Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ 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. Importantly, Synopsys, Inc. (NASDAQ:SNPS) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Synopsys’s Debt?
You can click the graphic below for the historical numbers, but it shows that Synopsys had US$107.2m of debt in July 2021, down from US$131.4m, one year before. But on the other hand it also has US$1.53b in cash, leading to a US$1.42b net cash position.
A Look At Synopsys’ Liabilities
The latest balance sheet data shows that Synopsys had liabilities of US$2.33b due within a year, and liabilities of US$996.1m falling due after that. Offsetting these obligations, it had cash of US$1.53b as well as receivables valued at US$860.4m due within 12 months. So it has liabilities totalling US$940.2m more than its cash and near-term receivables, combined.
Of course, Synopsys has a titanic market capitalization of US$44.0b, so these liabilities are probably manageable. 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, Synopsys boasts net cash, so it’s fair to say it does not have a heavy debt load!
Also positive, Synopsys grew its EBIT by 25% in the last year, and that should make it easier to pay down debt, going forward. 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 Synopsys can strengthen its balance sheet over time.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. While Synopsys 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, Synopsys actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
We could understand if investors are concerned about Synopsys’s liabilities, but we can be reassured by the fact it has has net cash of US$1.42b. The cherry on top was that in converted 141% of that EBIT to free cash flow, bringing in US$1.2b. So is Synopsys’s debt a risk? It doesn’t seem so to us. When analysing debt levels, the balance sheet is the obvious place to start.