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Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Activision Blizzard, Inc. (NASDAQ:ATVI) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Activision Blizzard's Debt?
You can click the graphic below for the historical numbers, but it shows that as of December 2020 Activision Blizzard had US$3.33b of debt, an increase on US$2.68b, over one year. But on the other hand it also has US$8.65b in cash, leading to a US$5.32b net cash position.
A Look At Activision Blizzard's Liabilities
We can see from the most recent balance sheet that Activision Blizzard had liabilities of US$3.10b falling due within a year, and liabilities of US$4.97b due beyond that. Offsetting these obligations, it had cash of US$8.65b as well as receivables valued at US$1.05b due within 12 months. So it can boast US$1.63b more liquid assets than total liabilities.
This surplus suggests that Activision Blizzard has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Activision Blizzard has more cash than debt is arguably a good indication that it can manage its debt safely.
In addition to that, we're happy to report that Activision Blizzard has boosted its EBIT by 62%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Activision Blizzard can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Activision Blizzard may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Activision Blizzard generated free cash flow amounting to a very robust 84% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
While we empathize with investors who find debt concerning, you should keep in mind that Activision Blizzard has net cash of US$5.32b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$2.2b, being 84% of its EBIT. So is Activision Blizzard's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Activision Blizzard , and understanding them should be part of your investment process.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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