Warren Buffett said: “Volatility is far from synonymous with risk. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We notice that Bandwidth Inc. (NASDAQ:BAND) has debt on its balance sheet. But the real question is whether this debt makes the business risky.
When is debt a problem?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we look at debt levels, we first consider cash and debt levels, together.
Check out our latest analysis for bandwidth
What is Bandwidth’s debt?
As you can see below, at the end of September 2021, Bandwidth had $479.2 million in debt, up from $277.5 million a year ago. Click on the image for more details. However, he has $321.8 million in cash to offset this, resulting in a net debt of approximately $157.3 million.
A Look at Bandwidth Responsibilities
According to the last published balance sheet, Bandwidth had liabilities of US$109.1 million due within 12 months and liabilities of US$562.5 million due beyond 12 months. In return, he had $321.8 million in cash and $75.2 million in receivables due within 12 months. It therefore has liabilities totaling $274.6 million more than its cash and short-term receivables, combined.
Given Bandwidth’s publicly traded shares are worth a total of US$1.45 billion, it seems unlikely that this level of liability is a major threat. However, we think it’s worth keeping an eye on the strength of its balance sheet, as it can change over time.
We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
While we’re not concerned about Bandwidth’s net debt to EBITDA ratio of 4.5, we believe its extremely low interest coverage of 0.098x is a sign of high leverage. It appears that the company is incurring significant depreciation and amortization costs, so perhaps its debt load is heavier than it appears at first glance, since EBITDA is undoubtedly a generous measure benefits. It seems clear that the cost of borrowing money is having a negative impact on shareholder returns lately. One of the redeeming factors for Bandwidth is that it turned last year’s EBIT loss into a US$2.5 million gain over the last twelve months. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Bandwidth can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a company can only repay its debts with cold hard cash, not with book profits. It is therefore worth checking how much of earnings before interest and tax (EBIT) is supported by free cash flow. Over the past year, Bandwidth has experienced substantial negative free cash flow, overall. While this may be the result of spending for growth, it makes debt much riskier.
Our point of view
To be frank, Bandwidth’s interest coverage and history of converting EBIT to free cash flow makes us rather uncomfortable with its level of leverage. That said, his ability to manage his total liabilities isn’t all that worrying. Overall, we think it’s fair to say that Bandwidth has enough debt that there is real risk around the balance sheet. If all goes well, it can pay off, but the downside of this debt is a greater risk of permanent losses. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. For example, we have identified 3 bandwidth warning signs of which you should be aware.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.