Steven Holden weighs up the business landscape as firms continue to grapple with the fallout from the global pandemic. Is New Zealand about to witness a new wave of zombie companies?
Zombie companies are those that need bailouts in order to operate; carrying debt that outweighs their value. Debt that in some cases can never be repaid. These companies are propped up by government subsidies and new debt that if removed, would result in serious financial damage and company failure.
“Zombie companies were prevalent in the GFC, when businesses were able to continue trading due to the financial endorsements from lenders. It was this exact approach that led to widespread unsustainable business models that were supported by governments.”
While this term has gained traction over the past three months as the global economy attempts to grapple with the Covid financial crisis, it isn’t a new term. In fact, zombie companies were prevalent in the GFC, when businesses were able to continue trading due to the financial endorsements from lenders. It was this exact approach that led to widespread unsustainable business models that were supported by governments, and one that we are now seeing occur over a decade later. By way of example it is estimated that back in 2005, five percent of companies in the US were so-called zombie companies. This rose after the GFC and the various post-GFC subsidy packages to 16 percent in 2019, and has already risen to 19 percent as at May 2020 with (a lot) more to come.
Global push to support businesses
Governments are currently providing financial support to businesses on an unprecedented scale. According to Bank of America calculations, the amount of total global stimulus, both fiscal and monetary, is now a “staggering” $18.4 trillion in 2020 consisting of $10.4 trillion in fiscal stimulus and $7.9 trillion in monetary stimulus – for a grand total of 20.8 percent of global GDP, injected mostly in just the past three months.
In New Zealand, assistance upwards of $25 billion ($7.1bn Fiscal plus $18bn Monetary) has been paid out, amounting to 12.3 percent of GDP, roughly half of the US and global percentage, including the provision of a 12+8 week lump-sum wage support paid to affected employers.
And we are seeing the same approach happen around the world as governments look to ensure the survival of economies on the brink. While in the UK, more than a quarter of workers are now furloughed, Australia has seen a number of schemes with measures totalling $213.6 billion from the Commonwealth, $11.8 billion from the states and $105 billion in RBA-government lending – with federal, state and local governments now employing more than 72 percent of the nation’s 13.2 million-strong labour force.
This government support was vital in order to bring some form of recovery from this widespread and hard-hitting pandemic. Yet unfortunately, it means many companies are not yet to see the aftermath of Covid-19.
And while it may seem like an easier option to revert back to financial performance pre-Covid-19 to justify a prosperous future and as a rationale for further forbearance, this approach won’t help them survive as debt mounts up. In fact, over the coming months, we will see governments start to pull back financial support, and this will reveal the large scale damage that is set to prevail.
Critical long-term decisions
Companies currently receiving aid by governments and adopting a short-term focus, can find themselves making seriously detrimental long-term decisions in a bid to ‘make it through’ the coming months.
Reducing capital expenditure
As companies focus on the short-term, they put long-term investments on hold. For example, a manufacturing company that was planning on purchasing a modern piece of machinery to improve efficiencies, margins and guarantee a profit in the long-term may be retracted.
Tourism, on the other hand, would be deferring capital expenditure and investments into refurbishments of sites and upgrading of facilities. That important investment into refurbishing hotel facilities every few years may be delayed. While pushing back the upgrade of beds, painting of walls and replacement of lobby furniture will save significant cash over the short term, over the medium to long term it will damage the customer experience and brand value, resulting in a far less valuable business.
Restructuring is completed slowly
Company costs can be very rigid. Businesses can be locked into long term leases on premises, employment contracts can have redundancy provisions, and supplier agreements can have pricing that is linked to minimum volumes.
If the company has formed the view that demand will be reduced for a long period of time, then changing the cost structure is critical to ensure profitability. However, lease termination costs, supplier re-negotiation and employee redundancies all cost money to implement.
For those that are managing cashflow, they will likely look for ways to avoid hefty one-off implementation costs associated with the above changes. Consequently, changes are made in a piecemeal fashion.
Eroding employee confidence
New Zealand’s wage subsidy, for businesses significantly affected by coronavirus, has enabled New Zealand companies to put off restructures while they figure out the delayed, long-term financial impacts of Covid-19. This has led to drawn-out restructuring processes, which has a significantly negative impact on employee wellbeing, with continuous change adding to the uncertainty of their role and future.
Sadly, larger restructures are set to come to the forefront as government support programmes start to unwind and boards form a new, realistic view of what the sustainable level of demand for their goods and services will be.
We will also likely see a lot more ‘Deed of Company Arrangements’ for insolvent companies, and ‘Schemes of Arrangements’ for solvent companies that will be used to share the financial burden among stakeholders.
Forbearance and zombie companies
For the businesses that have been given leniency by the banks, debt reduction will occur through a combination of operational performance improvements and equity raises. As we witnessed post the GFC, the wave of equity raises to repair balance sheets took 18 months.
Whilst forbearance will be in line with the friendly bank image the Big Four have tried so desperately to foster, it may end up amplifying the problem facing New Zealand, with company performance continuing to erode and causing negative impacts to the broader economy.
In fact, for companies where operational improvement or future equity raises are not realistic, providing forbearance will simply create a wave of zombie companies that eventually become insolvent once support is withdrawn. The financial impact of this will be severe.
In order to ensure that New Zealand can gain future business and economic stability, New Zealand lenders should learn the lessons of how Europe managed and mismanaged the GFC. By taking such lessons on board and making brave decisions today, businesses will be dealt with fairly and efficiently as we navigate our way out of Covid-19.
Steven Holden (pictured), is director of Neu Capital New Zealand, a tech-enabled corporate finance firm, specialising in private institutional debt and equity transactions from $20m to $200m.
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