Is Cornerstone OnDemand (NASDAQ:CSOD) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Cornerstone OnDemand, Inc. (NASDAQ:CSOD) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

View our latest analysis for Cornerstone OnDemand

What Is Cornerstone OnDemand's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2021 Cornerstone OnDemand had US$1.09b of debt, an increase on US$294.3m, over one year. On the flip side, it has US$128.9m in cash leading to net debt of about US$958.9m.

How Strong Is Cornerstone OnDemand's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Cornerstone OnDemand had liabilities of US$553.4m due within 12 months and liabilities of US$1.16b due beyond that. Offsetting these obligations, it had cash of US$128.9m as well as receivables valued at US$137.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.44b.

This deficit isn't so bad because Cornerstone OnDemand is worth US$3.39b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 0.49 times and a disturbingly high net debt to EBITDA ratio of 6.4 hit our confidence in Cornerstone OnDemand like a one-two punch to the gut. The debt burden here is substantial. The silver lining is that Cornerstone OnDemand grew its EBIT by 153% last year, which nourishing like the idealism of youth. If it can keep walking that path it will be in a position to shed its debt with relative ease. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Cornerstone OnDemand's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Cornerstone OnDemand actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

We weren't impressed with Cornerstone OnDemand's net debt to EBITDA, and its interest cover made us cautious. But its conversion of EBIT to free cash flow was significantly redeeming. When we consider all the elements mentioned above, it seems to us that Cornerstone OnDemand is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. For example - Cornerstone OnDemand has 3 warning signs we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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