Zombies

The Rise of Corporate Zombies: A Financial Epidemic

When we hear the term “zombies,” images of the walking dead from horror movies and TV shows might spring to mind. However, in the financial world, zombies refer to something entirely different, yet potentially as menacing to the economy. Corporate zombies, or zombie companies, are businesses that are essentially the walking dead of the corporate world. They are companies that earn just enough money to continue operating and service debt but are unable to pay off their debt completely. This phenomenon has significant implications for the economy, markets, and investors.

Understanding the Zombie Company Phenomenon

Zombie companies are typically characterized by their chronic reliance on debt and their inability to cover their debt servicing costs with current profits over an extended period. These companies are often able to survive thanks to low interest rates and investors' willingness to continue funding them, hoping for a turnaround that may never come.

• They are often unable to invest in growth or innovation.
• They may crowd out healthier companies by taking up market share and resources.
• They are vulnerable to any increase in interest rates or tightening of credit conditions.

The existence of zombie companies can lead to a misallocation of capital, as funds are tied up in unproductive firms rather than being invested in more dynamic sectors of the economy. This can stifle economic growth and innovation, creating a drag on productivity and employment.

Spotting a Zombie: Characteristics and Examples

Zombie companies can be found across various industries, but they share common traits that make them recognizable:

• Interest Coverage Ratio: They often have an interest coverage ratio of less than one, meaning they can't cover interest payments on debt from their current earnings.
• Stagnant Revenue: Their revenues are typically flat or declining, indicating a lack of growth potential.
• High Debt Levels: They carry high levels of debt on their balance sheets, often with deteriorating debt-to-equity ratios.

Examples of zombie companies can be found in sectors that have undergone significant disruption or face structural challenges. For instance, certain retail chains that have failed to adapt to the rise of e-commerce may fall into this category, as well as some legacy players in the technology sector that have been overtaken by more innovative competitors.

The Impact of Zombies on the Economy and Markets

The prevalence of zombie companies can have far-reaching effects on the economy and financial markets:

• Reduced Economic Dynamism: By occupying space in the market, zombies prevent more productive firms from accessing valuable resources, such as skilled labor and investment capital.
• Increased Financial Risk: The continued existence of zombie firms can pose risks to financial stability, as their eventual failure could lead to significant losses for creditors and investors.
• Distorted Market Signals: The presence of zombie companies can distort market signals, making it harder for investors to assess the true health of the economy and individual sectors.

For example, during the COVID-19 pandemic, government support measures and accommodative monetary policies helped many businesses stay afloat. However, this also led to concerns that such measures were propping up zombie companies, potentially leading to a wave of insolvencies once support was withdrawn.

Case Studies: The Zombie Effect in Action

Looking at case studies helps to understand the real-world implications of zombie companies. For instance, Japan's “Lost Decade” in the 1990s is often cited as a period where zombie firms were kept alive through bank loans and government support, contributing to a prolonged period of economic stagnation. Similarly, the European debt crisis brought attention to zombie banks that continued to operate despite being essentially insolvent, thanks to government bailouts and other forms of support.

More recent examples can be found in the energy sector, where some shale oil and gas companies have continued to operate despite prices being too low to cover their costs, largely due to investors' willingness to fund them in hopes of a rebound in oil prices.

Strategies for Investors in a Zombie-Infested Market

For investors, navigating a market with a significant number of zombie companies requires careful analysis and a strategic approach:

• Due Diligence: Investors should conduct thorough due diligence to identify companies with solid fundamentals and avoid those with unsustainable debt levels.
• Focus on Quality: Investing in high-quality companies with strong balance sheets and competitive advantages can provide a buffer against the risks posed by zombies.
• Monitor Macroeconomic Indicators: Keeping an eye on interest rate trends and credit conditions can help investors anticipate changes that might affect the viability of zombie companies.

By being aware of the risks and maintaining a disciplined investment approach, investors can protect their portfolios from the potential fallout associated with zombie companies.

Conclusion: Surviving the Zombie Apocalypse

The rise of zombie companies is a phenomenon that poses significant challenges to economic growth and financial stability. These firms, burdened by debt and unable to invest in their future, can crowd out healthier businesses and create risks for investors. Understanding the characteristics of zombie companies and their impact on the economy is crucial for policymakers, businesses, and investors alike.

As we move forward, it will be important to monitor the prevalence of zombie firms and the policies that may be contributing to their survival. For investors, staying informed and focusing on quality investments will be key strategies for navigating a landscape that may be haunted by corporate zombies. By doing so, we can hope to avoid the economic stagnation that these entities can bring and instead foster a dynamic and resilient economy.