Investors see more Xero growth as convertible notes oversubscribed

Friday 28th September 2018

Investors still see upside in Xero's growth story in oversubscribing to a US$300 million convertible note offer that would see them pay a 70 percent premium to turn those securities into shares.

The five-year notes pay annual interest of 2.375 percent and have an initial conversion price of US$46.34, compared to a A$49 reference price. However, to convert that to ordinary shares in 2023 the exercise price is US$60, representing a 70 percent premium.

Chief financial officer Sankar Narayan says this type of offer is commonplace in the US, but hasn't been used outside North America in the way Xero's used it. Linking the security to the company's equity was an attractive way to raise money without watering down existing investors' holdings, he said.

"As an alternative to equity raising it was a lot less dilutive to existing shareholders, that's why it's popular in the US," Narayan told BusinessDesk. "Capital markets are really good globally and it was a really opportune time to do it."

Xero will spend almost US$30 million on a call option it has with joint lead managers Goldman Sachs and Morgan Stanley to cover the higher conversion price in five years time. Another US$7.4 million will cover commissions, professional fees and admin costs. The funds will also go to repaying NZ$30.9 million of term debt.

That will leave about US$242 million to pursue acquisitions and investments along the lines of its recent Hubdoc purchase. And depending on the level of conversion in five years, it could provide another cash injection for the company.

Chief executive Steve Vamos said Hubdoc was a good indication of the type of investment Xero is interested in. That centres around extending the features, functionality and usage cases for small business, accountants and bookkeepers using the platform.

"We're a growth company, we're a global company. This is a reflection of our very strong intent to build our platform," Vamos said.

Macquarie Securities analyst Avinash Srinivasan said Xero has a wide range of options given more than 700 applications connect to its platform. Morningstar's Gareth James said acquisitions may extend short-term losses but will also accelerate the "already high revenue growth rates".

Xero had to scale the offer, which Narayan said attracted both existing and new investors. The notes will be trade over the counter on the Singapore Exchange Securities Trading, which is common for these types of securities.

Morningstar's James said he was comfortable with the convertible note as a means to raise money but would have preferred a pro-rata equity issue to take advantage of what he sees as an overvalued share price.

"If Xero's business model stumbles, note holders will likely want repayments of the debt in cash and Xero may find refinancing difficult, a situation which could force the company to issue new equity at a beaten down share price and materially dilute shareholders," he said.

The ASX-listed shares last traded at A$49.21, still a premium to the A$49 reference price used in the offer.

(BusinessDesk)

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