There are numerous definitions of what qualifies as a zombie company, but generally speaking, “zombie company” is a name for companies that should go belly up but are allowed to continue. Typically, these companies have so much debt that any cash generated is being used to pay interest on the debt, with no spare cash to reduce debt or invest in future growth.
One could reasonably wonder why this sort of financial condition persists. While there are numerous contributing factors, perhaps one of the more important is a reluctance on the part of lenders to accept reality and write off low quality debt. In addition, unusually low interest rates make it easier for impaired companies to continue to meet interest obligations. But perhaps the most important reason is government support for questionable lending policies in an effort to avoid job losses.
Supporting existing jobs is probably, at best, a short-term policy. Continuing to supply capital to zombie companies reduces investment in potentially more product companies, to the detriment of overall economic growth and increases in employment.
Investors should be very careful in making portfolio decisions in that, even though zombie companies may appear cheap, their long-term prospects are such that investment returns are likely to be lower than from more expensive looking opportunities with higher growth potential.
All comments and suggestions are welcome.
Walter J. Kirchberger, CFA®