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 can see that Twitter, Inc. (NYSE:TWTR) does use debt in its business. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Twitter's Debt?
As you can see below, Twitter had US$2.70b of debt, at June 2019, which is about the same the year before. You can click the chart for greater detail. However, its balance sheet shows it holds US$6.69b in cash, so it actually has US$3.99b net cash.
How Strong Is Twitter's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Twitter had liabilities of US$1.73b due within 12 months and liabilities of US$2.44b due beyond that. Offsetting these obligations, it had cash of US$6.69b as well as receivables valued at US$719.9m due within 12 months. So it can boast US$3.23b more liquid assets than total liabilities.
This surplus suggests that Twitter has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Twitter boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that Twitter has boosted its EBIT by 70%, 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 Twitter 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. Twitter 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. Happily for any shareholders, Twitter actually produced more free cash flow than EBIT over the last two years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
While we empathize with investors who find debt concerning, you should keep in mind that Twitter has net cash of US$3.99b, as well as more liquid assets than liabilities. The cherry on top was that in converted 225% of that EBIT to free cash flow, bringing in US$1.1b. So is Twitter's debt a risk? It doesn't seem so to us. We'd be very excited to see if Twitter insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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