There's no doubt that money can be made by owning shares of unprofitable businesses. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.
So should Arlo Technologies (NYSE:ARLO) shareholders be worried about its cash burn? For the purposes of this article, cash burn is the annual rate at which an unprofitable company spends cash to fund its growth; its negative free cash flow. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.
Does Arlo Technologies Have A Long Cash Runway?
A company's cash runway is the amount of time it would take to burn through its cash reserves at its current cash burn rate. When Arlo Technologies last reported its balance sheet in June 2019, it had zero debt and cash worth US$138m. Looking at the last year, the company burnt through US$91m. So it had a cash runway of approximately 18 months from June 2019. Notably, however, analysts think that Arlo Technologies will break even (at a free cash flow level) before then. In that case, it may never reach the end of its cash runway. You can see how its cash balance has changed over time in the image below.
How Well Is Arlo Technologies Growing?
Notably, Arlo Technologies actually ramped up its cash burn very hard and fast in the last year, by 154%, signifying heavy investment in the business. As if that's not bad enough, the operating revenue also dropped by 11%, making us very wary indeed. In light of the above-mentioned, we're pretty wary of the trajectory the company seems to be on. While the past is always worth studying, it is the future that matters most of all. So you might want to take a peek at how much the company is expected to grow in the next few years.
How Hard Would It Be For Arlo Technologies To Raise More Cash For Growth?
Arlo Technologies revenue is declining and its cash burn is increasing, so many may be considering its need to raise more cash in the future. Companies can raise capital through either debt or equity. Many companies end up issuing new shares to fund future growth. By looking at a company's cash burn relative to its market capitalisation, we gain insight on how much shareholders would be diluted if the company needed to raise enough cash to cover another year's cash burn.
Arlo Technologies has a market capitalisation of US$250m and burnt through US$91m last year, which is 36% of the company's market value. 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.
How Risky Is Arlo Technologies's Cash Burn Situation?
Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Arlo Technologies's cash runway was relatively promising. There's no doubt that shareholders can take a lot of heart from the fact that analysts are forecasting it will reach breakeven before too long. Based on the factors mentioned in this article, we think its cash burn situation warrants some attention from shareholders, but we don't think they should be worried. While it's important to consider hard data like the metrics discussed above, many investors would also be interested to note that Arlo Technologies insiders have been trading shares in the company. Click here to find out if they have been buying or selling.
Of course Arlo Technologies may not be the best stock to buy. So you may wish to see this freecollection of companies boasting high return on equity, or this list of stocks that insiders are buying.
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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. Thank you for reading.