1 Key Risk with Cordlife Group Ltd That Investors Have To Know

Getting to know about cord blood is likely something that all expecting parents will experience. The presence of cord blood banking companies promoting their services in baby fairs, clinics, and hospitals is quite a common sight.

In Singapore, Cordlife Group Ltd (SGX: P8A) would likely be a familiar outfit for new or would-be parents. The company is a leading private umbilical cord blood and cord lining banking services provider.

The idea of storing the cord blood of your new born baby is similar to buying an insurance policy – you hope you never have to use it, but feel safer if you have it.

It is not hard to see why demand for such services might grow a lot higher in the future. As medical technology advances, it’s likely that more applications for cord blood in the treatment of diseases would emerge and that might increase the appeal of cord blood-banking amongst parents.

Besides riding the aforementioned trend, Cordlife Group has also been actively expanding its geographical footprint and offerings. A recent example of the latter would be the “Metascreen” service, a non-invasive metabolic screening test for newborn babies.

It’s thus reasonable to think that Cordlife Group should have a bright future ahead. We have actually taken a closer look at the investing merits of the company in our Tug-of-Fools series. You can find out more about it in here.

But all that being said, there’s a risk with this company that investors should be cognizant of.

The long tail risk

According to Cordlife Group’s annual report, a typical customer contract has a finite useful life of 18 years.

What this means is if you’re a customer, you’d basically pay for Cordlife Group’s services upfront, but the company will be storing your child’s cord blood for at least 18 years. In other words, you’d have to trust that the company will continue to operate successfully for the next 18 years and that nothing will happen to the firm’s storage vault which contains your child’s precious cord blood.

Customers can now choose to have a 21-year deferred payment scheme in which payments that Cordlife Group receives can be better-matched (in terms of timing) to the obligations that the firm has to meet. But, the company still has a sizeable portion of deferred revenue (Cordlife has some S$26 million worth of deferred revenue as of 31 December 2014) stemming from customers who choose to pay for everything upfront.

The issue at hand

The problem with the presence of deferred revenue has to do with Cordlife’s cash flow management.

When a company has already received payment for a service that it will deliver only in the far future, it’s easy for the firm to not consider the future obligation. When this happens, the company may overspend the cash it has already received and not sock enough away to fulfill its obligation in the future to deliver the good or service it has sold.

Insurance firms are great examples of companies with such problems as they often take in premiums way before they have to pay out any claims. But, insurance companies are restricted by regulations to maintain some investment or financial assets on hand to offset its future obligations.

Unlike an insurance company however,  Cordlife Group is not restricted by any regulations to maintain a buffer to meet future obligations. Therefore, investors have to trust that Cordlife’s management will have the discipline to maintain a strong balance sheet and manage the company’s cash flows prudently.

This issue is pertinent now considering how Cordlife has a net-debt (total borrowings net of cash) to equity ratio of 75% as at 31 December 2014; that’s not a low level of leverage and investors might want to watch the progress of the firm’s balance sheet.

Foolish Summary

The issue with deferred revenue might have lesser significance as time goes by if more and more customers opt for the 21-year deferred payment scheme.

But that said, if I am an investor in Cordlife now, I would still watch its balance sheet like a hawk.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim doesn't own shares in any company mentioned.