Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that iQIYI, Inc. (NASDAQ:IQ) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is iQIYI’s Debt?
As you can see below, at the end of March 2021, iQIYI had CN¥20.6b of debt, up from CN¥16.8b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥13.3b, its net debt is less, at about CN¥7.32b.
A Look At iQIYI’s Liabilities
The latest balance sheet data shows that iQIYI had liabilities of CN¥25.2b due within a year, and liabilities of CN¥14.5b falling due after that. Offsetting these obligations, it had cash of CN¥13.3b as well as receivables valued at CN¥3.55b due within 12 months. So it has liabilities totalling CN¥22.9b more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since iQIYI has a market capitalization of CN¥63.2b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it’s clear that we should definitely closely examine whether it can manage its debt without dilution. There’s no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine iQIYI’s ability to maintain a healthy balance sheet going forward.
Over 12 months, iQIYI saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that hardly impresses, its not too bad either.
Caveat Emptor
Importantly, iQIYI had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥3.9b at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn’t help that it burned through CN¥6.5b of cash over the last year. So suffice it to say we consider the stock very risky. There’s no doubt that we learn most about debt from the balance sheet.