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 software-as-a-service business Salesforce.com lost money for years while it grew recurring revenue, if you held shares since 2005, you'd have done very well indeed. But while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?
Given this risk, we thought we'd take a look at whether MEI Pharma (NASDAQ:MEIP) shareholders should be worried about its 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). We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.
How Long Is MEI Pharma's Cash Runway?
A company's cash runway is calculated by dividing its cash hoard by its cash burn. When MEI Pharma last reported its balance sheet in September 2019, it had zero debt and cash worth US$66m. Importantly, its cash burn was US$31m over the trailing twelve months. So it had a cash runway of about 2.1 years from September 2019. Notably, analysts forecast that MEI Pharma will break even (at a free cash flow level) in about 3 years. Essentially, that means the company will either reduce its cash burn, or else require more cash. Depicted below, you can see how its cash holdings have changed over time.
How Well Is MEI Pharma Growing?
Some investors might find it troubling that MEI Pharma is actually increasing its cash burn, which is up 13% in the last year. Given that its operating revenue increased 206% in that time, it seems the company has reason to think its expenditure is working well to drive growth. If revenue is maintained once spending on growth decreases, that could well pay off! It seems to be growing nicely. Clearly, however, the crucial factor is whether the company will grow its business going forward. For that reason, it makes a lot of sense to take a look at our analyst forecasts for the company.
How Hard Would It Be For MEI Pharma To Raise More Cash For Growth?
We are certainly impressed with the progress MEI Pharma has made over the last year, but it is also worth considering how costly it would be if it wanted to raise more cash to fund faster growth. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. Many companies end up issuing new shares to fund future growth. By comparing a company's annual cash burn to its total market capitalisation, we can estimate roughly how many shares it would have to issue in order to run the company for another year (at the same burn rate).
MEI Pharma's cash burn of US$31m is about 22% of its US$144m market capitalisation. 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 MEI Pharma's Cash Burn A Worry?
On this analysis of MEI Pharma's cash burn, we think its revenue growth was reassuring, while its increasing cash burn has us a bit worried. One real positive is that analysts are forecasting that the company will reach breakeven. Cash burning companies are always on the riskier side of things, but after considering all of the factors discussed in this short piece, we're not too worried about its rate of cash burn. While it's important to consider hard data like the metrics discussed above, many investors would also be interested to note that MEI Pharma insiders have been trading shares in the company. Click here to find out if they have been buying or selling.
If you would prefer to check out another company with better fundamentals, then do not miss this free list of interesting companies, that have HIGH return on equity and low debt or this list of stocks which are all forecast to grow.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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