So why the red flags for Bookham and Avanex?
As with your household budget, a company can only spend more than it earns for a limited time. Sooner or later, if it does not turn free cash flow positive, it must:
1. Issue debt;
2. Dilute shareholders through common stock, warrant and/or convertible debt issues;
3. Sell itself or assets; or
4. Declare bankruptcy.
None is happy for investors. To avoid disaster, or at least to make an intelligent speculation rather than take a match to your cash, you absolutely must know your company’s cash burn and how long it can operate without taking these steps. Do not let management’s PR siren song distract you from the hard facts; do not fall prey to message board boosters. Stick to the numbers and you will see that Bookham and Avanex are in trouble.
What is cash burn?
To determine whether a company is spending more than it takes in – burning cash – subtract net capital expenditures from net cash from operations. Result positive: good. Result negative: bad. You can find this information easily on the cash flow statement. (Hear This! If that financial statement is not your best investing friend, cozy up to it without delay.)
Yes, net cash from operations includes changes in working capital and tax benefits from stock options. We leave them out of our normal valuation work because they are unsustainable and, in the case of tax benefits from stock options, not the business of the company. But we include them for cash burn analysis because working capital (changes in inventory, accounts receivable, and the like) can create or drain actual cash, and the tax benefits from stock options are real money.
Survival term is how long the cash and short-term investments will last at the trailing-twelve-month burn rate before the company has its back to the wall and must choose one of the four options: debt issuance, stock sale, company or asset sale, or bankruptcy. It is crucial to know this figure for all speculations in cash-burning companies so you can be an intelligent speculator rather than a dice roller.
Here are the cash burns (trailing-12-months through June 30, 2006) for the leading optical networking equipment makers, as well as their most recent quarter’s cash and equivalents, survival terms, cash burn trends, and any of the four steps taken to deal with the situation.
TTM Cash Burn: $40 million
Cash and Equivalents June 30, 2006: $74 million
Survival Term: 1.9 years
Cash Burn Trend: Dramatic improvements in last two years; last four quarters too uneven to discern trend.
Recent Actions: Company took step #2 in March 2006, when it issued 24 million shares at 6.4% premium to buyers who also received warrants for stock at $2.73 a share. The stock sale alone is a 17% dilution for existing shareholders.
Bookham Technology (BKHM)
TTM Cash Burn: $64 million
Cash and Equivalents July 1, 2006: $39 million
Survival term: 0.6 years
Cash Burn Trend: Worsening
Recent Actions: Company took steps #2 and #3. In Sept. 2006, Bookham sold new stock and warrants with net proceeds of $23.5 million and in FY 2006 sold a building (in a sale-leaseback) with net proceeds of $14 million. The stock sale alone dilutes shareholders about 25%. The cash proceeds from both deals extend Bookham’s life at current burn rates about eight months. Nevertheless, the company’s accountant issued a going concern letter in September.
TTM Cash burn: $89 million
Cash and Equivalents June 30, 2006: $937 million
Survival term: 10.5 years
Cash Burn Trend: Large improvement from 2004 to 2005; three quarters to date in FY 2006 too uneven to discern trend.
Recent Actions: The company took step #1 in April 2006 when it issued $300 million in 0.25% convertible debt, representing 10% potential dilution. On Sept. 25, 2006, the company instituted a 1:7 reverse stock split.
JDS Uniphase (JDSU)
TTM Cash Burn: $126 million
Cash and Equivalents June 30, 2006: $1,222 million
Survival term: 9.7 years
Cash Burn Trend: Some improvement YOY; last four quarters more or less flat.
Recent Actions: Company has taken step #1, issuing this fiscal year $425 million in zero-coupon convertible debt at 1%, in part to finance an acquisition. This represents about 7% potential dilution, along with the 2003 convertible offering’s potential 6%. The company will institute a 1:8 reverse stock split on Oct. 17, 2006.
While no cash burn is desirable, the differences are obvious. Ciena and JDS Uniphase could continue at current burn rates and not have to issue debt or stock for 11 and 10.5 years, respectively, while Avanex at current rates has a mere 1.9 years and Bookham something less than a year. It’s rational to be concerned or worse about Bookham and Avanex’s precarious cash situations. Every time each sells shares, your ownership share declines, and the cash burn trends suggest that recent stock sales will not be the last. Plus, at some point, if the situation continues or worsens, there will be no buyers on any terms.
Bookham’s days are numbered, and Avanex may have few more. Without dramatic changes in revenues, these companies will faced more financing steps that do not benefit shareholders. True, company survival in any manner is usually better than not, but the bottom line is this: does any such speculative investment offer enough of a home run opportunity to compensate for such white-knuckle risk? My answer is a definite “no” for both, but your knuckles may be tougher.
Remember: Using one metric alone is never the right way to make a good investment, but using cash burn alone can help you avoid a poor one.