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 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 note that Absolute Software Corporation (TSE:ABST) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Absolute Software's Debt?
The image below, which you can click on for greater detail, shows that at December 2021 Absolute Software had debt of US$266.7m, up from none in one year. However, it also had US$61.6m in cash, and so its net debt is US$205.1m.
How Strong Is Absolute Software's Balance Sheet?
We can see from the most recent balance sheet that Absolute Software had liabilities of US$158.0m falling due within a year, and liabilities of US$366.9m due beyond that. On the other hand, it had cash of US$61.6m and US$42.0m worth of receivables due within a year. So its liabilities total US$421.3m more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of US$439.2m, 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. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Absolute Software 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.
Over 12 months, Absolute Software reported revenue of US$155m, which is a gain of 39%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.
Despite the top line growth, Absolute Software still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost US$4.3m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. For example, we would not want to see a repeat of last year's loss of US$13m. So in short it's a really risky stock. 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. For instance, we've identified 3 warning signs for Absolute Software (1 is a bit unpleasant) you should be aware of.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.