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The Growing Threat of Zombie Companies

10th June, 2024

The Growing Threat of Zombie Companies

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In News

  • Many companies, termed as "zombies," are burdened with debt to the extent that they are barely surviving, only managing to pay the interest on their loans and often one bad business hit away from collapsing.
  • An Associated Press analysis revealed that the number of such companies has surged globally to nearly 7,000, with 2,000 in the United States alone, due to years of accumulating cheap debt followed by rising inflation and borrowing costs reaching decade highs.

Definition and Overview

  • Zombies: Companies heavily laden with debt, barely able to pay interest on their loans, and at risk of collapse.
  • Numbers: Nearly 7,000 publicly traded zombies globally, with 2,000 in the U.S.
  • Causes: Years of accumulating cheap debt followed by high inflation increasing borrowing costs.

Characteristics of Zombie Companies

  • Financial Health: Unable to generate enough revenue from operations to cover interest payments for the past three years.
  • Sectors Affected: Utilities, food producers, tech companies, hospital and nursing home chains, real estate firms.
  • Notable Examples: Carnival Cruise Line, JetBlue Airways, Wayfair, Peloton, Telecom Italia, Manchester United.

The Rise of Zombies

  • Global Increase: The number of zombies has surged by a third or more in several countries, including Australia, Canada, Japan, South Korea, the UK, and the US.
  • Employment Impact: Zombies employ at least 130 million people across a dozen countries.

Current Financial Environment

  • Bankruptcies: U.S. corporate bankruptcies at a 14-year high, with similar trends in Canada, the UK, France, and Spain.
  • Interest Rates: Some zombies may survive if central banks cut interest rates, but scattered defaults and bankruptcies could still impact the economy.

Warning Signs and Historical Context

  • Debt Accumulation: Central banks cut interest rates to near zero during the 2009 financial crisis and 2020-21 pandemic, sparking a borrowing binge.
  • Credit Bubble: Low rates led to heavy borrowing by governments, consumers, and companies, creating a credit bubble beyond just zombies.
  • Stock Buybacks: Many companies used debt to repurchase stock, benefiting executives but not strengthening financial health.

Sector-Specific Examples

  • SmileDirectClub: Spent heavily on stock buybacks, leading to bankruptcy and significant job losses.
  • JetBlue: Increased debt for aircraft purchases and stock buybacks, now struggling with high interest costs.
  • Manchester United: Loaded with debt by the Glazer family, facing infrastructure issues and falling stock prices.

Economic Implications

  • Government and Consumer Debt: High debt levels across governments and consumers add to economic vulnerability.
  • Potential for Widespread Collapse: Concentrated zombie collapses could significantly impact the economy, similar to allowing small fires to prevent a large inferno.

Future Outlook and Risks

  • Refinancing Challenges: Many zombies need to refinance $1.1 trillion in loans, with significant amounts due by the end of the year.
  • Interest Rate Impact: Sustained high interest rates could lead to more bankruptcies and economic strain.
  • Debt Maturity: Large amounts of corporate debt will mature in the coming years, posing risks if interest rates remain high.

Examples of Corporate Responses

  • Telecom Italia: Selling assets to manage debt but facing continued stock pressure.
  • iHeartMedia: Struggling post-bankruptcy with real estate and radio tower sales.
  • Peloton: Layoffs to manage soaring debt, with stock prices plummeting from pandemic highs.

Conclusion

  • The increasing number of zombie companies poses significant risks to the global economy.
  • High debt levels, the potential for widespread bankruptcies, and the strain on employment and sectors highlight the urgency for effective financial management and possible regulatory interventions.
  • The future stability of these companies and the broader economic impact will largely depend on interest rate trends and the ability of companies to manage and reduce their debt burdens.

PRACTICE QUESTION

Q. Which of the following best defines "Zombie Companies"?

a) Companies that primarily invest in emerging technologies with high growth potential.
b) Companies that are heavily laden with debt, barely able to pay interest on their loans, and at risk of collapse.
c) Companies that have recently emerged from bankruptcy and are financially stable.
d) Companies that consistently outperform their industry peers in terms of profitability and growth.

Correct Answer: b) Companies that are heavily laden with debt, barely able to pay interest on their loans, and at risk of collapse.