridiculous because a gross index (capital plus dividends) has been used to reach this conclusion, whereas all of the world's major sharemarket indices are capital only.

Why should we use a gross index to measure a record market high when we don't add all earlier dividends to the share price of an individual company to determine its high point?

The NZX50 Capital Index closed at 2467 on yesterday, compared with its record high of 3969 in September 1987. Thus, the market is still 38 per cent below its peak when measured under the more traditional and accurate capital only method.

The NZX50 Capital Index appreciated by 18 per cent last year, compared with 116.8 per cent in 1983, 12.7 per cent in 1984, 31.4 per cent in 1985 and 99.2 per cent in 1986.

We are a long, long way from the euphoria and excesses of the mid-1980s.


Brian Gaynor is an executive director of Milford Asset Management.

- NZ Herald

Brian Gaynor

Brian Gaynor is a Weekend Herald columnist.

Brian Gaynor has written a weekly investment column for the Weekend Herald since April 1997. He has a particular particular passion for the NZX and its regulation. He has experienced - and suffered through - the non-regulated period prior to the establishment of the Securities Commission in 1978 and the Commission’s weak stewardship until it was replaced by the Financial Markets Authority (FMA) in 2011. He is also a Portfolio Manager at Milford Asset Management.

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