Financial indiscipline scores over underperformers

From the perspective of lenders, the primary risk for zombie businesses is that they will remain trapped in a cycle of dependence.

A majority of lenders questioned for the survey were concerned by lack of profitability and working capital in these underperforming businesses and with consumer demand in many sectors still slack, there is nothing on the radar screen to suggest the situation will improve.

Lenders also see management teams’ respective strengths as a key issue, and this is felt acutely amongst smaller businesses.

Consequently, there is little optimism that zombies will be able to pay down debt in the immediate future.

Success blinds

According to a lender, “Many clients in the ‘zombie’ category are good at their primary activity, but financially unsophisticated and often poor at business management. Their businesses have frequently been successful in the early stages, but outgrown their ability to manage, often with poor debt structures accumulated along the way. It is this early success that all too often blinds the business owner to the need to change or to accept advice early enough for the business to remain viable.”

What is more, the situation could well be worsened by macro-economic events, with lenders warning that deteriorating economic conditions or a hike in interest rates would make it even harder for already marginal companies to return to genuine viability.

Whilst the current macroeconomic backdrop in New Zealand is arguably quite benign, lenders’ fears about macroeconomic changes are echoed by key industry players.

Significant risks

In his quarterly Financial Stability Report, Reserve Bank of New Zealand Governor Graeme Wheeler said, “The external environment poses significant risks for the New Zealand financial system.”

In an already stressed situation, the macroeconomic tide turning could create a rapidly deteriorating situation for a zombie.

Early proactive action is invaluable to preserving options and value.

What is interesting however is that lenders do not believe action from the government will have much meaningful impact on zombies.

Regulatory changes and government/public sector spending cuts rank among the lowest as influencing factors over a zombie’s solvency.

For a zombie company, the key factors that the management or owner can most influence are control of working capital, effective credit management, preserving and motivating key personnel and managing relations with the IRD and other key suppliers.

These are all areas where restructuring specialists such as KPMG can add real value.

Terminal choice

Sometimes, enough is enough.

Releasing a business from the half-life existence of being a zombie can breathe new life into people, re-energise stakeholders and be a catalyst for positive change.

In other words, turning off the life support might be the best answer.

The reality is that there are businesses that have had their day and cannot be saved.

Artificially keeping them alive cannot be the answer long-term.

However, with the right controls, insights and leadership, there are also plenty of companies that are being nursed back to health and are set to prosper again.

Exit options

Faced with these circumstances, it is hardly surprising that lenders are concerned about their own exit options.

Looking back over the last 12 months, lenders taking part in the survey reported that solvent exits, notably through refinancing or a sale of a business, were more common than insolvent exits, involving receiverships, liquidations or even administrations.

Looking ahead, the outlook is mixed.

On the plus side, lenders believe that solvent solutions will remain their preferred method for dealing with zombies over the next 12 months. However, the fastest growth area for resolving a zombie situation is expected to be receivership.

That said, lenders expect that across the board, zombie exits, whether solvent or insolvent, will increase by about 10%.

This uplift in activity might be interpreted as an active step towards flushing through positive change in the economy.

Shaun Adams is Head of Restructuring & Insolvency Services at KPMG based in Auckland. The above article, extracted and modified from his recent study titled, ‘Zombie Companies: Are they haunting the economy?’ will appear in three parts.

KPMG is the Sponsor of the ‘Business Excellence in ICT’ of Indian Newslink Indian Business Awards

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