Snap's (NYSE:SNAP) stock price recently dipped after the company announced a new $1 billion debt offering. The convertible senior notes, which will be sold privately to institutional buyers, will mature in 2027.

The notes can then be converted to cash, Class A shares of Snap, or a combination of cash and stock. The interest rate, conversion rates, and other specific terms will be set when Snap prices the offering.

The initial buyers will also have an option to buy an additional $150 million in convertible notes, which could boost the total value of the offering to $1.15 billion. Snap says it could also induce some conversions of its convertible senior notes for 2025 and 2026 while it prices its latest debt offering.

Cash rains down on a young woman.

Image source: Getty Images.

The new debt offering seems to have dampened the market's enthusiasm for Snap's stock after its recent first-quarter earnings beat, but will it actually impact the company's long-term prospects?

Diving into Snap's long-term debt

Snap has issued convertible debt twice. In Aug. 2019 it raised $1.15 billion (after deducting certain fees) by selling $1.27 billion in 2026 notes. Snap's stock price has since exceeded the minimum conversion price for these notes, so they became eligible for optional conversions in the first quarter of 2021.

Then in April 2020 Snap raised $889 million by selling $1 billion in convertible notes that will mature in 2025. Snap's rising stock price also made these notes eligible for optional conversions in the first quarter.

Snap's 2025 notes bear an interest rate of 0.25%, while its 2026 notes have an interest rate of 0.75%.

Snap also entered a revolving five-year credit facility in July 2016. It raised its limit from $1.1 billion to $1.25 billion in early 2018, and the revolver's term was extended to August 2023 later that year.

How much debt does Snap have?

Snap ended the first quarter with $2.25 billion in outstanding convertible notes, which accounted for just over two-thirds of its total liabilities. This gives it a total debt-to-equity ratio of just under 2.0.

That ratio is very high for a social media company. Pinterest (NYSE:PINS) and Facebook (NASDAQ:FB) have debt-to-equity ratios of 0.16 and 0.22, respectively, and neither company is holding any term debt.

Therefore, a new $1 billion offering could propel Snap's ratio toward 2.5, depending on how many of the 2025 and 2026 notes it converts in the optional exchange agreements. However, converting too much of that older debt into new shares could further dilute Snap's stock.

SNAP Shares Outstanding Chart

Source: YCharts

Snap's number of outstanding shares has steadily risen since its IPO, mainly due to its heavy dependence on stock-based compensation, and will likely keep rising for the foreseeable future.

Did Snap need to generate fresh cash?

If we track Snap's net losses and negative free cash flow (FCF) over the past three years, we'll notice its debt offerings in 2019 and 2020 kept it solvent.

Metric

2018

2019

2020

Net Loss

($1.26 billion)

($1.03 billion)

($945 million)

Free Cash Flow

($810 million)

($341 million)

($225 million)

Cash and Equivalents

$387 million

$520 million

$546 million

Marketable Securities

$862 million

$1.59 billion

$1.99 billion

Data source: Snap.

Snap won't turn profitable on a GAAP basis anytime soon, but it generated a positive FCF of $126 million in the first quarter of 2021 -- marking the first time its free cash flow ever turned positive.

That key improvement, which was driven by Snapchat's 22% year-over-year growth in daily active users (DAUs), its rising ad prices, and its declining infrastructure costs per DAU, indicate it will eventually eliminate its dependence on debt offerings to stay afloat.

But for now Snap still needs to buy itself more time. Raising another $1 billion will give Snap more cash to expand its augmented reality and social commerce ecosystems with fresh investments and acquisitions. It could also support Spotlight, Snapchat's TikTok challenger, with more cash prizes for viral short videos.

I'm not worried about Snap's debt yet

Snap's dependence on convertible debt offerings is noteworthy, but I'm not worried about its rising debt levels yet. Snapchat is still growing at a healthy rate, its ecosystem is expanding, and it still expects to grow its annual revenue by about 50% over the next few years.

 
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.