This is an audio transcript of the Unhedged podcast episode: ‘The zombie companies

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Ethan Wu
Zombie companies — these are companies without functional business models that limber on and walk the streets of corporate America, kept alive by a supernatural drip feed of cheap capital. But now that the Federal Reserve has called time on such cheap capital and interest rates are 5 per cent and there’s not money everywhere, people are wondering if all these zombies are gonna make it to the other side. This is Unhedged, the markets and finance show for the Financial Times and Pushkin. I am reporter Ethan Wu here in the New York studio, joined by Katie Martin in London, back from the dead at last.

Katie Martin
Yes, I had a small detour to eat some brains of my own. No, I was slightly zombie-like. I managed to get Covid for a fifth time, which, I mean, it’s not quite a record, but I feel like it’s a solid, solid performance. But it wiped me out so I was out of action for a little bit.

Ethan Wu
Katie, you’ve had the most Covid cases of literally anybody I know in my work or personal life. It’s incredible. I bring you up all the time for that reason.

Katie Martin
It’s not like I’m going around like licking door handles or something. I don’t know why I keep getting it, but it likes me.

Ethan Wu
Well, Katie, we are glad you are feeling better. And, you know, today we wanna talk about, you know, not health-related zombies, but corporate zombies — companies that have business models that, you know, may not work in a world where interest rates are high and money is more expensive. And, you know, I think the big flashy example that’s gotten a decent amount of attention recently is WeWork, right — this slightly ridiculous real estate company founded by Adam Neumann that was going to solve like every problem under the sun. It went bust this month. And I think it’s created some predictions that it’s sort of the first of many of companies birthed in the cheap money era that simply is just not gonna survive.

Katie Martin
Yeah. What if this kind of laughably-run real estate company effectively, this office space company littered with every excess of the cheap money era, what if this is the, you know, a sign of things to come? The answer is kind of yes and no. I mean, WeWork was just a badly run company. It always had been. And sure, it wouldn’t have got off the ground if it hadn’t been for cheap backing from venture capital companies and from just cheap money in the debt markets. But there is definitely a big concern out there that although WeWork might be the biggest, shiniest, arguably most ridiculous example of stuff that happened in the easy money era, there are lots of other companies out there that have also loaded up on cheap debt.

And now a couple of bad things are happening. First of all, if you are a company that’s like, not the safest company in the world, you got a bit of a risky profile. You’ve probably borrowed on a floating-rate basis, which means that your interest payments go up and down in line with the benchmark interest rate. I say up and down. That’s up and up and up and up and up and up and up. And so, you know, monthly repayments for a lot of these, you know, particularly smaller companies are getting really onerous at this point. And there’s a lot of companies that are kind of struggling to keep on top of their debts. And the more pessimistic people out there in markets say, see, this is the reckoning. It’s coming. There’s a lot of corporate America and corporate Europe, for that matter, that is gonna hit a wall where it simply cannot keep affording to make these interest payments. And the other bit is refinancing, it’s taking on new debts — a significantly more expensive undertaking than it was when Covid hit.

Ethan Wu
Absolutely. And it’s definitely broader than just WeWork, right? If you look at the Russell 3000, which is like a big, broad index of US companies — big, small, medium-sized — nearly a quarter of them cannot cover their interest expenses month to month with cash flow with the money that they’re getting from their operations. That’s a scary number. There’s a lot that don’t turn a profit and interest expenses, like you said, Katie, have not been going up and down. They’ve been going up. But to understand numbers like that, to understand this discussion of zombies, we’ve got to take it back to Covid, to the pandemic, when governments basically just said there will not be defaults, there will not be a credit cycle. We have turned it off.

Katie Martin
Yes, it was absolutely like suspended animation. So Covid hit, markets went gaga. Companies suddenly have no money coming through the door. And so central banks and governments said, well, we can’t have simply every company in our country going bust, you know, overnight. We have to keep the system alive. So they pumped money into these companies. And the thing is that it may surprise you to hear that was nearly four years ago.

Ethan Wu
What? Stop it.

Katie Martin
No, seriously, Ethan Wu, our life is flashing before our eyes. You know, it’s nearly four years since that massive injection of, like, super-low interest rates. And so a lot of the companies that took out these loans to stay alive in 2020 are now at the point where that debt is starting to expire. They need to pay back the chunk of money that they borrowed. And so normally what you do is say, well, I’m gonna go back to the bond market or I’m gonna go back to the loan market or whatever it is, and I’m gonna say, can I borrow some more money, please? And the market’s gonna say, no, no, sure. But you know how in 2020 we gave you this money for basically nothing, like a 2 per cent interest rate, whatever. It’s gonna cost you 6, 7, 8, 9 per cent now. And there’s a lot of companies that are just not gonna be able to make the maths work and just aren’t gonna be able to roll over this debt. So the worry is, do we have this zombie army that’s about to, you know, come out of retirement and start just wandering around, eating everybody else’s brains and making life difficult for the whole of corporate America?

