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.’ 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 can see that Strongbridge Biopharma plc (NASDAQ:SBBP) does use debt in its business. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. 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 Strongbridge Biopharma’s Net Debt?
The image below, which you can click on for greater detail, shows that at March 2021 Strongbridge Biopharma had debt of US$17.4m, up from none in one year. However, it does have US$73.9m in cash offsetting this, leading to net cash of US$56.5m.
How Strong Is Strongbridge Biopharma’s Balance Sheet?
According to the last reported balance sheet, Strongbridge Biopharma had liabilities of US$22.0m due within 12 months, and liabilities of US$30.2m due beyond 12 months. Offsetting these obligations, it had cash of US$73.9m as well as receivables valued at US$2.85m due within 12 months. So it can boast US$24.5m more liquid assets than total liabilities.
This surplus suggests that Strongbridge Biopharma has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Strongbridge Biopharma has more cash than debt is arguably a good indication that it can manage its debt safely. 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 Strongbridge Biopharma’s ability to maintain a healthy balance sheet going forward.
In the last year Strongbridge Biopharma wasn’t profitable at an EBIT level, but managed to grow its revenue by 35%, to US$32m. Shareholders probably have their fingers crossed that it can grow its way to profits.
So How Risky Is Strongbridge Biopharma?
By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that Strongbridge Biopharma had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through US$36m of cash and made a loss of US$44m. But at least it has US$56.5m on the balance sheet to spend on growth, near-term. With very solid revenue growth in the last year, Strongbridge Biopharma may be on a path to profitability. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. The balance sheet is clearly the area to focus on when you are analysing debt.