Although I have never managed to get through watching one in its entirety, I guess most of us are familiar with the main plotlines behind the typical zombie movie if there is such a thing. The world is taken over by the 'living dead' who appear to in some ways be living but in other ways just going through the motions of being alive. They are automaton and scary, usually with some horrible intentions towards those who are really alive. Not being a fan of the concept myself, I was nevertheless attracted to an article I read this week about the so-called 'zombie economy'. Although it was written with the EU zone specifically in mind, it struck me as being very universally applicable at the current time.
First of all I should start by explaining what a zombie economy is. In many ways the analogy that a zombie is something which appears to be alive but it really isn't is as appropriate to some companies as it is to monsters in horror movies. As a result of the horrific economic fallout that has emanated from the pandemic many companies have received extraordinary assistance in an attempt to keep them alive for a hopefully better future. Effectively they have been put on a life support machine in the hope that they will manage to get through the current crisis and return to healthier days. It is a perfectly sensible strategy - some would argue the only sensible strategy - but it is an approach which is not without significant problems and challenges for the future.
The pandemic has had a huge impact on the balance sheets of many companies. Even those who have benefited from significant government assistance also in many cases will have seriously depleted their cash reserves in an effort to survive. That is the first and immediate hit to the strength or otherwise of their balance sheets but there is another one to take into account in addition to this most obvious factor. This is the fact that many government assistance schemes in many different countries have come in the form of loans rather than grants. Even in a time of low interest rates those loans come with significant costs attached. These have two dimensions. Firstly there is the cost of servicing the loans. This means interest payments on a regular basis. Whilst some government schemes do not require immediate repayment of interest there are few which are totally interest free. In the long run servicing charges will need to be paid and these will be the first hit against the profits of many companies in the future. Although the interest rates themselves are low, if the amount borrowed is high the cost could still be significant. This will limit the ability of the companies involved to spend money on other things and that could have a significant negative operational impact. It's what soccer fans might call the 'Glazer effect', the Glazers being the owners who purchased Manchester United Football Club some 15 years or so ago in a deal that was heavily based on debt financing. The problem with this was that once the interest on these loans had been repaid, Manchester United had limited amounts available to spend on their team as a result. Many would argue this had a significant long term negative impact on the way that the team performed on the pitch. It worked very well for the Glazers – who according to the Forbes List of 2016 were worth $4.6 billion – but not so well for the organisation whose operational performance deteriorated as a result.
Then there is paying back the capital element of the loans in the future. One thing is for sure, accessibility to loans at the moment is almost certain to be easier than it will be in the future given the uniqueness of current times. Therefore refinancing at some future point by merely taking out a new loan to replace the one which is ending may not be an option, and even if it was the interest rates are likely to be higher. Therefore in many cases a loan will need to be repaid and this again will impact on cash reserves. The knock-on effect of this will be that there is less money available for investment purposes and this in turn will have a wider economic impact which will hit the economy as a whole and not just individual companies in isolation. There is one other danger to take into account. For some of the businesses which have been kept alive by emergency assistance there may be no viable long-term future. It is increasingly important going forward that only those companies which can survive in the medium to longer term are kept alive. Hard as it is others will have to be let go. Even for those which are viable, major steps such as converting loans to government equity stakes may be necessary. It is a terrible predicament for governments who are understandably and rightly nervous of creating mass unemployment but the zombie economy is a problem that is not going to go away.
Wayne Bartlett is an author for accountingcpd. To see his courses, click here.