The walking debt: 'zombie companies' unable to meet borrowing costs rise 10% in 2022, finds new Kearney report

- 'Zombie companies' that cannot cover interest with current operating profit now account for almost 5% of all companies across the globe

- Global debt carried by these companies equals nearly $400 billion finds report

- Real estate sector again poses 'considerable risk to global economy'

LONDON,Oct. 26,2022 -- Leading global consultancy partnership Kearney has today released new data showing that a rapidly increasing number of businesses have become 'zombie companies',namely firms that have been unable to cover interest costs on their borrowing for the past three years,based on their current operating profit. These so-called 'zombie companies' are at imminent risk of insolvency as interest rates rise around the world,and now account for 4.7% of all listed companies globally.

The Kearney study has drawn on approximately 4.5 million data records from around 70,000 listed companies from 154 industries and 152 countries. It finds that the number of zombie businesses has risen by 10% since 2021,to almost 2,000,and could increase further as interest rates continue to rise.

Across the globe,the share of zombie companies averages between 4% and 6%,but with significant differences in growth rates. While North America saw the share of zombie firms rise from 3.5% to 5.7% between 2010 and 2021,Europe saw a much larger increase from 1.2% to 5.5%.

Stress tests undertaken as part of Kearney's study show that the proportion of 'zombie companies' is set to rise higher. Barring any changes to the economic environment,the number of zombies would rise by 17% if 2021 average net-interest rates (currently 1.5%) rose by 1.5x in 2022,or increase by 38%,if these interest rates doubled.

Worldwide,these firms already account for $108 billion in inefficiently deployed equity and together carry a total debt of nearly $400 billion. Globally,most zombie companies are found in the midmarket,although this is likely to represent only the tip of the iceberg: a larger number of midmarket companies are not listed on the stock exchange and are therefore not included in these figures,but could also fit the definition of a 'zombie company'.

Of all the industries studied,the real estate sector has the highest percentage of zombie firms globally,with real estate developers (9%) and diversified real estate companies (11%) particularly affected. If interest rates continue to rise relative to 2021,up to 15% of companies in the real estate sector will be zombified—that's one in seven listed companies in this sector. This means that,as in the years before the financial crash of 2008/9,the real estate sector once again poses a considerable risk to the global economy.

Nils Kuhlwein von Rathenow,Partner at Kearney,comments:

"Over the past year,it's become clear that rising energy and raw material costs,strained supply chains and staff shortages are weighing on companies' revenues,with financing problems compounding the problem for many.

"However,only a few firms with unsustainable business models actually exit the markets due to insolvency,and every year more and more become 'zombie' businesses,in part thanks to easy access to capital. But as interest rates rise,this will become even more unsustainable,potentially increasing the number of zombie entities by nearly 40% again."

Christian Feldmann,Partner at Kearney,adds:

"A particularly worrying finding from our analysis is that one in seven listed companies in the global real estate sector is at risk of being classified as a zombie company,ominously mirroring the years before the financial crisis of 2008/2009.

"As a whole,we're seeing around $500 billion misallocated by these zombie businesses,leaving them at significant risk of default. Against this backdrop,both institutional and private investors,legislators and capital market regulators are challenged by efficiently allocating capital in a timely manner,avoiding the risk of zombie firms,and equipping insolvency laws to ensure that 'sick' companies exit the market in a timely manner. The figures are clear,we need action now."

Notes to Editors

Methodology

For the purpose of Kearney's analysis,Kearney experts examined around 4.5 million records of some 70,000 listed companies from 154 industries and 152 countries. As such,analysis covers all listed companies worldwide in the period since the turn of the millennium.

Kearney based its analysis on the OECD's definition of a zombie company:

The company has been on the market for more than 10 years.

It has been unable to cover its interest burden from its operating result over three consecutive years.

In concrete terms,we have implemented these criteria as follows:

We only analyzed stock-listed companies for data availability reasons

Revenues have been greater than zero for 10 years in a row.

The interest coverage ratio EBITDA/net interest payments have been <1 for three years in succession.

Applying these criteria,Kearney determined for each of the approximately 70,000 companies examined whether it matched the definition of a zombie company in a given year. So,while zombie companies can be resurrected,they can also suffer a relapse and return to zombie status again. Furthermore,Kearney determined how each individual zombie company has evolved over time. The following scenarios are possible for a zombie company that is exiting zombie status:

Insolvency/liquidation: a zombie company ceases operations and is wound up. No further distinction was made as to how and why operations were shut down.

Acquisition: a zombie company,while in zombie status,is bought by another company and either continues to exist as a subsidiary of the parent company or is fully integrated.

Resurrection: a zombie company recovers and continues to operate in the marketplace as an independent business without interest charges exceeding its operating profits.

Furthermore,Kearney analyzed for 2021 how the stress of an increased interest rate would impact the number of zombies. For this purpose,Kearney assumed interest rate stress factors of 1.5 (stress scenario 1) and 2 (stress scenario 2),respectively—that is,the interest rate is one and a half times or double the rate it was in 2021.

About Kearney

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www.kearney.com

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