Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies InterDigital, Inc. (NASDAQ:IDCC) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does InterDigital Carry?
As you can see below, at the end of June 2019, InterDigital had US$434.4m of debt, up from US$291.9m a year ago. Click the image for more detail. However, its balance sheet shows it holds US$831.2m in cash, so it actually has US$396.8m net cash.
How Strong Is InterDigital's Balance Sheet?
According to the last reported balance sheet, InterDigital had liabilities of US$242.9m due within 12 months, and liabilities of US$501.9m due beyond 12 months. On the other hand, it had cash of US$831.2m and US$57.2m worth of receivables due within a year. So it can boast US$143.5m more liquid assets than total liabilities.
This surplus suggests that InterDigital has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, InterDigital boasts net cash, so it's fair to say it does not have a heavy debt load!
Shareholders should be aware that InterDigital's EBIT was down 89% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 most recent three years, InterDigital recorded free cash flow worth 70% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While we empathize with investors who find debt concerning, you should keep in mind that InterDigital has net cash of US$397m, as well as more liquid assets than liabilities. The cherry on top was that in converted 70% of that EBIT to free cash flow, bringing in US$48m. So we don't have any problem with InterDigital's use of debt. Over time, share prices tend to follow earnings per share, so if you're interested in InterDigital, you may well want to click here to check an interactive graph of its earnings per share history.
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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