Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Absolute Software Corporation (TSE:ABST) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
View our latest analysis for Absolute Software
What Is Absolute Software's Debt?
As you can see below, at the end of September 2021, Absolute Software had US$267.1m of debt, up from none a year ago. Click the image for more detail. On the flip side, it has US$55.9m in cash leading to net debt of about US$211.2m.
A Look At Absolute Software's Liabilities
The latest balance sheet data shows that Absolute Software had liabilities of US$142.0m due within a year, and liabilities of US$369.1m falling due after that. Offsetting this, it had US$55.9m in cash and US$34.4m in receivables that were due within 12 months. So it has liabilities totalling US$420.9m more than its cash and near-term receivables, combined.
This deficit is considerable relative to its market capitalization of US$505.0m, so it does suggest shareholders should keep an eye on Absolute Software's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Absolute Software 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, Absolute Software reported revenue of US$136m, which is a gain of 27%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.
Caveat Emptor
While we can certainly appreciate Absolute Software's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost US$3.4m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of US$6.4m. So in short it's a really risky stock. 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. We've identified 4 warning signs with Absolute Software (at least 2 which are concerning) , and understanding them should be part of your investment process.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.
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About TSX:ABST
Absolute Software
Absolute Software Corporation develops, markets, and provides software services that support the management and security of computing devices, applications, data, and networks for various organizations.
Undervalued average dividend payer.