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. We can see that Weibo Corporation (NASDAQ:WB) 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 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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Weibo Carry?
As you can see below, at the end of September 2020, Weibo had US$2.42b of debt, up from US$1.68b a year ago. Click the image for more detail. However, its balance sheet shows it holds US$3.18b in cash, so it actually has US$759.6m net cash.
How Strong Is Weibo's Balance Sheet?
According to the last reported balance sheet, Weibo had liabilities of US$831.5m due within 12 months, and liabilities of US$2.47b due beyond 12 months. On the other hand, it had cash of US$3.18b and US$1.06b worth of receivables due within a year. So it can boast US$926.4m more liquid assets than total liabilities.
This short term liquidity is a sign that Weibo could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Weibo has more cash than debt is arguably a good indication that it can manage its debt safely.
In fact Weibo's saving grace is its low debt levels, because its EBIT has tanked 24% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Weibo 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. Weibo 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. During the last three years, Weibo produced sturdy free cash flow equating to 61% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to investigate a company's debt, in this case Weibo has US$759.6m in net cash and a decent-looking balance sheet. So we don't have any problem with Weibo's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Weibo you should be aware of.
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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