Is 2U (NASDAQ:TWOU) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that 2U, Inc. (NASDAQ:TWOU) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for 2U

How Much Debt Does 2U Carry?

The image below, which you can click on for greater detail, shows that at March 2022 2U had debt of US$934.5m, up from US$280.4m in one year. However, because it has a cash reserve of US$216.6m, its net debt is less, at about US$717.9m.

How Strong Is 2U's Balance Sheet?

According to the last reported balance sheet, 2U had liabilities of US$392.2m due within 12 months, and liabilities of US$1.03b due beyond 12 months. Offsetting these obligations, it had cash of US$216.6m as well as receivables valued at US$107.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.10b.

Given this deficit is actually higher than the company's market capitalization of US$807.7m, we think shareholders really should watch 2U'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 future earnings, more than anything, that will determine 2U's ability to maintain a healthy balance sheet going forward. 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, 2U reported revenue of US$967m, which is a gain of 16%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Over the last twelve months 2U produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable US$157m at the EBIT level. 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 burned through US$100m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - 2U has 3 warning signs we think 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.

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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.