Ethan Wu
And you’re seeing more companies — again, more than just WeWork — struggling with this higher-rate environment. You had a recent column, Katie, where you noted, you know, bankruptcies are climbing, defaults are climbing; like, there’s stress building in the system for sure.

Katie Martin
Yeah, yeah. There were 118 debt defaults in September, according to S&P, which are one of the rating agencies. A lot of these were distressed exchanges where companies go to . . . 

Ethan Wu
What is that?

Katie Martin
So they go to their creditors, they go to the people that have lent them money in the debt markets and say, right, we wanna buy back out debt at these incredibly depressed prices that are out there. But also, we’re going to effectively give you money back on disadvantageous terms for you, the lender. So you get screwed in some way by this transaction. So it’s a sign of distress from companies that they have to go down this route. Or even, some companies are going down the route of saying, OK, we’ve got like four bonds outstanding. What we’re gonna do is we’re gonna keep current on three of them, but one of them we’re going to default on. So it’s a selective default.

So companies are saying, we know this is bad, but we simply cannot afford to stay current on all of our debt. So we’re going to choose to default on this one bond. The problem is that is what rating agencies describe as a slippery slope. So it tends to indicate that there are more defaults that are coming ahead. So what we’re already seeing is more defaults. We’re seeing defaults that are not just companies kind of going bust entirely and failing to pay back all of their debt. We’re seeing them kind of try and make ends meet and kind of buy a little bit more time with things like distressed exchanges or things like selective defaults.

You know, there is definitely stress that’s out there in the corporate sector. The big question for investors is, is this something that is just like, nature is healing? This is how markets are supposed to work, companies are supposed to go bust. Or does this mean that this is like this horrible little drumbeat like we saw with the subprime crisis back in kind of 2006, 2007, where it’s kind of some sort of awful warning about something terrible that’s coming down the line? That is the question. I tend to be on the optimistic side of the scale here. I don’t know about you, but it’s definitely something that’s playing on investors’ minds.

Ethan Wu
That’s exactly the right question, right? Is it normalisation from a period of, like, extreme monetary and fiscal intervention to stave off a crisis, or is it something maybe a little bit more systemic, something that would shake the financial system, something where you could see cascading defaults, not just, you know, defaults here and there popping up. Companies default all the time. It’s not necessarily a catastrophe that they do, at least for either the broader economy or, you know, broader corporate America.

I think one place that some people are concerned about in terms of systemic risks is private equity. And you note this in your column, Katie, these distressed exchanges, which have made up a good chunk of corporate stress recently, have been in companies that are owned by these private equity shops, right? And these companies tend to be a little bit weaker. They’ve got kind of crappier balance sheets. A lot of them are gonna have floating-rate debt like you mentioned. And just in general, they’re going to be, you know, fixer-uppers. They’re not gonna be, you know, the big, blue-chip S&P 500 companies, right? And I think there are fears that private markets, which we don’t have a lot of transparency into, we don’t know exactly what the interlinkages are between different parts of the private markets world. They’re holding the bag on some of these crappier companies that are really gonna suffer under a 5 per cent interest rate world. And that’s where I think some of the systemic fears are coming from, too.

Katie Martin
Yeah, there are channels whereby this could become systemic, right? There are certain channels whereby this can hurt, right? If you own bonds that default then sucks to be you. This is the game. You know, you either got unlucky or you should’ve done your homework better. But it can start trickling through the system a little bit more kind of effectively, if you like, when it does all end up living in certain private equity portfolios that go wrong. And you know, there’s a lot of investors that didn’t really necessarily love private equity, but they got involved in private equity when yields were really low and this was a good way to try and find returns. And now they’re finding that these private equity portfolios are stuffed full of companies that are struggling to pay back their debts. Hmm. It doesn’t look like we’ve got very good visibility yet on how serious that is going to get. So one of the things that fund managers say to me all the time is watch private equity, watch the riskier ends of the credit markets, because if there is going to be a big stress event that comes from these higher interest rates and the impact of that that we’re seeing, that’s where it’s gonna come from.

