As the US$72m market cap Merrimack Pharmaceuticals, Inc. (NASDAQ:MACK) released another year of negative earnings, investors may be on edge waiting for breakeven. Savvy investors should always reassess the situation of loss-making companies frequently, and keep informed about whether or not these businesses are in a strong cash position. Selling new shares may dilute the value of existing shares on issue, and since Merrimack Pharmaceuticals is currently burning more cash than it is making, it’s likely the business will need funding for future growth. Looking at Merrimack Pharmaceuticals’s latest financial data, I will estimate when the company may run out of cash and need to raise more money.
What is cash burn?
With a negative free cash flow of -US$57.5m, Merrimack Pharmaceuticals is chipping away at its US$40m cash reserves in order to run its business. Companies with high cash burn rates can eventually turn into ashes, which makes it the biggest risk an investor in loss-making companies face. Unprofitable companies operating in the exciting, fast-growing biotech industry often face this problem, and Merrimack Pharmaceuticals is no exception. These companies face the trade-off between running the risk of depleting its cash reserves too fast, or falling behind competition on innovation and gaining market share by investing too slowly.
When will Merrimack Pharmaceuticals need to raise more cash?
We can measure Merrimack Pharmaceuticals's ongoing cash expenditure requirements by looking at free cash flow, which I define as cash flow from operations minus fixed capital investment, is a measure of how much cash a company generates/loses each year.
In the past year, free cash outflows (excluding one-offs) rose by 32%, which is substantial. This means that, if Merrimack Pharmaceuticals continues to burn cash at this rate, given how much money it currently has in the bank, it may actually need to raise capital again within the next couple of months! Moreover, even if Merrimack Pharmaceuticals kept its cash burn level at -US$57.5m, it will still have to raise capital within the next year. Even though this is analysis is fairly basic, and Merrimack Pharmaceuticals still can cut its overhead in the near future, or open a new line of credit instead of issuing new shares, the outcome of this analysis still gives us an idea of the company’s timeline and when things will have to start changing, since its current operation is unsustainable.
The risks involved in investing in loss-making Merrimack Pharmaceuticals means you should think twice before diving into the stock. However, this should not prevent you from further researching its investment potential. Now you know that if the company was to continue to grow its cash burn rapidly, it may not be able to sustain its operations given the current level of cash reserves. This suggests an opportunity to enter into the stock, potentially at an attractive price, should Merrimack Pharmaceuticals raise capital to fund its growth. Keep in mind I haven't considered other factors such as how MACK is expected to perform in the future. I suggest you continue to research Merrimack Pharmaceuticals to get a more holistic view of the company by looking at:
- Historical Performance: What has MACK's returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.
- Management Team: An experienced management team on the helm increases our confidence in the business – take a look at who sits on Merrimack Pharmaceuticals’s board and the CEO’s back ground.
- Other High-Performing Stocks: If you believe you should cushion your portfolio with something less risky, scroll through our free list of these great stocks here.
NB: Figures in this article are calculated using data from the trailing twelve months from 30 June 2019. This may not be consistent with full year annual report figures. Operating expenses include only SG&A and one-year R&D.
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