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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that RealNetworks, Inc. (NASDAQ:RNWK) does have debt on its balance sheet. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does RealNetworks Carry?
The image below, which you can click on for greater detail, shows that RealNetworks had debt of US$6.78m at the end of September 2020, a reduction from US$7.50m over a year. However, its balance sheet shows it holds US$13.2m in cash, so it actually has US$6.46m net cash.
A Look At RealNetworks's Liabilities
According to the last reported balance sheet, RealNetworks had liabilities of US$105.6m due within 12 months, and liabilities of US$12.9m due beyond 12 months. On the other hand, it had cash of US$13.2m and US$13.0m worth of receivables due within a year. So it has liabilities totalling US$92.2m more than its cash and near-term receivables, combined.
This deficit casts a shadow over the US$47.1m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, RealNetworks would probably need a major re-capitalization if its creditors were to demand repayment. RealNetworks boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total. There's no doubt that we learn most about debt from the balance sheet. But it is RealNetworks's earnings that will influence how the balance sheet holds up in the future. 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 wasn't profitable at an EBIT level, but managed to grow its revenue by 163%, to US$174m. So there's no doubt that shareholders are cheering for growth
So How Risky Is RealNetworks?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And the fact is that over the last twelve months RealNetworks lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of US$20m and booked a US$20m accounting loss. With only US$6.46m on the balance sheet, it would appear that its going to need to raise capital again soon. The good news for shareholders is that RealNetworks has dazzling revenue growth, so there's a very good chance it can boost its free cash flow in the years to come. While unprofitable companies can be risky, they can also grow hard and fast in those pre-profit years. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with RealNetworks (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.
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.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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