Is Arima Communications (TPE:8101) A Risky Investment?

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.' 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 Arima Communications Corp. (TPE:8101) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Arima Communications

How Much Debt Does Arima Communications Carry?

The image below, which you can click on for greater detail, shows that Arima Communications had debt of NT$833.1m at the end of September 2020, a reduction from NT$894.6m over a year. However, it does have NT$166.4m in cash offsetting this, leading to net debt of about NT$666.7m.

How Healthy Is Arima Communications's Balance Sheet?

According to the last reported balance sheet, Arima Communications had liabilities of NT$1.81b due within 12 months, and liabilities of NT$244.8m due beyond 12 months. Offsetting these obligations, it had cash of NT$166.4m as well as receivables valued at NT$642.9m due within 12 months. So it has liabilities totalling NT$1.25b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of NT$836.5m, we think shareholders really should watch Arima Communications's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. There's no doubt that we learn most about debt from the balance sheet. But it is Arima Communications's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, Arima Communications made a loss at the EBIT level, and saw its revenue drop to NT$3.1b, which is a fall of 19%. We would much prefer see growth.

Caveat Emptor

While Arima Communications's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping NT$635m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it had negative free cash flow of NT$156m over the last twelve months. That means it's on the risky side of things. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - Arima Communications has 3 warning signs (and 1 which is potentially serious) we think 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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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.
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