Zombies – they may remind you of the slow walking mindless undead of many a horror film but the term is increasingly cropping up in relation to thousands of companies. Paul Wood discusses why this is.
The zombie walk
The origins of the credit crunch are well documented. In the subsequent recession, as well as struggling with difficult market conditions, businesses in the UK find it difficult to obtain credit from traditional lending sources and many have therefore looked to survive by other means. This often involves taking extended credit from suppliers, entering into time-to-pay agreements with HMRC and/or freezing or reducing payments of capital to banks and other lenders.
Some businesses have accrued so much debt that they have little prospect of ever being able to repay it. The directors of these businesses continue working each day with no end to the misery in sight as the recession continues to bite and the infection continues to spread. It is not difficult to see how the zombie term came about.
Spreading the zombie infection
Suppliers, reluctant to lose what may be a key customer, succumb to the will of zombie companies and become increasingly exposed to them so that eventually they cannot afford for their zombie clients to fail. This cascades down the supplier chain, with each debtor in turn deferring payments and causing many more companies to become infected with the burden of the original zombie company's debt.
Secured lenders have also been supporting these zombie companies, so that they often cannot afford to enforce their security when the zombie company is unable to pay. As the value of the assets of these companies withers away and decomposes, secured creditors are realising that the zombie companies have little or no inherent value and that there is significant risk of default and loss. While we expect that lenders have appropriately impaired these loans in their own accounts, achieving an acceptable exit is often far from easy.
Zombie death
Recent research by R3 suggests that this infection has spread to around 146,000 companies and that 8% of businesses admit to only being able to service the interest (not the principal) on their debts. Given their debts, the loss of a significant customer, the failure of a key supplier or even a modest increase in interest rates would tip many of these businesses over the edge.
The whole UK economy now risks many years of depression as these businesses continue to infect corporates and financial institutions in the UK and abroad.
The only option left for many of these creditor companies is to cut off the life blood of these zombie companies – namely the extended credit. As in all previous recessions, a proportion of these businesses need to fail to allow healthy businesses the space to grow and pull the economy out of the doldrums. This recession is no different. These zombie companies are tying up capital and resource that could be put to better use elsewhere in the economy. The fact that the infection has spread so virulently will make any correction drastic in its effect; many businesses will go insolvent with the loss of thousands of jobs.
However, strong healthy businesses will be left, with directors that have taken appropriate steps to secure the long-term viability of their companies. This is an extreme measure, which may be a politically and socially difficult pill to swallow, but it is the only way the UK economy can return to strong, sustained growth.
The big question is what will be the catalyst for this to start?
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