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

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that 2U, Inc. (NASDAQ:TWOU) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

View 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 September 2022 2U had debt of US$935.7m, up from US$748.9m in one year. On the flip side, it has US$170.2m in cash leading to net debt of about US$765.6m.

A Look At 2U's Liabilities

Zooming in on the latest balance sheet data, we can see that 2U had liabilities of US$383.1m due within 12 months and liabilities of US$1.03b due beyond that. On the other hand, it had cash of US$170.2m and US$128.2m worth of receivables due within a year. So its liabilities total US$1.12b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the US$541.2m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, 2U would likely require a major re-capitalisation if it had to pay its creditors today. 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.

In the last year 2U wasn't profitable at an EBIT level, but managed to grow its revenue by 5.8%, to US$971m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Importantly, 2U had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping US$128m. 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 US$95m over the last twelve months. That means it's on the risky side of things. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that 2U is showing 3 warning signs in our investment analysis , and 1 of those is a bit concerning...

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.