Key Takeaways
- Zombie firms cover interest but not debt principal.
- Rely on borrowing or bailouts to survive.
- Stagnant growth and vulnerable to rate hikes.
What is Zombies?
Zombie companies are businesses that barely generate enough revenue to cover their operating expenses and interest on debt, but lack sufficient cash flow to repay principal or invest in growth. These firms survive through continual borrowing, low interest rates, or external support, often remaining stagnant in a challenging macro environment.
Often called "living dead" companies, zombies pose risks to economic productivity by tying up capital without contributing to expansion or innovation.
Key Characteristics
Zombie companies exhibit distinct financial traits that differentiate them from healthy firms:
- Low Interest Coverage Ratio (ICR): They typically have an interest coverage ratio below 1, meaning operating profits do not cover debt interest.
- High Debt Dependence: Revenues cover interest and operating costs but not principal repayments, requiring loan rollovers or bailouts.
- Stagnant Growth: Lack of funds for research, development, or expansion leads to prolonged negative sales growth.
- Sensitivity to Interest Rates: Rising rates increase debt burdens, pushing many zombies toward insolvency.
How It Works
Zombie companies operate by sustaining just enough cash flow to meet immediate obligations without reducing debt principal or investing in improvements. They often rely on evergreen lending, where creditors extend or roll over loans to avoid recognizing losses.
This process traps zombies in a cycle of financial distress, as they cannot improve their competitiveness or productivity. Understanding their weighted average cost of capital (WACC) is crucial, as increasing borrowing costs can accelerate their decline.
Examples and Use Cases
Zombie firms appear across sectors and economies, often highlighted during periods of economic stress or low interest rates:
- Airlines: Companies like Delta have faced financial pressures but differ from zombies by maintaining growth strategies.
- Post-Financial Crisis Firms: Many U.S. and Japanese firms lingered as zombies during and after recessions, crowding out healthier competitors.
- Startups: Some early-stage ventures become zombies when unable to secure follow-on funding, stalling growth despite initial capital.
- Consumer Impact: Increased labor costs and reduced labor productivity can exacerbate challenges for these companies.
Important Considerations
Investors and policymakers should recognize that zombie companies can distort markets by misallocating resources and suppressing overall economic growth. While some support may be justified to preserve jobs, prolonged backing risks encouraging inefficiency.
Monitoring metrics like debt obligations and adapting to changing interest rates is vital. Consider exploring best low interest credit cards as part of broader financial strategies to manage costs related to debt servicing.
Final Words
Zombie companies persist by barely covering debt costs but lack the means to grow or repay principal, making them highly vulnerable to economic shifts and rising interest rates. Monitor your investments for signs of stagnant growth and high debt reliance to avoid exposure to these financial dead-ends.
Frequently Asked Questions
Zombie companies are financially distressed businesses that generate just enough revenue to cover operating costs and interest payments but cannot repay their debt principal or invest in growth. They survive through continuous borrowing, low interest rates, or external support like government bailouts.
Zombie companies typically have an interest coverage ratio (ICR) below 1, meaning they cannot cover debt interest from operating profits, often for three or more consecutive years. They also show high debt dependence, lack of growth, and negative sales trends over time.
These firms face cash flow constraints that force them to prioritize interest payments over debt reduction or investment. They rely on evergreen lending from banks to roll over loans, which delays restructuring and traps them in a cycle of stagnation.
Rising interest rates increase the cost of debt for zombie companies, worsening their financial strain and pushing many toward insolvency. For example, rate hikes after 2022 contributed to a rise in insolvencies in places like the U.K.
Zombie companies misallocate resources by locking in capital, talent, and market share that could be used by healthier firms. This congestion effect lowers productivity, stifles economic growth, and depresses innovation across markets.
The term was first coined by economist Edward Kane in 1987 to describe struggling U.S. savings and loans institutions. It was later applied to Japanese firms during their 'lost decade' and to companies surviving the post-Great Recession period.
Yes, some startups become zombies when they fail to secure follow-on investment and lack a long-term plan for growth. These early-funded ventures survive on initial capital but remain stagnant and unable to scale.
Zombie companies are more prevalent in advanced economies experiencing prolonged low interest rates or economic shocks. While some regions like Japan and the U.K. have notable examples, recent U.S. data shows fewer zombies than initially feared.
