According to Banerjee and Hoffman, (2018) a Zombie company is an established company that is being artificially kept alive and unable to service its mounting debts. Their key takeways from their research were:
[Corporate Zombiism appears]:
“ to be linked to reduced financial pressure, reflecting in part the effects of lower interest rates. They are also less productive and crowd out investment in and employment at more productive firms.”
Their paper also asserts that it is important to not only assess past performance, but also future in identifying this type of company. Fast forward 2 years, and the term Zombie company appears to be expanding. The current COVID-19 pandemic, along with government stimuli may be increasing the prevalence of corporate zombies even further.
In an excellent article in The Washington Post, (June 2020) , David Lynch re asserts Banerjee and Hoffman’s definition, but detail the reasons for this – an extended period of cheap credit PLUS government stimuli, that will multiply the numbers of such companies many fold in the coming months.
“The Federal Reserve’s efforts to fight the impact of the coronavirus upon the economy may be inadvertently making it possible for a growing number of companies to remain in this twilight state. And as the walking dead of the corporate world multiply, some analysts worry they are draining the life from the healthy parts of the economy”
The term appears to have been coined following the deep period of stagflation experienced within Japan during the early 1990s, where easing interest rates allowed businesses to gorge on debt financing. Essentially, whilst interest rates are low, and arguably, Governments are pumping stimulus money into businesses, these zombies will continue to survive and continue to consume resources (Capital and labour) that may otherwise be more efficiently used elsewhere.
The alternate of course, is for central policy makers to let these companies go to the wall, with an ensuing short term unemployment issues. Does this ring true though for the times we are currently living in? These times of COVID-19? Arguably no. The aggregated hit to the economy and jobs could be catastrophic in the short term. But what of the path many economies are taking, and in some respects, artificially propping up businesses? What also, about the hit to the innovation and startup sectors. In Australia for instance, many argue that the economy has an over reliance on either bricks and mortar, or digging things up from the ground. Hardly a sustainable economic master plan. Australia needs to also replace its outdated manufacturing capability. In recent years, we have seen many traditional manufacturing jobs lost overseas, particularly to China. Back to the central tenet of this blog, if this is the case, what do you do with zombie startups – remembering that the country needs to innovate to thrive, but that the startup sector is not generally one with significant reserves or consistent profitability … yet! Do governments let these otherwise future profitable companies go to the wall in order to maintain economic efficiency?
So, corporate zombiism, is a fascinating subject and the numbers of which are growing. How would you know if you’re dealing with a zombie company and what could you do if you are?
Here’s a game for you. When you look through your client lists or companies you do business with them, how many do you think are zombies..? What would you look for? An initial clue is set out in the definition above. What levels of debt does the company have in relation to say it’s equity, or even the percentage of debt or debt servicing relative to its revenues? What trends do you see over time for these relative measures? Are they growing? They maybe static too, for instance where debt has risen proportionately to revenue growth.
Other indicators may be in the business’ overall health score. Generally, we’d look for a static or growing health score of greater than 1.8, (get a look at Jazoodle’s business health indicator via our free demo), as the score assesses asset, debt, equity and revenues and measures these over time.
Example of a falling trend of an ASX listed company
It may also be worth also assessing, especially in current times, the level of below the line revenues being recorded. Is there an over reliance on non-recurring Government money? This may also be shown as “Other non recurring revenues” in the income statement. Check the notes for these carefully.
It is also worth assessing the liquidity measures of a company. Assess both basic as well as quick measures along with interest coverage (the ability to cover interest from revenues)
A quick note here. The quick ratio is particularly important to understand the ability of a company to pay its short term obligations through liquid assets only, ie cash or debtors, and ignores inventory which is not so easily quickly liquidated.
When spotting a zombie, we have maintained that there are a number of indicators that a company can use in order to understand the potential inefficiency or indeed future risk of a company they are doing business with. Depending upon your company policies, these may be easily assessed. One thing I would note however, is that even if your company does assess its clients or other partner’s tendency to zombiism, many go wrong in that they may only do this once, at the outset of a relationship. Here’s where we come onto the part of the blog that assesses what can be done further.
Obviously, one critical component is to understand your partner or client’s ability to pay its obligations on an ongoing basis. The amount of time and effort involved will be proportionate to the level of financial exposure your business is willing to tolerate. Having a clear and well communicated set of policies around client or partner financial risk is critical. We also argue that any financial risk checking should be an ongoing exercise. Who’s to say that your new great client doesn’t get into difficulties next month or in our case, September when stimuli are wound back. Thankfully for you, Jazoodle’s platform, will always show you, even day to day, the latest standing of your new client or partner over time.
If via these checks and ongoing monitoring, you spot downward trends in your client’s risk profile, or indeed, your client payment times are starting to extend what can you do?
First and foremost, is have a conversation with them. Understand why this may be the case, and how this may impact your relationship in the future. No one likes having to face up to difficult conversations but this is one you absolutely must have. Can you renegotiate terms? Should you assess and then enact a divorce of your client / partner before it goes too far? Is a separation better now than say in 6 months when things may go awry anyway?
Secondly, it would be recommended to run some tolerances with your client. The Jazoodle platform has a good scenario modelling tool built in for you to assess your client’s tolerances to changes to the market or their business. A simple one would be to reduce revenues by the amount of Government stimulus there currently is, and/or by the downturn in the overall economy. Where does this leave them.. and you?
Thirdly, assess how easy it would be to replace your client with a direct substitute or alternate client? Discussing such an event with your sales organisation may best be done early and initial research and targeting done in this space.
Finally, assess your client contract. Is there a means to terminate early, or change payment terms ? A discussion with your company lawyers or counsel would be highly advisable.
We have discussed what corporate zombie is, the risk of increasing numbers of these, plus how to identify one. There are some great solutions out there, such as Jazoodle’s, which may help mitigate your client / partner financial risk, identify an early or late stage zombie, or assess over time changes and tendency toward zombiism. In these strange times, investing in insights will give your company the edge and stave off potential problems in the future. Isn’t it better to have Instight, rather than hindsight?
Andrew Paton-Smith is the founder and CEO of cloud platform Jazoodle, a platform that give businesses the power to look forward, not back. Https://jazoodle.com