The direct benefit for GigaMedia Limited (NASDAQ:GIGM), which sports a zero-debt capital structure, to include debt in its capital structure is the reduced cost of capital. However, the trade-off is GIGM will have to adhere to stricter debt covenants and have less financial flexibility. While GIGM has no debt on its balance sheet, it doesn’t necessarily mean it exhibits financial strength. I will take you through a few basic checks to assess the financial health of companies with no debt.
Is GIGM growing fast enough to value financial flexibility over lower cost of capital?
Debt capital generally has lower cost of capital compared to equity funding. Though, the trade-offs are that lenders require stricter capital management requirements, in addition to having a higher claim on company assets relative to shareholders. The lack of debt on GIGM’s balance sheet may be because it does not have access to cheap capital, or it may believe this trade-off is not worth it. Choosing financial flexibility over capital returns make sense if GIGM is a high-growth company. GIGM delivered a negative revenue growth of -31%. While its negative growth hardly justifies opting for zero-debt, if the decline sustains, it may find it hard to raise debt at an acceptable cost.
Does GIGM’s liquid assets cover its short-term commitments?
Since GigaMedia doesn’t have any debt on its balance sheet, it doesn’t have any solvency issues, which is a term used to describe the company’s ability to meet its long-term obligations. However, another measure of financial health is its short-term obligations, which is known as liquidity. These include payments to suppliers, employees and other stakeholders. At the current liabilities level of US$5m liabilities, it seems that the business has been able to meet these commitments with a current assets level of US$63m, leading to a 13.39x current account ratio. However, a ratio greater than 3x may be considered as quite high.
As a high-growth company, it may be beneficial for GIGM to have some financial flexibility, hence zero-debt. This may mean this is an optimal capital structure for the business, given that it is also meeting its short-term commitment. In the future, GIGM’s financial situation may change. I admit this is a fairly basic analysis for GIGM’s financial health. Other important fundamentals need to be considered alongside. You should continue to research GigaMedia to get a better picture of the stock by looking at:
- Historical Performance: What has GIGM’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.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
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