David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that InterDigital, Inc. (NASDAQ:IDCC) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 InterDigital's Net Debt?
The chart below, which you can click on for greater detail, shows that InterDigital had US$327.2m in debt in March 2020; about the same as the year before. But it also has US$780.9m in cash to offset that, meaning it has US$453.7m net cash.
How Healthy Is InterDigital's Balance Sheet?
According to the last reported balance sheet, InterDigital had liabilities of US$185.8m due within 12 months, and liabilities of US$503.3m due beyond 12 months. On the other hand, it had cash of US$780.9m and US$25.6m worth of receivables due within a year. So it actually has US$117.4m more liquid assets than total liabilities.
This short term liquidity is a sign that InterDigital could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that InterDigital has more cash than debt is arguably a good indication that it can manage its debt safely.
Importantly, InterDigital grew its EBIT by 32% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine InterDigital's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While InterDigital has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, InterDigital actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While we empathize with investors who find debt concerning, you should keep in mind that InterDigital has net cash of US$453.7m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$58m, being 118% of its EBIT. So we don't think InterDigital's use of debt is risky. 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. Be aware that InterDigital is showing 5 warning signs in our investment analysis , and 1 of those is a bit concerning...
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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