Zombie Companies Definition & Overview

KEY TAKEAWAYS

• Businesses that barely break even in order to pay off their debt are known as zombies.
• Zombie businesses are thought to be on the verge of insolvency and lack excess money to support expansion.
• Rarely, a zombie business may extend its resources, create a profitable product, and lower its obligations.
• Investments involving zombies are very risky, so they should be treated with caution.

What Are Zombie Companies?

A zombie company is a company that barely makes enough money to cover expenses and pay off debt but is unable to do so. Such businesses lack surplus money to invest in order to promote growth. This is because they barely manage to cover overhead costs such as wages, rent, and interest on loans. 

Zombie companies are frequently exposed to higher borrowing prices. And they could be saved from bankruptcy or financial assistance by a single unforeseen occurrence. This could be something such as a market disruption or a dismal quarter. Banks are particularly important to zombies since money is, in a sense, their life support. 

The “living dead” or “zombie stocks” are other terms used to describe zombie businesses.

Why Do Zombie Companies Exist?

The phrase zombie company was first used in Japan to refer to businesses that were only making enough money to service the interest on their loans. Japanese banks continued to help weak or failing firms after the burst of the country’s asset price bubble in late 1991. This was rather than letting them file for bankruptcy. As a result, Japan experienced the “Lost Decade,” a time of economic stagnation.

The phrase regained currency in 2008, at the height of the Global Financial Crisis. It was applied to businesses that the U.S. Troubled Asset Relief Program (TARP) had bailed out.

Effect of Zombie Companies on the Economy

Poor organizations’ survival lowers the overall productivity on average. Therefore, zombie companies are considered a barrier to productive growth. According to economists, these businesses are harmful to society. They monopolize the market and hoard talent. These are assets that ought to be available to more prosperous and innovative businesses.

A zombie business is unable to expand and is ineffective without money to reinvest. They contribute to reduced productivity in the global economy. This is because they are uncompetitive survivors.

Some businesses contribute significantly to the economy. This is despite the fact that these businesses have a negative impact on it. For instance, a zombie business might get a government bailout because it employs a lot of people. Massive employment losses in the event of bankruptcy might have a profound effect on society.

How Do You Identify a Zombie Company?

There is no one-size-fits-all way to identify a zombie company. But they do share some common characteristics. The inability to pay back loans and a high debt-to-equity ratio or interest coverage ratio are the two traits that are most commonly shared by such companies.

These businesses are unable to lower the actual principle of the loan. This is because their cash flow is insufficient to cover principal and interest. They are stagnant as a result and lack capacity. Making them incapable of making investments or expanding.

How Do Zombie Firms Survive?

Zombie firms strongly rely on interest rate stability to survive. Commercial banks are under pressure to issue credit and provide low-interest rates. This is as a result of governments’ and central banks’ attempts to restore the economies and financial institutions. This is following a financial crisis.

Even if there aren’t many zombie companies, their rise has been aided by years of lax monetary policy. Particularly quantitative easing, heavy leverage, and record low-interest rates. According to economists, such measures stifle productivity, growth, and innovation while preserving inefficiencies. 

Zombies will be the first to lose out when the market changes since they are unable to pay their basic debts due to increased interest rates. Successful companies, however, may suffer any downturn more than they should. This is because they are less able to capitalize on their success due to financial restrictions.

However, spending such resources is unwise. As it prevents growth at successful organizations and, as a result, prevents job creation. Keeping zombies on life support may help maintain jobs.

Summary

Zombie companies are businesses that, for an extended period of time, cannot cover their debt servicing costs out of existing profits. 

It’s important to note that any form of zombie stock is extremely risky. It is therefore not suitable for all investors because a zombie’s life expectancy is frequently highly unpredictable.

Investors that have a high-risk tolerance and are looking for speculative chances frequently choose to invest in zombie companies. This is mainly a good opportunity because of the underreporting of this group.