We're Hopeful That Sovereign Cloud Holdings (ASX:SOV) Will Use Its Cash Wisely

Just because a business does not make any money, does not mean that the stock will go down. For example, although software-as-a-service business Salesforce.com lost money for years while it grew recurring revenue, if you held shares since 2005, you'd have done very well indeed. But while the successes are well known, investors should not ignore the very many unprofitable companies that simply burn through all their cash and collapse.

So, the natural question for Sovereign Cloud Holdings (ASX:SOV) shareholders is whether they should be concerned by its rate of cash burn. For the purposes of this article, cash burn is the annual rate at which an unprofitable company spends cash to fund its growth; its negative free cash flow. Let's start with an examination of the business' cash, relative to its cash burn.

View our latest analysis for Sovereign Cloud Holdings

Does Sovereign Cloud Holdings Have A Long Cash Runway?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. As at December 2020, Sovereign Cloud Holdings had cash of AU$21m and no debt. In the last year, its cash burn was AU$8.8m. Therefore, from December 2020 it had 2.3 years of cash runway. Arguably, that's a prudent and sensible length of runway to have. The image below shows how its cash balance has been changing over the last few years.

How Well Is Sovereign Cloud Holdings Growing?

Sovereign Cloud Holdings reduced its cash burn by 6.8% during the last year, which points to some degree of discipline. Having said that, the revenue growth of 58% was considerably more inspiring. It seems to be growing nicely. Of course, we've only taken a quick look at the stock's growth metrics, here. You can take a look at how Sovereign Cloud Holdings is growing revenue over time by checking this visualization of past revenue growth.

Can Sovereign Cloud Holdings Raise More Cash Easily?

While Sovereign Cloud Holdings seems to be in a decent position, we reckon it is still worth thinking about how easily it could raise more cash, if that proved desirable. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. Many companies end up issuing new shares to fund future growth. By comparing a company's annual cash burn to its total market capitalisation, we can estimate roughly how many shares it would have to issue in order to run the company for another year (at the same burn rate).

Sovereign Cloud Holdings has a market capitalisation of AU$88m and burnt through AU$8.8m last year, which is 10% of the company's market value. Given that situation, it's fair to say the company wouldn't have much trouble raising more cash for growth, but shareholders would be somewhat diluted.

Is Sovereign Cloud Holdings' Cash Burn A Worry?

It may already be apparent to you that we're relatively comfortable with the way Sovereign Cloud Holdings is burning through its cash. For example, we think its revenue growth suggests that the company is on a good path. Its weak point is its cash burn reduction, but even that wasn't too bad! Based on the factors mentioned in this article, we think its cash burn situation warrants some attention from shareholders, but we don't think they should be worried. Taking an in-depth view of risks, we've identified 4 warning signs for Sovereign Cloud Holdings that you should be aware of before investing.

Of course Sovereign Cloud Holdings may not be the best stock to buy. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

When trading Sovereign Cloud Holdings or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.