Disruptive technologies are new ways of getting things done that “disrupt” current ways of doing things.  History is replete with examples of disruptive technologies dating back to mankind’s first spear.  A contemporary example is cloud computing, which frees consumers and corporations from the burden of housing computing resources at their location.

What is being billed as the largest IPO on the ASX in 2015 – the return of MYOB, Australia’s leading provider of accounting software is returning to the ASX in what could be the largest IPO of 2015. 

Cloud computing is not new but the trend is still accelerating.  A recent study from Goldman Sachs claims spending by corporations on cloud computing resources will grow at a compounded annual growth rate (CAGR) of 30% through 2018.  The CAGR for the Information Technology (IT) sector as a whole is a mere 5% over the same period.

Perhaps of greater interest to investors is the fact small to medium sized businesses (SME’s) have been quicker to move other applications to the cloud, citing security concerns as a rationale for continued use of on-site accounting software.  Software Advice is a US based market research firm that assists its clients in sorting through the maze of business software.  A recent study from the firm shows the growth potential of cloud based accounting amongst SME’s.  The following graph from the Software Advice website shows what they found regarding current usage of accounting software.

 

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Granted that this is a US based study of unknown sample size, but 84% of respondents not on the cloud with their accounting operations suggest a bright future.  A February 2014 MYOB Business Monitor survey of SME’s here showed similar results, with only 18% or respondents claiming they used cloud based accounting software “all or most” of the time.  

Given its current 60% market share of traditional on-site accounting software, is MYOB your best investment for the anticipated migration to the cloud for accounting applications?

If you have been following the financial news on this IPO you already know that MYOB is late to the game with cloud accounting software, entering the market with one full program and some hybrid additions to existing products beginning in 2013.  However, the company has invested heavily in new products and will introduce new cloud offerings throughout 2015.

You also know the company faces stiff completion for the cloud space from New Zealand based Xero Limited (XRO) which dual listed on the ASX in November 2012.  XRO is strictly a cloud based provider, with not a single on-site accounting software product.  Xero is currently the top provider in Australia and has a global presence with existing operations in the UK and further expansion into the US in the near future.  There is a third player in the picture as well, Reckon Limited (RKN) which like MYOB is moving from on-site offerings to more cloud-based products.  

Reckon is tiny in comparison to the other two players in the space, with a current market capitalization of around $215 million.  Compare that to Xero’s market cap of about $2.8 billion and the projected market cap for MYOB of around $2.6 billion post IPO.  Reckon gets little mention in the commentary about the coming “cloud accounting war” yet RKN has been on the ASX since 1999 and has an average annual rate of total shareholder return over the last ten years of 14.6%.  Reckon has a current dividend yield of 4.9% (60% franked) with a two year dividend growth forecast of 10.4%.  Over ten years the dividend growth rate is 18.2%, which explains the high total shareholder return given the volatility of the stock price.  The following chart shows the share price movement for RKN since it began trading.  

The company reported Full Year 2014 results back in February and surprised the market with a 5% rise in NPAT and a 3% increase in revenue, not including the cost of a 2013 one-time charge.  Reckon switched to a subscription based payment model, which the CEO claims is responsible for the improved results. The forward outlook was bright, with the expected launch of the company’s cloud accounting product Reckon One into the UK and the launch of its document management system in the US.  On 23 April the company announced a major update to Reckon One designed to make the user experience easier.  The company claims its $5 per month cost for the base program and $2 to $3 per month for add-ons enhances its reputation as an affordable offering.  Reckon may be smaller but it has a broader and deeper product line.

Despite their considerable size difference, what RKN and MYOB have in common that XRO lacks is profitability.  XRO has seen outsized revenue growth, and plowed the cash back into the business.  On 24 April the company announced Full Year 2014 results with an impressive 77% growth in revenue.  However, the loss posted almost doubled, dropping 96% to a negative $69.5 million from the prior loss of $35.5 million.

