Is Model N (NYSE:MODN) Using Debt In A Risky Way?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Model N, Inc. (NYSE:MODN) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Model N

What Is Model N's Net Debt?

The image below, which you can click on for greater detail, shows that Model N had debt of US$39.4m at the end of March 2020, a reduction from US$49.0m over a year. But it also has US$61.3m in cash to offset that, meaning it has US$21.9m net cash.

How Strong Is Model N's Balance Sheet?

We can see from the most recent balance sheet that Model N had liabilities of US$68.0m falling due within a year, and liabilities of US$43.6m due beyond that. Offsetting these obligations, it had cash of US$61.3m as well as receivables valued at US$26.4m due within 12 months. So its liabilities total US$23.9m more than the combination of its cash and short-term receivables.

Of course, Model N has a market capitalization of US$1.09b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Model N boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Model N can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, Model N reported revenue of US$150m, which is a gain of 2.4%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

So How Risky Is Model N?

While Model N lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow US$13m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Consider risks, for instance. Every company has them, and we've spotted 3 warning signs for Model N you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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