Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 RealNetworks, Inc. (NASDAQ:RNWK) makes use of debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is RealNetworks's Debt?
The image below, which you can click on for greater detail, shows that at June 2019 RealNetworks had debt of US$7.88m, up from none in one year. But it also has US$26.3m in cash to offset that, meaning it has US$18.5m net cash.
How Strong Is RealNetworks's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that RealNetworks had liabilities of US$117.1m due within 12 months and liabilities of US$22.9m due beyond that. Offsetting these obligations, it had cash of US$26.3m as well as receivables valued at US$32.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$81.7m.
When you consider that this deficiency exceeds the company's US$61.6m market capitalization, you might well be inclined to review the balance sheet, just like one might study a new partner's social media. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. Given that RealNetworks has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since RealNetworks will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
In the last year RealNetworks managed to grow its revenue by 62%, to US$118m. Shareholders probably have their fingers crossed that it can grow its way to profits.
So How Risky Is RealNetworks?
Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months RealNetworks lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through US$24m of cash and made a loss of US$21m. But at least it has US$26m on the balance sheet to spend on growth, near-term. With very solid revenue growth in the last year, RealNetworks may be on a path to profitability. Pre-profit companies are often risky, but they can also offer great rewards. For riskier companies like RealNetworks I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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