Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that InterDigital, Inc. (NASDAQ:IDCC) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, 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 InterDigital's Net Debt?
The chart below, which you can click on for greater detail, shows that InterDigital had US$607.8m in debt in December 2023; about the same as the year before. However, its balance sheet shows it holds US$1.01b in cash, so it actually has US$398.6m net cash.
NasdaqGS:IDCC Debt to Equity History April 5th 2024
How Healthy Is InterDigital's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that InterDigital had liabilities of US$881.1m due within 12 months and liabilities of US$308.1m due beyond that. On the other hand, it had cash of US$1.01b and US$137.1m worth of receivables due within a year. So it has liabilities totalling US$45.8m more than its cash and near-term receivables, combined.
Having regard to InterDigital's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$2.44b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, InterDigital boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that InterDigital has boosted its EBIT by 49%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine InterDigital's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While InterDigital 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, InterDigital actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Summing Up
We could understand if investors are concerned about InterDigital's liabilities, but we can be reassured by the fact it has has net cash of US$398.6m. The cherry on top was that in converted 105% of that EBIT to free cash flow, bringing in US$169m. So we don't think InterDigital's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for InterDigital that you should be aware of before investing here.
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.
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