Rate rise set to put stake through heart of zombie companies

November 14, 2013 6:10 pm

Rate rise set to put stake through heart of zombie companies

By Brian Groom, Business and Employment Editor

Stores Unlimited, not its real name, looked a classic “zombie company” – a topic back in the news as the prospect of higher interest rates means more struggling businesses face insolvency. Four years ago, the southeast England retailer, with a turnover of £30m, was losing £2m a year and barely generating enough cash to pay the interest on its £10m debt. In previous recessions “it would have been curtains”, said the turnround professional sent in to rescue it.But a recovery timetable was agreed with banks. After asset sales and a painful contraction, the company is back among the living, still owned by the man who founded it 40 years ago, and will make £500,000 profit this year, albeit with reduced turnover of £14m and just a third of its original 135 staff.

“The business was stagnating and we had to dig our way out of it. It’s a long process,” said the person who led the reorganisation.

Ultra-low interest rates have helped keep alive more than 100,000 “zombie” companies by some estimates – businesses that would have been killed off in earlier recessions. But the zombies have been generating barely enough cash to service debts and keep creditors at bay.

Some economists believe this has prevented capital from being moved to more efficient companies that can create jobs and growth. Others say it has protected jobs and helped businesses become viable again.

Not all are faring so well as Stores Unlimited. This weekBarratts, the shoe retailer, went into administration for a third time and Blockbuster UK, the DVD rental chain, for a second – both lack a convincing business model.

The Bank of England said it on Wednesday that it was likely to consider raising interest rates as early as this time next year, 18 months sooner than the central bank previously indicated.

“Once we get more economic growth and interest rates rising, we will see more of these zombies die,” said Richard Fleming, UK head of restructuring at KPMG, the professional services firm. Companies would hit trouble as they took on orders but were unable to get working capital, he said.

Mr Fleming added that banks would be more willing to pull the plug on debtors, partly because lenders’ balance sheets were now strong enough to crystallise losses and also there would be more buyers for assets.

Others are sceptical. “I am not a fan of the idea that with an improving economy you will suddenly get this clear-out,” said Lee Manning, restructuring partner at Deloitte, the financial consultants. He said banks had developed a “culture of forbearance and assistance”.

A 0.5 percentage point rise in interest rates would cost £5,000 a year for a company with £1m debt. “That’s not going to bring a company down,” Mr Manning said, though some businesses could find turnover hit if customers spent less.

Corporate insolvencies usually peak after recessions but not this time. Liquidations in England and Wales rose to 19,077 in 2009, well below the 1992 peak of 24,225, but have since fallen more than a fifth.

Once we get more economic growth and interest rates rising, we will see more of these zombies die

– Richard Fleming, KPMG

R3, the insolvency specialists’ trade association, estimates that the number of “zombie” businesses, paying interest on debt but not the debt itself, fell from 160,000 last November to 102,000 in August, or 6 per cent of businesses with a turnover of at least £50,000.

Experian, the business information company, argues there is little evidence that zombies even exist: it thinks there were tens of thousands of “hidden insolvencies” among companies that quietly stopped trading in 2008-09.

But Begbies Traynor, an insolvency specialist, puts zombies at 432,000 using a wider definition of corporate distress. Julie Palmer, partner, said insolvencies could rise over the next two years.

Christine Elliott, chief executive of the Institute for Turnaround, which represents turnround specialists, said up to two-thirds of zombies could be made viable and half of those could contribute to economic growth.

Stephen Pegge, external relations director at Lloyds Banking Group, did not see a “particular risk” of a sharp rise in insolvencies. “There is no evidence of significant pressure on cash flow arising from the pace of growth and interest rates. We have been more successful this time in turning round businesses,” he said.

Mr Pegge said 70 per cent of clients in intensive care had returned to viability. “A lot of that pain has been taken.”

. . .

Threats to the undead

Interest rates
Since March 2009 interest rates have been at a record low of 0.5 per cent, allowing struggling companies to cover interest payments though not repay debt. A rate rise, which the Bank of England may consider from late next year, could push some over the edge, though some experts think a small and gradual increase could be absorbed.

Overtrading
The classic problem in a recovery is that cash-strapped companies take on too many orders and then find they cannot get the working capital, pushing them into insolvency because they cannot pay suppliers. So far in the prolonged downturn this has not happened: views are divided over whether it will increase as recovery picks up.

Banks
Lenders have been slower than in the past to push struggling companies into liquidation, in part to avoid crystallising losses. Some think they will be less lenient as recovery gathers pace because their balance sheets are stronger and there will be more buyers for assets. But others say banks now have a “culture of forbearance”.