Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Weibo Corporation (NASDAQ:WB) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Weibo’s Net Debt?
As you can see below, at the end of December 2019, Weibo had US$1.68b of debt, up from US$884.1m a year ago. Click the image for more detail. However, its balance sheet shows it holds US$2.40b in cash, so it actually has US$726.7m net cash.
A Look At Weibo’s Liabilities
Zooming in on the latest balance sheet data, we can see that Weibo had liabilities of US$800.9m due within 12 months and liabilities of US$1.72b due beyond that. Offsetting this, it had US$2.40b in cash and US$807.1m in receivables that were due within 12 months. So it can boast US$688.9m more liquid assets than total liabilities.
This short term liquidity is a sign that Weibo could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Weibo has more cash than debt is arguably a good indication that it can manage its debt safely.
On the other hand, Weibo saw its EBIT drop by 3.6% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Weibo can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Weibo may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Weibo produced sturdy free cash flow equating to 60% of its EBIT, about what we’d expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While we empathize with investors who find debt concerning, you should keep in mind that Weibo has net cash of US$726.7m, as well as more liquid assets than liabilities. So we don’t think Weibo’s use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Like risks, for instance. Every company has them, and we’ve spotted 2 warning signs for Weibo (of which 1 makes us a bit uncomfortable!) you should know about.
When all is said and done, sometimes its easier to focus on companies that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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