Ethan Wu
Yeah. Let’s take stock and calibrate our anxiety here, Katie, because I think you’re absolutely right that stress is going up. It’s not going to slow down, probably. Like, we should expect at least several more months or maybe a year of, you know, climbing default rates, increasing bankruptcies. And then the other bit of it is that if you look at some of the true zombies, right, like companies that have no profits, that are struggling to pay their interest expenses, their shares are tumbling. There’s a huge profusion of those companies in one particular sector, and that’s biotech, right? And these are kind of weird. It’s not what we think of when we think of a company like, you know, some insurance company in some city or some factory or whatever. These are in some ways like speculative bets on like a research project. And I think those can probably go bust without wider implications, right? These are companies equity investors have bet on to have success like clinical trials, turning out like a big, you know, blockbuster drug or whatever. I don’t think it necessarily has to implicate the rest of the economy if some, you know, biotech shrimps somewhere out there go bust.

Katie Martin
I broadly agree. And yeah, if you get a really ugly recession, then of course it’s a different story. But, you know, people have been wrong and wrong and wrong, wrong, wrong and wrong again on predicting recessions. You know, it’s just not happening. I think, you know, we do have to wake up to the very live possibility that recession is not gonna happen. And actually, that makes life a bit more difficult for these borrowers because it means that interest rates are not gonna fall as quickly as perhaps the market is pricing in at the moment. So those repayment costs, those debt refinancing costs are going to stay high. You know, this is just a new world or at the very least, an old world that has come back. And it’s not going away. Money is not free anymore. And that means that some companies are gonna make it and some of them aren’t.

Ethan Wu
Yeah. Katie, in the interest of calming everyone about this issue, I’d like to read you a column that was written in the FT in February 2020 by one friend of the show, Robert Armstrong.

Katie Martin
Oh, that guy.

Ethan Wu
That guy. If rates jump, bubbles and zombies will go from being a negative but manageable policy side-effect to a pressing threat to stability. The bubbles would burst just as the zombie hordes were forced into a rush of disorganised reorganisations and liquidations.

Katie Martin
I like going back through Rob’s old columns. Please don’t do it to mine. (Laughter)

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Ethan Wu
(Laughter) Or mine. All right, Katie, will be back in a moment with Long/Short.

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Welcome back. This is Long/Short, that part of the show where we go long a thing we love, short a thing we hate. Katie, I am short this OpenAI hullabaloo. What a disaster, man.

Katie Martin
I am limit short this thing. (Ethan laughs) What is going on? Could someone please tell me what is going on? What are all these tech bros doing? I don’t understand it.

Ethan Wu
I mean, without rehashing the whole thing, like basically, the OpenAI board decided that they were going to inform no stakeholders that they’re going to fire the CEO and then just did it. And then they set up a whole crisis. Now all the employees wanna quit. I don’t think we know exactly like what set it all off, like it remains to be seen. But, Katie, can we just handle this like adults? Like, just give people a heads-up, like call them beforehand, have a Zoom.

Katie Martin
Have a Zoom. And I don’t know, the whole idea of, like, this technology that’s supposed to make or break humanity, having it all rely on some one guy called Sam who also does this thing where he goes around with an orb scanning people’s eyeballs in return for crypto. I don’t know. Is this the governance structure that we would create if we were doing it from scratch? I’m gonna say no. I’m also short this whole hullabaloo.

Ethan Wu
Katie, if it’s not the zombies eating your brain, it’s gonna be the artificial general intelligence scanning your eyeballs.

Katie Martin
Those guys, man.

Ethan Wu
Katie, are you long or short something?

Katie Martin
Well, I feel like I quite literally have to be long Covid. (Ethan laughs) It’s a poor joke and one that I thought I had to make. I’ve had it five times. That’s enough times now, thank you very much. If I insist on getting again, then I’m gonna ask for a variant to be named after me because I just think this is ridiculous.

Ethan Wu
What do you need? Ten? You get it 10 times? Like on your 10th, you get a variant named after you?

Katie Martin
Yeah. I don’t think it’s like one of those, like, loyalty cards in the coffee shop, but I don’t know. If it is, surely I’ll find out soon.

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Ethan Wu
All right, Katie. Well, we hope you stay healthy. And listeners, we hope you stay healthy, too. We’ll be back in your feed with another episode of Unhedged on Thursday. Catch you then.

Unhedged is produced by Jake Harper and edited by Bryant Urstadt. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhecz. Cheryl Brumley is the FT’s global head of audio. Special thanks to Laura Clarke, Alastair Mackie, Jacob Weisberg and Jess Truglia. FT Premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com/unhedgedoffer. I’m Ethan Wu. Thanks for listening.

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