Just because a business does not make any money, does not mean that the stock will go down. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.
So should Arena Pharmaceuticals (NASDAQ:ARNA) shareholders be worried about its cash burn? For the purpose of this article, we'll define cash burn as the amount of cash the company is spending each year to fund its growth (also called its negative free cash flow). We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.
Does Arena Pharmaceuticals Have A Long Cash Runway?
A company's cash runway is the amount of time it would take to burn through its cash reserves at its current cash burn rate. As at September 2020, Arena Pharmaceuticals had cash of US$1.2b and no debt. Looking at the last year, the company burnt through US$311m. Therefore, from September 2020 it had 3.8 years of cash runway. Notably, analysts forecast that Arena Pharmaceuticals will break even (at a free cash flow level) in about 5 years. That means unless the company reduces its cash burn quickly, it may well look to raise more cash. The image below shows how its cash balance has been changing over the last few years.
Is Arena Pharmaceuticals' Revenue Growing?
Given that Arena Pharmaceuticals actually had positive free cash flow last year, before burning cash this year, we'll focus on its operating revenue to get a measure of the business trajectory. Sadly, operating revenue actually dropped like a stone in the last twelve months, falling 100%, which is rather concerning. While the past is always worth studying, it is the future that matters most of all. For that reason, it makes a lot of sense to take a look at our analyst forecasts for the company.
How Hard Would It Be For Arena Pharmaceuticals To Raise More Cash For Growth?
Since its revenue growth is moving in the wrong direction, Arena Pharmaceuticals shareholders may wish to think ahead to when the company may need to raise more cash. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. Commonly, a business will sell new shares in itself to raise cash and drive growth. By looking at a company's cash burn relative to its market capitalisation, we gain insight on how much shareholders would be diluted if the company needed to raise enough cash to cover another year's cash burn.
Arena Pharmaceuticals has a market capitalisation of US$4.9b and burnt through US$311m last year, which is 6.4% of the company's market value. Given that is a rather small percentage, it would probably be really easy for the company to fund another year's growth by issuing some new shares to investors, or even by taking out a loan.
Is Arena Pharmaceuticals' Cash Burn A Worry?
As you can probably tell by now, we're not too worried about Arena Pharmaceuticals' cash burn. For example, we think its cash runway suggests that the company is on a good path. Although we do find its falling revenue to be a bit of a negative, once we consider the other metrics mentioned in this article together, the overall picture is one we are comfortable with. One real positive is that analysts are forecasting that the company will reach breakeven. Based on the factors mentioned in this article, we think its cash burn situation warrants some attention from shareholders, but we don't think they should be worried. Readers need to have a sound understanding of business risks before investing in a stock, and we've spotted 4 warning signs for Arena Pharmaceuticals that potential shareholders should take into account before putting money into a stock.
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