Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Model N, Inc. (NYSE:MODN) makes use of debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Model N Carry?
You can click the graphic below for the historical numbers, but it shows that Model N had US$49.1m of debt in June 2019, down from US$58.8m, one year before. But it also has US$58.5m in cash to offset that, meaning it has US$9.42m net cash.
A Look At Model N's Liabilities
We can see from the most recent balance sheet that Model N had liabilities of US$67.0m falling due within a year, and liabilities of US$45.3m due beyond that. On the other hand, it had cash of US$58.5m and US$25.5m worth of receivables due within a year. So it has liabilities totalling US$28.3m more than its cash and near-term receivables, combined.
Of course, Model N has a market capitalization of US$876.7m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Model N also has more cash than debt, so we're pretty confident it can manage its debt safely. 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 Model N 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 Model N actually shrunk its revenue by 7.9%, to US$141m. That's not what we would hope to see.
So How Risky Is Model N?
Although Model N had negative earnings before interest and tax (EBIT) over the last twelve months, it generated positive free cash flow of US$7.7m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. With revenue growth uninspiring, we'd really need to see some positive EBIT before mustering much enthusiasm for this business. When I consider a company to be a bit risky, I think it is responsible to check out whether insiders have been reporting any share sales. Luckily, you can click here ito see our graphic depicting Model N insider transactions.
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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