What is Zombie Company?
A Zombie Company is a corporate entity that has very limited cash flows, only sufficient enough to pay the interest on the debt borrowed but does not the principal amount of the loan. This is because revenue generated by the business operations only covers the fixed routine & operating costs and thus a Zombie Company is dependent on the bank for its bailout.
Explanation
- Zombie means someone who is unconscious but is controlled by someone else. A zombie is a dead person who is brought back into life but who is not able to speak or move easily.
- Similar terms have been crafted for a zombie company, and thus, it can be said to be living dead.
- It always needs a bailout, and it depends on banks for its survival. Thus, the debt liability will not get reduced with time as the company is paying only the interest component. However, one should note that if the floating interest rate increases, the funds will be short of paying the routine fixed costs.
History
- In the 1990s, when the Japanese asset price bubble collapsed, the period was said to be a “lost decade.” In the said period, Japanese banks continued supporting the weaker or loss-making firms at the time of need. It was the first time when the term “Zombie Company” was used.
- Again in 2008, when the United States’ Troubled Asset Relief Program was starting to provide support to the weaker section of the corporates, the concept started reviving again.
- Even from 2008 to the latest 2018, the non-corporate debt of China has increased four times. The Chinese government had bailed out many zombie companies, as a result of which overcapacity has been increased in many sectors.
Example
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For eg:
Source: Zombie Company (wallstreetmojo.com)
Explanation
- As you can see, the Calendar year 2017 was the last year in which the organization had enough demand to meet all its expenses, including interest & was still left with enough surplus before tax.
- After the economic slow down (say 2018), the demand reduced & the company strives hard to survive since the fixed routine expenses cannot be reduced below a certain level. As you can see, the EBITEBITEarnings before interest and tax (EBIT) refers to the company's operating profit that is acquired after deducting all the expenses except the interest and tax expenses from the revenue. It denotes the organization's profit from business operations while excluding all taxes and costs of capital.read more is barely sufficient to pay off the interest component.
- Thus, they need support from banks for lowering the interest rate to survive for the near long term. This way, the commercial banksCommercial BanksA commercial bank refers to a financial institution that provides various financial solutions to the individual customers or small business clients. It facilitates bank deposits, locker service, loans, checking accounts, and different financial products like savings accounts, bank overdrafts, and certificates of deposits.read more are required to provide credit to such companies.
How Does Zombie Company get Fresh Funding?
Since Zombie Companies are already debt-ridden & have a lower credit history, it is difficult for such companies to raise new funding.
However, if the company has enough production capacity to raise its revenue, some banks/organization may give fresh funding by the following means:
- The company may raise finance for each sale invoice they raise. This gives confidence in business operations to the banks.
- Another way is to take finance from the companies which are non-zombie in the same sector (for example, raw material supplier company, distributor company, etc.). Well, this is difficult, yet if business relations among the peer companies, it can happen.
- The zombie can raise finance by giving directors’ guarantee certificate. As the company is an artificial company, banks often have confidence over the management skills of the director of the said company.
- Existing assets may be used for refinancing byway of top loans.
Effects on the Economy
No country wishes to have zombie companies in their economic environment because of their overall lower productivity. This entails the lower growth of the country. They also restrict the growth of the most useful resources. They also acquire a figure out of total market shareMarket ShareMarket share determines the company's contribution in percentage to the total revenue generated within an industry or market in a certain period. It depicts the company's market position when compared to that of its competitors.read more, and thus, such companies are often called “Uncompetitive Survivors.” Their existence is of no importance to the government of the land.
However, they are also providers of jobs to a large number of people, and this is the only reason why the government has to bail out such companies. Even if they weaken the economic growth, for a few years, at least, the government has to bail out such companies.
Since productivity is at a lower level, it also pinches the government with lower tax revenues.
Conclusions
In the time of COVID19, it may happen that many companies come to the situation of being a zombie company. So as to bring the economic stability of the country, the supply chain should stay intact. At these crucial times, the support of the government is very important for the corporate entities (since these entities are employment providers and tax generators for the country). If the residents of the country start using domestic goods and/services, it will help the zombie companies to refurbish themselves.
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