A typical zombie movie starts on a day like any other, with everyone going about their business, until a lead character spots a shambling emissary of the undead from afar and takes a while to twig what’s going on.
Before said protagonist has got their head around the situation, one zombie becomes five, five becomes 10, 10 becomes 20 – and before long, it’s clear the town has a horde on its hands. Cue a desperate scramble for distance and cover as our heroes seek to evade the encroaching taint of living death.
As in film, so in business. This year, one of the earliest sightings of approaching zombies in the corporate world came when the Australian arm of international law firm Norton Rose Fulbright issued a warning. In a May report, the firm said that economic stimulus provided in the early months of the pandemic could have pumped artificial life into businesses that the market would otherwise have allowed to slide into the grave.
The report thundered: “This could indeed spark a pandemic of a different kind – that of the ‘zombie company’, with entities taking advantage of subsidies and a benign financial market (with historically low interest rates) to keep open the doors to businesses that will never be self-sustaining – all while tying up the very capital investment needed to support new projects and business models in a post COVID-19 world.”
It stressed: “We need to have an honest conversation that some of the business models that were so successful when the clock ticked over into 2020 may no longer be sustainable in the circumstances we now find ourselves in.”
Fast forward to September, and similar concerns were arising in Europe.
A Reuters news report noted that in H1 2020, business insolvencies in Germany had seen a year-on-year drop of 6.2%, thanks to Angela Merkel’s administration temporarily waiving a key filing obligation. By stark contrast, it pointed out, Chapter 11 bankruptcies in the US had ballooned by 26%.
At that point, Berlin was gearing up to provide the business community with even more flexibility, sparking criticism from political opponents. Much like Norton Rose Fulbright’s report, these critics argued that the additional stimulus ran the risk of hindering ‘creative destruction’ – a term coined in the 1940s by economist Joseph Schumpeter to encapsulate the ‘out with the old, in with the new’ churn that market forces impose on business.
Even figures within Merkel’s CDU/CSU alliance were troubled. While legal and consumer spokesman Jan-Marco Luczak acknowledged that providing extra stimulus was only “good and right” under the circumstances, he warned: “It is also clear that we must not permanently switch off the self-cleaning process of the market. Companies that are not healthy and have no economic prospects independently of corona must exit.”
The following month, a report from corporate recovery specialists Begbies Traynor warned of the economic shock that could hit the UK, should a normalisation of social conditions prompt a swarm of domestic zombie firms to implode all at once.
“With so many businesses limping along,” said partner Julie Palmer, “there could be a flood of insolvencies when the courts… get back to anywhere near normal capacity and attempt to clear the backlog of pending cases. This in itself, combined with the end of the furlough scheme and other government support measures, is likely to have a material impact on the UK business failure rate.”
She added: “Unfortunately for the many zombie companies in existence across the UK, a perfect storm is on the horizon. A combination of a grim economic backdrop and very poor trading conditions – particularly in the most vulnerable sectors, such as hospitality – will take its toll. This is expected to feed through to Q1 2021, particularly when the government ends its high-profile corporate life support measures.”
In November, another Reuters bulletin revealed that Swiss liquidators had embarked on a massive hiring drive ahead of a situation similar to that anticipated in the UK. One senior figure at a state-run service in Zürich said that he required the extra staff because without them the expected insolvencies “will be so significant that our system wouldn’t be able to cope”.
As German political concerns grew over the potential effects of further stimulus, the Bank for International Settlements published what amounted to a slice of zombie-company anthropology: Corporate zombies: Anatomy and life cycle.
The study explained that the life cycle of zombie companies is distinguished by a number of key features: “In the years before they become a zombie,” it said, “they experience falling profitability, productivity, employment and investment.
“Initially they stay afloat by raising leverage and increasing equity issuance as well as by increasing asset disposals relative to non-zombie firms. After zombification, their performance remains significantly poorer than that of non-zombie firms.”
It noted: “A zombie firm faces a significantly higher probability of exiting the market through bankruptcy or takeover, by about 10 percentage points cumulatively in the following four years (compared to non-zombie firms).”
Of the total number of zombie firms that have emerged since the mid-1980s, the study pointed out, “About 25% have exited the market so far (died). Around 60% of zombie firms have managed to recover, meaning that they were at some point no longer identified as zombie firms by our criteria.”
However, the recovered firms remain weak and fragile. “Their productivity, profitability, investment and employment growth remain well below those of non-zombies. Reflecting this weak performance, they face a high probability of relapsing into zombie state.”
So, how can this problem be contained?
“Kill them!” I hear you cry – no doubt thanks to years of zombie-movie training.
However, it’s not quite as simple as that.
One organisation that has been keeping close watch on this issue is US think tank the Peterson Institute for International Economics (PIIE).
