‘Zombie’ companies on the rise

Ever since the ‘80s, a small number (4 per cent) of publicly listed companies began being classified as ‘zombies’. The core criteria are that (1) such companies are unable to pay the interest expenses with their operating income. Additional criteria are the following:

(2) The gap between their return on equity and their cost of equity, is lower than 4 per cent,

(3) Their yearly sales growth is below 3 per cent,

(4) Their three-year average sales growth is below 3 per cent, and

(5) Their ‘Altman Z-Score’ — that measures liquidity, solvency as well as profitability and is also used to predict bankruptcy filings — is below 1.8.

The ‘90s ‘resuscitated’ the definition of zombie companies with the Japanese crisis, and such a word started being associated more broadly with the idea of bail-out by government or financial institutions for companies that had slim chances of survival.

COVID-19 has brought once again the horror movie definition to the highlights of the media worldwide. Just before the pandemic it was estimated that 400 out of the top 3,000 large companies listed in the US stock market were zombies.

As of now, according to Bloomberg, the number grew by 50 per cent, bringing the total to 600 companies that are unable to pay the interest expenses with their operating income.

The zombies in the US stock exchange have now accumulated a total of $1.36 trillion in debt: an increment of almost 280 per cent since before the pandemic.

Groups linked to travel and tourism are some of the most recent additions to the group of zombies. Some of the most recognisable names are established vast companies such as Marriott International (hotels) and Carnival (cruises).

But only focusing on criteria number 1 does not provide a full projection of the situation. For instance, Amazon and Salesforce fall under such a category, despite the fact that they both generate significant revenues and they habitually reinvest in future growth.

Streaming service Roku and online furniture retailer Wayfair ended up in the infamous list, but probably due to their increased amount of investment. Both of them are in fact generating larger revenue during the pandemic, given that more people stay at home, therefore more susceptible to engage with entertainment services and home improvement products.

A different story applies to cinema theatre operators such as AMC Entertainment Holdings, with revenues significantly reduced.

Car maker Tesla is also considered a zombie company given the gigantic amount of funding received. Similarly ride hailing service Uber, which has been exposed to debt ever since its inception.

An interesting example is biotech Moderna, which has been attracting more and more investments with a potential growth and generous revenues ahead.

In the toys and games industry, Mattel and Hasbro, both zombies of category 1, have engaged in a price war to the lowest point, with the goal of “snatching” clients from the competitor.

Such a “zombie” exit strategy however, is not readily available for highly regulated industry, the medical sector for instance.

Hospital operator Community Health System, which barely failed to satisfy criteria number 3, by growing revenues by 2.9 per cent (where the criteria impose 3 per cent minimum growth) has opted for a divestment strategy instead.

So zombie companies might be the new buzz definition, but not necessarily spells calamity, provided that not all definition criteria are satisfied. [The writer is a member of the International Press Association]

STEFANO VIRGILLI

stefano@virgilli.com