Xero seems like a growth stock on steroids and as such, the market has expressed its displeasure at hints of the possibility of less than spectacular growth.  Here is a share price movement for XRO since it began trading on the ASX.

On 21 March 2014 the company hit an all-time high and has been on a gradual decline until early this year.  At the time the price began its descent there was no apparent events triggering the slide, although some speculate rumours about the possibility of MYOB IPO contributed.  In addition, there may have been concerns about the pace of growth in the critical US market.  Yet Xero announced alliances with companies in the UK and the US, one being tax giant H & R Block, which could have been seen in a positive light.  Whatever the cause, XRO is still down about 23% year over year.  Following the release of the FY 2014 results the stock dropped more than 10% intraday, which you can see on close inspection of the end of the chart.

While some investors may be growing weary of the journey to profitability, Xero has the backing of some big name investors, including a US Silicon Valley- venture capital firm, Accel Partners, and Matrix Capital Management. Accel invested US$100 million on Xero for its global growth efforts and the 25 February announcement sent XRO stock up close to 25%. Matrix, Xero’s largest institutional holder, added close to $11 million at the same time.  Xero has no debt and $263 million in cash, according to the latest financial reporting.

While investors may have been shocked at the size of the loss, the growth story in terms of customer subscriptions appears intact, with a 67% increase in paying customers year over year.  Xero gets some favorable press when compared with MYOB, but challenging the leading cloud accounting service in the US – Quick Books Online from financial software giant Intuit – is testing the patience of its supporters.  

In many ways MYOB has the earmarks of a successful IPO.  The company has a solid financial track record and leading market share.  MYOB was a public company until 2009 when it was acquired by a Private Equity Firm and then sold to its current owner, US based Bain Capital.  Some analysts have commented positively on the fact Bain will not be selling any of its stock in the IPO.  The company currently controls about 95% of MYOB, which will drop to a 57% ownership stake due to the dilution resulting from the newly sold shares.  However, others point out that contrary to the belief Bain is “keeping skin in the game” the company can begin to shed its shares after the first financial reporting period in 2015 and then again in 2016.  A visit to the MYOB investment prospectus, however, shows Bain cannot sell unless MYOB shows 20% year over year growth.  

An IPO Investment Prospectus should be an indispensable tool for retail investors considering a new float.  However, in this case some of the reporting in the prospectus is in question.  First, the CEO of rival Xero Limited challenged the way MYOB was counting its cloud customers.  Whatever the truth, the ASIC (Australian Securities and Investment Commission) is looking into the possibility of a variety of financial disclosures in the prospectus not being complete.

MYOB management expressed no cause for concern and appears to have been proven right by the response of the company’s noteholders to the offering.  Private corporations often resort to selling fixed income long term bonds and shorter term notes to raise capital.  MYOB’s noteholders have been offered the opportunity to redeem the notes at $101 plus accrued interest, or exchange a note for $100 in shares of MYOB at a 2.5% discount.  The response to an offer like this is considered an indication of the strength of the IPO and influences the final issue price.

That part of the IPO process is now history and 60% of MYOB’s existing noteholders are buying into the company.  To put that into perspective, last year 40% of Healthscope’s noteholders converted to shares in that company’s IPO.  In the IPO Prospectus MYOB management estimated that 50% of its noteholders would accept the shares.  It appears likely this IPO will price out at the top of the range, somewhere close to $4.00.

MYOB has dominant market share of desktop accounting software users.  You can see that already growth in the few cloud offerings MYOB has is outpacing traditional software by a wide margin.  Xero has more than doubled the cloud additions at MYOB between 2013 and 2014.  MYOB reportedly has 700,000 customers using its traditional software products on a non-paying basis with another 374,000 customers on a paying subscription basis.  MYOB management claims brand loyalty ensures that those customers will stay with MYOB as it expands its cloud offerings.  Xero is betting its easy to use offerings, built from the ground up to maximize the capabilities of the cloud, will attract users frustrated with current desktop accounting software.  Time will tell.

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