In October, senior fellow Joseph E Gagnon warned in a blog that when the economy is operating below potential – and the forces that could return it to potential are either absent or weak – the costs of killing zombie firms are “huge”.
Gagnon stressed: “Killing a zombie immediately wipes out the income its workers have to spend on goods and services throughout the economy. This decline in spending drags GDP down by potentially more than 100% of what the zombie firm used to produce via a Keynesian multiplier effect.”
He explained: “Studies show that increases in industry productivity from major trade liberalisations (which led to wholesale entry and exit of firms) are on the order of 10% to 20%. If efficient competitors could take over the entirety of a zombie’s sales, economy-wide income could rise by 10% to 20% of what the zombie used to produce.”
However, he pointed out, “this growth takes time as firms make plans to hire new workers and install the capital they need.”
The practical upshot of all this, he added, is that the potential 100% or more GDP drop-off that would stem from killing a zombie company “is only gradually offset by eventual improvements in productivity, amounting to a small fraction of the lost GDP”.
With all that in mind, to what extent should corporate treasurers fear this apparently imminent zombie apocalypse?
To put the apparent plague into some sort of perspective, The Treasurer spoke to Naresh Aggarwal, associate director, policy and technical, at the Association of Corporate Treasurers (ACT). In his view, the debate around zombie companies has simply amplified a number of fundamental strategic considerations that treasurers should bear in mind as a matter of professional routine.
“We went into 2020 knowing that we were likely to head into some form of global recession,” he says. “All the forecasts pointed to that. And as many commentators have discussed, COVID-19 has merely accelerated the pace of change that was going to happen anyway.”
He explains: “Whether it was leaders at the end of last year preparing to shift into business plans for 2020 and onwards, or others in March and April having to apply to government schemes and then revamp their business plans for the next three or four years, every organisation that was thinking about those points properly would have faced the same question: what do our future prospects look like?”
A prime example of change acceleration, Aggarwal points out, is Amazon versus the high street. “It’s been pretty well documented that some industries are in terminal decline, unless we see some form of government intervention,” he says.
“You only need to look at case studies such as House of Fraser to see that certain firms are meeting quite significant challenges to their business propositions. Unless they reinvent themselves or find a way to retain their customer bases, they will continue to struggle.
“‘Zombie’ is an interesting word that has attracted a kind of zeitgeist around it. But we must remember that, to some extent, what’s happening now is no different to what we’ve seen throughout history.”
Aggarwal notes: “Whenever I speak to journalists about how badly the economy is doing, I’m always at pains to make clear that quite a lot of treasurers I’m in contact with have had really good years. One treasurer I spoke to in the summer has had his highest cash balances ever. And that’s without taking government money.
“Bond issues this year have been at record levels. Equity markets are generally pretty high. Borrowing costs are very, very low. For the right companies, there’s a lot of money out there. As such, it’s really important to understand where, as a business, you sit within the broader value chain.”
For treasurers who may be concerned about whether their firms are entering Zombie Land, it is vital to make an honest, objective assessment of future fitness. Aggarwal notes: “Ask yourself, is there any value in the market that you produce for, or deliver and sell to? Because it may have gone. Or if it hasn’t gone entirely, it may have become so small that chasing it may not be worth your while. Can you make enough money to satisfy shareholders and other stakeholders – both in the short term, and in the medium and long term?”
The same tests apply to any wholly owned subsidiaries that may be part of your corporate group. “If any business in your organisation looks like it may be heading to Zombie Land,” Aggarwal continues, “you must work out whether it is really becoming a zombie or just plodding along. Why are you sustaining it? Is it to prop up a storied brand, to maintain a local presence – or out of pure sentiment?
“Challenge yourself on what the value is of having a drag on earnings, if you have a business that’s either declining or simply not growing. Is it worth carving out and selling off? Or is it better to just close it down?”
How, then, does Aggarwal think the zombie trend will play out over the coming months? “My sense is that we’ll see more zombies arising at a quicker rate,” he says, “and they’ll be bigger – brands that we thought were pretty resilient. But it’s nothing specifically new.
“It calls into question the role of government. Do we need an investment bank to intervene, or a strategic industrial policy? And how do you value the benefits? That’s a particularly interesting question now we’re in the ESG world, where it’s not just shareholder outputs we’re meant to measure, but societal ones, too.”
He explains: “A coal mine is a great example. The valuation process looks really simple: ‘How much does it cost to run? How much do we make from selling the coal? OK, that’s making a loss – let’s close it down.’ But while coal is bad from an ESG perspective, the social impacts of closing a mine are dreadful. Especially in a small community, where it’s hard to find alternative work and opportunities. So, if we’re moving into a world that’s meant to be kinder and fairer, traditional metrics may need to be revisited.”
Matt Packer is a freelance business, finance and leadership journalist