Zombie companies are soaring, and many won’t survive

The term “zombie companies” refers to firms burdened with so much debt that they barely manage to stay afloat, unable to cover even the interest on their loans and just one bad hit away from going under. An analysis by the Associated Press found that the number of these struggling firms has surged to nearly 7,000 globally, with around 2,000 in the United States alone. These companies are the result of years of accumulating cheap debt followed by inflation driving borrowing costs to decade-high levels.

These predominantly small and mid-sized firms now face a critical moment, with due dates approaching on hundreds of billions of dollars in loans they may not be able to repay. Robert Spivey, Managing Director at Valens Securities, predicts the weakest among these companies will “get crushed,” and investor Mark Spitznagel warns, “The clock is ticking.”

Zombies are typically defined as companies that haven’t generated enough operational profit to cover their loan interest over the past three years. The AP analysis indicates a significant rise in their numbers across countries like Australia, Canada, Japan, South Korea, the UK, and the US. Even among companies that existed a decade ago, the proportion of zombies has increased by nearly 30%.

These companies span various sectors, including utilities, food production, technology, healthcare, and real estate, with some struggling due to the pandemic’s impact and others dealing with half-empty office spaces in major cities. The potential fallout from zombie companies collapsing is vast, with at least 130 million employees at risk in the analyzed countries.

Already, the number of bankruptcies among US companies has hit a 14-year high, a trend expected during a recession, not an expansion. Corporate bankruptcies are also rising in Canada, the UK, France, and Spain. Some analysts believe that if central banks cut interest rates, it could help these companies avoid severe measures like layoffs or business unit sales. Others argue that the pandemic temporarily swelled the ranks of zombies, and the impact might not be as dire as it seems.

The concept of zombies surged as low interest rates encouraged heavy borrowing by not just weak firms but also governments, consumers, and larger companies. Unlike healthier firms, many zombies lack substantial cash reserves and face variable interest rates, which have soared recently. Compounding their troubles, much of the borrowed money was used for stock buybacks rather than investments in expansion or technology.

For example, Bed Bath & Beyond’s downfall was partly due to heavy borrowing and spending $7 billion on stock buybacks over a decade, which coincided with substantial executive payouts. Similarly, JetBlue, dealing with pandemic fallout, saw its stock plummet as it struggled with doubled debt and substantial buybacks.

Some companies used borrowed cash directly for shareholder dividends, such as the Glazer family with Manchester United. The Glazers had the team take on significant debt while paying themselves substantial dividends, leading to underinvestment in infrastructure and declining performance.

The debt overhang is not limited to zombies. Governments, consumers, and larger companies also face mounting interest burdens, posing a broader economic risk. For instance, the US government is expected to spend $870 billion on interest payments alone this year. This widespread debt creates a “tinderbox” situation where any significant economic downturn could trigger widespread corporate collapses, warns investor Spitznagel.

Despite some zombies refinancing their loans earlier this year in anticipation of Federal Reserve rate cuts, many still face looming deadlines with $1.1 trillion in loans due by the end of the year. While 80% of publicly traded companies in the analyzed countries are not zombies, the remaining debt still poses a risk if interest rates don’t decline in the coming years.

Several zombies are already taking drastic measures, such as Telecom Italia selling off assets and Peloton laying off workers to manage their debt. If interest rates remain high, more bankruptcies and severe financial consequences are likely, as noted by fund manager George Cipolloni, emphasizing that when the money comes due, many companies won’t have the means to pay.

In summary, zombie companies represent a significant risk to the global economy, with many facing imminent financial crises if conditions don’t improve. Their struggles underscore broader issues in corporate debt management and the potential for widespread economic repercussions.