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. As with many other companies Zynga Inc. (NASDAQ:ZNGA) makes use of debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for Zynga
What Is Zynga's Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 Zynga had US$589.3m of debt, an increase on US$564.3m, over one year. However, its balance sheet shows it holds US$755.4m in cash, so it actually has US$166.1m net cash.
How Healthy Is Zynga's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Zynga had liabilities of US$1.15b due within 12 months and liabilities of US$1.18b due beyond that. Offsetting these obligations, it had cash of US$755.4m as well as receivables valued at US$233.8m due within 12 months. So it has liabilities totalling US$1.35b more than its cash and near-term receivables, combined.
Of course, Zynga has a market capitalization of US$8.53b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Zynga also has more cash than debt, so we're pretty confident it can manage its debt safely.
It was also good to see that despite losing money on the EBIT line last year, Zynga turned things around in the last 12 months, delivering and EBIT of US$209m. 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 Zynga 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. While Zynga has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Zynga actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Summing up
While Zynga does have more liabilities than liquid assets, it also has net cash of US$166.1m. The cherry on top was that in converted 142% of that EBIT to free cash flow, bringing in US$296m. So we don't think Zynga's use of debt is 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. Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Zynga , and understanding them should be part of your investment process.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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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