Is Activision Blizzard (NASDAQ:ATVI) Using Too Much Debt?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Activision Blizzard, Inc. (NASDAQ:ATVI) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

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What Is Activision Blizzard's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Activision Blizzard had debt of US$3.33b, up from US$2.67b in one year. But it also has US$7.60b in cash to offset that, meaning it has US$4.27b net cash.

A Look At Activision Blizzard's Liabilities

According to the last reported balance sheet, Activision Blizzard had liabilities of US$2.19b due within 12 months, and liabilities of US$5.01b due beyond 12 months. On the other hand, it had cash of US$7.60b and US$619.0m worth of receivables due within a year. So it actually has US$1.03b more liquid assets than total liabilities.

Having regard to Activision Blizzard's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$59.1b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Activision Blizzard has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Activision Blizzard grew its EBIT by 36% over the last twelve months, and that growth will make it easier to handle its debt. 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 Activision Blizzard 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Activision Blizzard may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Activision Blizzard recorded free cash flow worth a fulsome 89% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Activision Blizzard has net cash of US$4.27b, as well as more liquid assets than liabilities. The cherry on top was that in converted 89% of that EBIT to free cash flow, bringing in US$1.9b. So is Activision Blizzard's debt a risk? It doesn't seem so to us. 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. Be aware that Activision Blizzard is showing 1 warning sign in our investment analysis , 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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