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. 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. As with many other companies Zynga Inc. (NASDAQ:ZNGA) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Zynga's Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Zynga had US$558.4m of debt, an increase on none, over one year. However, it does have US$828.6m in cash offsetting this, leading to net cash of US$270.2m.
How Strong Is Zynga's Balance Sheet?
We can see from the most recent balance sheet that Zynga had liabilities of US$675.2m falling due within a year, and liabilities of US$786.1m due beyond that. Offsetting these obligations, it had cash of US$828.6m as well as receivables valued at US$144.9m due within 12 months. So its liabilities total US$487.8m more than the combination of its cash and short-term receivables.
Of course, Zynga has a market capitalization of US$5.80b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Zynga boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Zynga can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
In the last year Zynga wasn't profitable at an EBIT level, but managed to grow its revenue by19%, to US$1.1b. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
So How Risky Is Zynga?
Although Zynga had negative earnings before interest and tax (EBIT) over the last twelve months, it generated positive free cash flow of US$213m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. With revenue growth uninspiring, we'd really need to see some positive EBIT before mustering much enthusiasm for this business. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how Zynga's profit, revenue, and operating cashflow have changed over the last few years.
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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