Is MicroStrategy (NASDAQ:MSTR) using too much debt?

David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We can see that MicroStrategy Embedded (NASDAQ:MSTR) uses debt in its business. But should shareholders worry about its use of debt?

What risk does debt carry?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case, a company can go bankrupt if it cannot pay its creditors. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.

See our latest analysis for MicroStrategy

What is MicroStrategy’s net debt?

The image below, which you can click on for more details, shows that as of December 2021, MicroStrategy had $2.16 billion in debt, up from $486.4 million in one year. However, he has $63.4 million in cash to offset this, resulting in a net debt of approximately $2.09 billion.

How healthy is MicroStrategy’s balance sheet?

We can see from the most recent balance sheet that MicroStrategy had liabilities of US$312.0 million due in one year, and liabilities of US$2.27 billion due beyond. In return, he had $63.4 million in cash and $190.4 million in receivables due within 12 months. It therefore has liabilities totaling $2.32 billion more than its cash and short-term receivables, combined.

While that might sound like a lot, it’s not that bad since MicroStrategy has a market capitalization of US$5.13 billion, so it could probably bolster its balance sheet by raising capital if needed. But it is clear that it is essential to examine closely whether it can manage its debt without dilution.

We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.

MicroStrategy shareholders face the double whammy of a high net debt to EBITDA ratio (36.4) and fairly low interest coverage, as EBIT is only 1.6 times operating expenses. ‘interests. This means that we would consider him to be heavily indebted. Investors should also be troubled by the fact that MicroStrategy has seen its EBIT drop 19% over the past twelve months. If things continue like this, dealing with debt will be about as easy as putting an angry house cat in its travel box. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether MicroStrategy can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, while the taxman may love accounting profits, lenders only accept cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past two years, MicroStrategy has burned a lot of money. While this may be the result of spending for growth, it makes debt much riskier.

Our point of view

At first glance, MicroStrategy’s net debt to EBITDA left us hesitant about the stock, and its EBIT-to-free-cash-flow conversion was no more appealing than the single empty restaurant the night before. busiest of the year. That said, his ability to manage his total liabilities isn’t all that worrying. After reviewing the data points discussed, we believe that MicroStrategy has too much debt. While some investors like this kind of risky play, it’s definitely not our cup of tea. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. These risks can be difficult to spot. Every business has them, and we’ve spotted 4 warning signs for MicroStrategy (1 of which is a little unpleasant!) that you should know about.

In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.