The number of “zombie” companies has sharply increased with one in five U.S. firms are now zombies. This is primarily due to the Covid-19 pandemic.
What are “zombies”?
Firms whose debt servicing costs are higher than their revenue/profits but are kept alive by relentless borrowing. Zombies provide 2.2 million jobs in the U.S. As long as the Fed (or other central banks) keeps rates low for a long time, unproductive firms remain alive. But ultimately it lowers long-run growth rate of the economy.
If a V-shaped recovery is nebulous, and a prolonged U-shaped recovery is more likely then moribund companies scarred by the pandemic will keep borrowing. Is the Fed and the Government interfering in the process of creative destruction? Some think so!
If the pace of the recovery is quick enough, corporate-bond buyers say plenty of hard-hit companies should be able to turn things around. But the question on the minds of investors and economists alike is: how long will the Fed be willing to support firms via its pledge to buy corporate debt if the recovery is slower to develop than expected?
“The government has done more than I could have imagined to allow businesses to access capital, and if the markets shut down again the government will do even more,” said Bill Zox, chief investment officer of fixed income at Diamond Hill Capital Management, which manages around $19.5 billion.
Cruise lines have borrowed more than $8 billion via the bond market in recent weeks, selling notes secured by everything from ships to islands. Airlines, for their part, have gotten more than $14 billion in new financing from banks and investors while the vast majority of flights remain grounded.
“We have entire industries that are going to be protracted long-term if not permanently disrupted because of this,” said Vicki Bryan, a veteran credit analyst who runs Bond Angle LLC. “The cruise industry is ripe for elimination of companies. It should logically renounce the weaker players but that’s not happening because we have dirt-cheap money that we’re willing to throw back into the market from the Fed.”
Beyond just lending them money, creditors are also waiving or loosening financial markers on existing debt, allowing companies that have seen revenue dry up stave off potential tumult.
Vail Resorts Inc., owner of the eponymous winter vacation destination, was granted a two-year reprieve on key debt covenants last month, paving the way for the company to raise $600 million with a new bond offering. Marriott, one of the world’s largest hotel chains, struck a similar agreement with lenders.
A representative for Vail said that the company’s bank covenant waiver provided additional flexibility given the short-term dislocation from Covid-19, and that it remains confident in the long-term outlook for both profit and cash flow.
Yet amid the waivers, lenders are extracting higher interest rates or other concessions. Norwegian Cruise Line Holdings Ltd., AMC Entertainment Holdings Inc. and Avis all paid double-digit yields to borrow in recent weeks. That could depress their capacity to make capital expenditures and adapt to shifting consumer tastes as the coronavirus changes how people spend money.
“Taken together with margin contraction and leverage that was already near record highs, you may end up with a corporate sector that has less capacity to invest in growth,” said Noel Hebert, director of credit research at Bloomberg Intelligence.
Some say as successful as the Fed has been boosting credit-market liquidity, the support is only temporary, and will result in a wave of distress when it steps back.
“There will be plenty” of debt defaults and bankruptcies when corporate borrowers start running out of cash in the months ahead, Howard Marks, co-chairman of Oaktree Capital Group, said in a Bloomberg interview. “There are large, highly levered companies and investment vehicles that the government and Fed rescue program is not likely to reach and take care of.”
Others see central-bank intervention keeping companies alive for much longer, crowding out investment and employment at healthy firms, similar to what occurred in Japan during the nation’s ‘lost decade’ of the 1990s, where the ‘zombie company’ term was first applied.
The repercussions may only become apparent years from now, according to Marc Zenner, a former co-head of corporate finance advisory at JPMorgan Chase & Co.
Will this cause another crisis? Or, will economies move like Japan in its decade of stagnation?
1. America’s Zombie Companies Are Multiplying and Fueling New Risks, Lisa Lee and Michael F David, May 19, 2020 (www.bloomberg.com)
2. Highly Indebted “Zombie” Companies Control More Than 2 Million U.S. Jobs, Jeff Cox, May 20, 2020 (www.cnbc.com)
3. “Zombie” Companies May Soon Represent 20% of U.S. Firms, Dion Rabouin, June 15, 2020 (www.axios.com)