Many observers then spoke of the “burn rate”, i.e., the lapse of time remaining for a company before it consumes all the liquidity it has left. A definition of the expression “burn rate” could be “life expectancy”. Over the past few weeks, I have noticed that the expression is becoming more and more topical.
Do you remember the countless number of companies that went bankrupt in the early 2000s? Companies such as CDNow, Healtheon or Talk City?
Barring a market reversal, I have a feeling we could see a similar phenomenon over the next few years. After the boom years in which capital was virtually unlimited and inexpensive, conditions suddenly changed in 2022 with sharp increases in interest rates and the collapse of stock markets. Debt has become expensive and lenders skittish, while investors are reluctant to buy new equity issues.
Overnight, companies with a loss-making business model will now have to focus their efforts on generating cash flow and profitability, a drastic change after years of aiming for all-out revenue growth.
I calculate the “burn rate” of a loss-making company by comparing its negative free cash flows for the past 12 months to its current net cash.
Let’s take an example: AMC Entertainment, whose stock was very popular in 2021 during the “meme stocks” period. AMC Entertainment suffered negative free cash flow of approximately $717 million over the past 12 months. On its balance sheet as of September 30, 2022, we see that the company had cash of $684.6 million while its bank debt totalled more than $5.3 billion, for a net debt of $4.64 billion. In this extreme case, the “burn rate” would be negative (- 6.5 years = – 4.64 G/717 M). Needless to say, this company is in a particularly precarious financial situation (which could explain the nearly 85% drop in its stock in 2022).
Another example. Recently Enghouse Systems, which we have in our managed portfolios, announced that it intended to acquire the American company Qumu for US$18 million in cash. This company, whose stock is listed on the stock exchange (“QUMU”), offers cloud-based video solutions to businesses. The stock was worth more than $10 a share in March 2021 but the price offered by Enghouse is US$0.90. Why such a rout? Simply because Qumu is in deficit. I calculate that its burn rate is less than 6 months ($6M net cash / free cash flow of -$12.5M over the last 12 months). Qumu’s leaders opted to be bought out rather than take the risk of not having access to capital in the months to come.
As in 2000, there are currently many companies that have made the jump to the stock market in recent years and are still losing a lot of money. If you own some of them, I suggest you calculate their “burn rate” to measure the risk that they will not make it through what is shaping up to be a long period during which access to capital will be restricted.
On the other hand, we can expect companies that are profitable and in good financial health to finally experience their day in the sun It will be a just swing of the pendulum.
