Does Rovio Entertainment Oyj (HEL:ROVIO) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Rovio Entertainment Oyj (HEL:ROVIO) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. 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 Rovio Entertainment Oyj

What Is Rovio Entertainment Oyj's Debt?

As you can see below, Rovio Entertainment Oyj had €2.20m of debt at September 2020, down from €6.70m a year prior. However, it does have €126.7m in cash offsetting this, leading to net cash of €124.5m.

How Strong Is Rovio Entertainment Oyj's Balance Sheet?

The latest balance sheet data shows that Rovio Entertainment Oyj had liabilities of €36.9m due within a year, and liabilities of €8.80m falling due after that. Offsetting this, it had €126.7m in cash and €27.2m in receivables that were due within 12 months. So it actually has €108.2m more liquid assets than total liabilities.

It's good to see that Rovio Entertainment Oyj has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Rovio Entertainment Oyj has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Rovio Entertainment Oyj grew its EBIT by 70% over the last twelve months, and that growth will make it easier to handle its debt. 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 Rovio Entertainment Oyj 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Rovio Entertainment Oyj has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Rovio Entertainment Oyj recorded free cash flow worth a fulsome 97% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Rovio Entertainment Oyj has net cash of €124.5m, as well as more liquid assets than liabilities. The cherry on top was that in converted 97% of that EBIT to free cash flow, bringing in €45m. The bottom line is that we do not find Rovio Entertainment Oyj's debt levels at all concerning. There's no doubt that we learn most about debt from the balance sheet. 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 Rovio Entertainment Oyj (of which 1 is a bit concerning!) you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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