Zombie companies drain shareholder returns after M&A deals

Struggling ‘zombie companies’ might seem like bargains to acquiring firms, but purchasers should look before they leap. According to a study from Kearney, such companies end up heavily detracting from shareholder returns.

Defined by the OECD as companies that can’t cover the interest on their borrowing from operating profit for three years in a row, the number of zombie companies has been growing consistently in recent years. A 2022 study from Kearney found 5% of the global economy was made up of zombie companies. The number of zombie companies was then found to have grown again in the following year, rising to 5.25%.

Now, the latest update from Kearney suggests that the number of zombie companies has actually grown by 8.8% since 2010, to reach 5.8%. According to the researchers, that means at least 2,370 companies are now part of a rapidly-accelerating “invasion”.

Nils Kuhlwein, a partner at Kearney, commented, “Although the very worst of the pandemic aftermath has subsided, another problem is taking a toll on zombie companies: higher interest rates. Zombie companies may have been able to avoid considerable financial pain as a result of cheap borrowing costs, but this is no longer the reality. The problem for many zombies is that they lack deep cash reserves, and the interest they pay on many of their loans is variable —not fixed—making higher rates all the more painful.”

To determine its figures, Kearney analysed 75,000 globally listed enterprises across 154 industries and 152 countries. The data set includes more than 5.5 million individual data points and covers information from 2000 to the present day. And again, the firm cited higher borrowing costs as a driving force for the growing ranks of its zombie horde – as many companies are finding it difficult to stay afloat.

Illustrating this, in 2023 alone, Kearney identified 827 new zombie companies, a significant rise compared to the 534 companies that were “resurrected” by improved financial situations and the 127 that were delisted. This year-on-year increase underscores the severe impact of challenging financing and trading companies on these businesses, which now make up 5.8% of publicly traded companies globally.

So, with the cost of borrowing ham-stringing efforts to become healthy again, how might a company help itself to be among that number of resurrected former-zombie firms? One way is to pursue external investment, or total acquisitions, to help right their course. In the short-term, this might even be worthwhile for the investors – as in the first year of such a deal, the value that zombies create for buyers is more than double the market average – and even outpaces MSCI global equity market performance (an index score which captures large and mid-cap representation across 23 developed markets countries).

Christian Feldmann, partner at Kearney, added on that trend, “Given the harsh reality of the last year’s economic landscape, it’s not surprising that the number of zombie companies continues to rise as escalating borrowing costs posed exacerbated financial strain. It’s not enough for these companies to wait for the markets to change, and it may well be time to consider whether it’s more advantageous to dig themselves out of financial trouble or put themselves on the market.”

However, strategic investors need to be wary of such deals. Zombies’ “deal jewel” assets could be R&D, new products, or in the case of energy or natural resources companies, newly discovered physical assets – but after the initial boost those might provide, they could also prove to be a significant drain on resources. According to Kearney, “the good times don’t last”, and ultimately zombie buyers’ shareholder returns see decline even higher than the market average, to a 14.1% deficit three years after a deal, compared to a 13.2% deficit for all M&As, and an MSCI market performance increase of 7.6% – suggesting zombies might find themselves on the market and without security again in rapid fashion.