Howard Marks put it nicely when he said that, rather than worrying about share price volatility, ‘The possibility of permanent loss is the risk I worry about… and every practical investor I know worries about.’ 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. As with many other companies NetScout Systems, Inc. (NASDAQ:NTCT) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

What Is NetScout Systems’s Net Debt?

You can click the graphic below for the historical numbers, but it shows that NetScout Systems had US$350.0m of debt in June 2021, down from US$450.0m, one year before. However, its balance sheet shows it holds US$493.9m in cash, so it actually has US$143.9m net cash.

How Strong Is NetScout Systems’ Balance Sheet?

Zooming in on the latest balance sheet data, we can see that NetScout Systems had liabilities of US$367.6m due within 12 months and liabilities of US$662.5m due beyond that. Offsetting this, it had US$493.9m in cash and US$146.2m in receivables that were due within 12 months. So it has liabilities totalling US$390.0m more than its cash and near-term receivables, combined.

Given NetScout Systems has a market capitalization of US$2.00b, it’s hard to believe these liabilities pose much threat. Having said that, it’s clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, NetScout Systems boasts net cash, so it’s fair to say it does not have a heavy debt load!

It is well worth noting that NetScout Systems’s EBIT shot up like bamboo after rain, gaining 35% in the last twelve months. That’ll make it easier to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if NetScout Systems can strengthen its balance sheet over time.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While NetScout Systems 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. Over the last three years, NetScout Systems actually produced more free cash flow than EBIT. There’s nothing better than incoming cash when it comes to staying in your lenders’ good graces.

Summing up

While NetScout Systems does have more liabilities than liquid assets, it also has net cash of US$143.9m. And it impressed us with free cash flow of US$181m, being 668% of its EBIT. So is NetScout Systems’s debt a risk? It doesn’t seem so to us. There’s no doubt that we learn most about debt from the balance sheet.