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Here's Why We're Watching Emerge Gaming's (ASX:EM1) Cash Burn Situation

Simply Wall St

Even when a business is losing money, it's possible for shareholders to make money if they buy a good business at the right price. For example, although Amazon.com made losses for many years after listing, if you had bought and held the shares since 1999, you would have made a fortune. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.

So, the natural question for Emerge Gaming (ASX:EM1) shareholders is whether they should be concerned by its rate of cash burn. For the purpose of this article, we'll define cash burn as the amount of cash the company is spending each year to fund its growth (also called its negative free cash flow). Let's start with an examination of the business's cash, relative to its cash burn.

Check out our latest analysis for Emerge Gaming

Does Emerge Gaming Have A Long 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. As at December 2019, Emerge Gaming had cash of AU$2.5m and no debt. Importantly, its cash burn was AU$1.6m over the trailing twelve months. That means it had a cash runway of around 19 months as of December 2019. That's not too bad, but it's fair to say the end of the cash runway is in sight, unless cash burn reduces drastically. Depicted below, you can see how its cash holdings have changed over time.

ASX:EM1 Historical Debt May 16th 2020

How Is Emerge Gaming's Cash Burn Changing Over Time?

While Emerge Gaming did record statutory revenue of AU$1.0 over the last year, it didn't have any revenue from operations. To us, that makes it a pre-revenue company, so we'll look to its cash burn trajectory as an assessment of its cash burn situation. With cash burn dropping by 19% it seems management feel the company is spending enough to advance its business plans at an appropriate pace. Emerge Gaming makes us a little nervous due to its lack of substantial operating revenue. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.

How Hard Would It Be For Emerge Gaming To Raise More Cash For Growth?

While Emerge Gaming is showing a solid reduction in its cash burn, it's still worth considering how easily it could raise more cash, even just to fuel faster growth. Companies can raise capital through either debt or equity. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash to fund growth. We can compare a company's cash burn to its market capitalisation to get a sense for how many new shares a company would have to issue to fund one year's operations.

Emerge Gaming has a market capitalisation of AU$6.6m and burnt through AU$1.6m last year, which is 24% of the company's market value. That's not insignificant, and if the company had to sell enough shares to fund another year's growth at the current share price, you'd likely witness fairly costly dilution.

Is Emerge Gaming's Cash Burn A Worry?

Even though its cash burn relative to its market cap makes us a little nervous, we are compelled to mention that we thought Emerge Gaming's cash runway was relatively promising. Even though we don't think it has a problem with its cash burn, the analysis we've done in this article does suggest that shareholders should give some careful thought to the potential cost of raising more money in the future. On another note, Emerge Gaming has 5 warning signs (and 3 which are a bit unpleasant) we think you should know about.

Of course Emerge Gaming may not be the best stock to buy. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.

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. Thank you for reading.