There's no doubt that money can be made by owning shares of unprofitable businesses. For example, although software-as-a-service business Salesforce.com lost money for years while it grew recurring revenue, if you held shares since 2005, you'd have done very well indeed. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.
Given this risk, we thought we'd take a look at whether Cobalt Blue Holdings (ASX:COB) shareholders should be worried about its cash burn. For the purposes of this article, cash burn is the annual rate at which an unprofitable company spends cash to fund its growth; its negative free cash flow. Let's start with an examination of the business's cash, relative to its cash burn.
How Long Is Cobalt Blue Holdings's Cash Runway?
You can calculate a company's cash runway by dividing the amount of cash it has by the rate at which it is spending that cash. When Cobalt Blue Holdings last reported its balance sheet in June 2019, it had zero debt and cash worth AU$4.7m. Importantly, its cash burn was AU$9.7m over the trailing twelve months. So it had a cash runway of approximately 6 months from June 2019. With a cash runway that short, we strongly believe that the company must raise cash or else douse its cash burn promptly. Depicted below, you can see how its cash holdings have changed over time.
How Is Cobalt Blue Holdings's Cash Burn Changing Over Time?
In our view, Cobalt Blue Holdings doesn't yet produce significant amounts of operating revenue, since it reported just AU$70k in the last twelve months. Therefore, for the purposes of this analysis we'll focus on how the cash burn is tracking. With the cash burn rate up 45% in the last year, it seems that the company is ratcheting up investment in the business over time. However, the company's true cash runway will therefore be shorter than suggested above, if spending continues to increase. Admittedly, we're a bit cautious of Cobalt Blue Holdings due to its lack of significant operating revenues. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.
How Hard Would It Be For Cobalt Blue Holdings To Raise More Cash For Growth?
Given its cash burn trajectory, Cobalt Blue Holdings shareholders should already be thinking about how easy it might be for it to raise further cash in the future. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. Commonly, a business will sell new shares in itself to raise cash to drive growth. By looking at a company's cash burn relative to its market capitalisation, we gain insight on how much shareholders would be diluted if the company needed to raise enough cash to cover another year's cash burn.
Cobalt Blue Holdings has a market capitalisation of AU$20m and burnt through AU$9.7m last year, which is 48% of the company's market value. That's high expenditure relative to the value of the entire company, so if it does have to issue shares to fund more growth, that could end up really hurting shareholders returns (through significant dilution).
Is Cobalt Blue Holdings's Cash Burn A Worry?
As you can probably tell by now, we're rather concerned about Cobalt Blue Holdings's cash burn. In particular, we think its cash runway suggests it isn't in a good position to keep funding growth. And although we accept its increasing cash burn wasn't as worrying as its cash runway, it was still a real negative; as indeed were all the factors we considered in this article. After considering the data discussed in this article, we don't have a lot of confidence that its cash burn rate is prudent, as it seems like it might need more cash soon. When you don't have traditional metrics like earnings per share and free cash flow to value a company, many are extra motivated to consider qualitative factors such as whether insiders are buying or selling shares. Please Note: Cobalt Blue Holdings insiders have been trading shares, according to our data. Click here to check whether insiders have been buying or selling.
Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of interesting companies, and this list of stocks growth stocks (according to analyst forecasts)
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.