Is Zynga (NASDAQ:ZNGA) Using Too Much Debt?
The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Zynga Inc. (NASDAQ:ZNGA) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Zynga
What Is Zynga's Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2020 Zynga had US$576.7m of debt, an increase on US$100.0m, over one year. However, its balance sheet shows it holds US$1.26b in cash, so it actually has US$684.3m net cash.
How Healthy Is Zynga's Balance Sheet?
According to the last reported balance sheet, Zynga had liabilities of US$797.8m due within 12 months, and liabilities of US$889.0m due beyond 12 months. On the other hand, it had cash of US$1.26b and US$166.1m worth of receivables due within a year. So it has liabilities totalling US$259.8m more than its cash and near-term receivables, combined.
Since publicly traded Zynga shares are worth a very impressive total of US$10.6b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Zynga also has more cash than debt, so we're pretty confident it can manage its debt safely.
It was also good to see that despite losing money on the EBIT line last year, Zynga turned things around in the last 12 months, delivering and EBIT of US$106m. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Zynga 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Zynga has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Zynga actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Summing up
We could understand if investors are concerned about Zynga's liabilities, but we can be reassured by the fact it has has net cash of US$684.3m. The cherry on top was that in converted 188% of that EBIT to free cash flow, bringing in US$199m. So we don't think Zynga's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - Zynga has 2 warning signs we think you should be aware of.
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.
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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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