The Debt Dogs of Software

Charlie Munger, Warren Buffett's business partner, has condemned drugs, liquor, and leverage as humanity's three biggest downfalls. The first two are your own responsibility, but if you're invested -- or are thinking about investing -- in the software industry, you should know which companies in the space are the deepest in debt.

Leverage is not inherently bad for a company. A fast-growing company can intelligently employ debt to exploit its market opportunity. At low interest rates, debt can fund shrewd strategic acquisitions. Since it's generally cheaper than equity, debt can also lower a company's cost of capital.

But too often, companies end up abusing debt -- and as Munger reminds us, excessive leverage can lead to ruin. Let's examine a few of the most heavily indebted software companies.

Company

Total Debt/Capital

Interest Coverage

Bitauto Holdings (NYSE: BITA  )

739.7%

4.5

Rural/Metro (Nasdaq: RURL  )

160%

1.9

Team Health Holdings (NYSE: TMH  )

114.6%

6.8

Alliance Data Systems (NYSE: ADS  )

99.6%

2.0

Alliance Healthcare Services (NYSE: AIQ  )

94%

0.9

First of all, look at Bituato Holdings. The company has more than seven times as much debt as capital, yet it is capable of meeting its interest payments out of operating income more than four times over. This company also trades at a whopping 67 times its EBIDTA -- a very high multiple.

Of the others on the list, Alliance Healthcare Services merits comment. Though the least indebted of these five companies, it is the only one not bringing in enough operating income to pay the interest on its loans, as is indicated by its interest coverage ratio of less than one. Notably, Alliance also sports the lowest EV/EBITDA multiple of the five (at 5.1 times). That multiple might have the company showing up on value-oriented screens, but if the company is struggling just to meet its commitments, the low multiple may be appropriate.

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Neither Alex nor The Motley Fool owns stock in any company mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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