The direct benefit for Zedge Inc (AMEX:ZDGE), which sports a zero-debt capital structure, to include debt in its capital structure is the reduced cost of capital. However, the trade-off is ZDGE will have to adhere to stricter debt covenants and have less financial flexibility. Zero-debt can alleviate some risk associated with the company meeting debt obligations, but this doesn’t automatically mean ZDGE has outstanding financial strength. I will go over a basic overview of the stock’s financial health, which I believe provides a ballpark estimate of their financial health status. Check out our latest analysis for Zedge
Is ZDGE right in choosing financial flexibility over lower cost of capital?
There are well-known benefits of including debt in capital structure, primarily a lower cost of capital. Though, the trade-offs are that lenders require stricter capital management requirements, in addition to having a higher claim on company assets relative to shareholders. ZDGE’s absence of debt on its balance sheet may be due to lack of access to cheaper capital, or it may simply believe low cost is not worth sacrificing financial flexibility. However, choosing flexibility over capital returns is logical only if it’s a high-growth company. ZDGE delivered a negative revenue growth of -9.74%. While its negative growth hardly justifies opting for zero-debt, if the decline sustains, it may find it hard to raise debt at an acceptable cost.
Can ZDGE meet its short-term obligations with the cash in hand?
Since Zedge doesn’t have any debt on its balance sheet, it doesn’t have any solvency issues, which is a term used to describe the company’s ability to meet its long-term obligations. However, another measure of financial health is its short-term obligations, which is known as liquidity. These include payments to suppliers, employees and other stakeholders. At the current liabilities level of $1.9M liabilities, it seems that the business has been able to meet these commitments with a current assets level of $7.0M, leading to a 3.68x current account ratio. Though, a ratio greater than 3x may be considered as too high, as ZDGE could be holding too much capital in a low-return investment environment.
Are you a shareholder? Given that Zedge is a relatively low-growth company, not taking advantage of lower cost debt may not be the best strategy. As shareholders, you should try and determine whether this strategy is justified for ZDGE, and why financial flexibility is needed at this stage in its business cycle. I recommend taking a look into a future growth analysis to properly assess what the market expects for the company moving forward.
Are you a potential investor? ZDGE’s health in terms of financial liquidity should ease potential investors’ concerns. However, a relatively low revenue growth could hurt returns, meaning there is some benefit to looking at low-cost funding alternatives. Keep in mind I haven’t considered other factors such as how ZDGE has been performing in the past. You should continue your analysis by taking a look at ZDGE’s past performance to figure out ZDGE’s financial health position.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.