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Zombie buyers beware
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ZOMBIE BUYERS BEWARE

Mergers and Acquisitions

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July 17, 2024


STRATEGIC INVESTORS ARE PAYING PREMIUMS TO ACQUIRE UNDEAD COMPANIES, BUT THE
VALUE THEY GAIN IS SHORT-LIVED.


The zombie invasion continues. The number of corporate undead rose yet again in
2023, contributing to an increase that’s averaged 8.8 percent annually since
2010.

The number of zombie companies that don’t produce enough profits from operations
to meet their debt obligations increased 7.4 percent last year. The undead now
account for 5.8 percent of all publicly traded businesses worldwide.

What’s more, investors continue to pay substantial premiums for zombies because
in the first year after a deal, undead companies generate double-digit total
shareholder returns that are comparably higher than those of their non-zombie
counterparts. But in short order, the surplus value they create decreases to
be more in line with that of other, non-zombie companies.

If that’s not scary enough, this might be: the year-over-year zombie swell
hasn’t phased recent growth of global share prices. From 2019 to 2023, share
prices rose 9.9 percent a year, as measured by the MSCI All Country World Index
of global equity-market performance. Markets don’t seem to care that more
zombies are clawing their way into the world’s population of publicly traded
companies—or that refinancing debt obligations at today’s higher interest rates
could amplify the invasion.

Financial miscreants’ steady infiltration and investor interest in zombie deals
in the face of higher global share prices is a key finding of our fourth annual
analysis of the worldwide zombie phenomenon. For the report, we once again
analyzed global economic tensions, inflation, and other trends that turn
companies into zombies. Mergers and acquisitions are a vehicle through which
zombies recover, so we also studied why zombies are attractive as potential deal
candidates and the returns they produce.

Other frightening findings:

If companies had to refinance their current debt obligations at today’s higher
interest rates, the effect would be drastic. According to our stress tests on
the 45,000 active companies in our database, a two-fold rate increase would turn
close to eight of every 100 enterprises into a zombie (see sidebar: Interest
rate stress test).

Close
Interest rate stress test

Zombies’ steady rise could continue if companies have to refinance debt
obligations at today’s higher interest rates, according to our interest rate
stress tests.

To understand what the future could hold, we analyzed net average interest
expenses for the companies in our dataset and how higher interest rates could
affect them. We designed the stress tests to represent 50 percent and 100
percent interest rate increases respectively, and applied the increases to
individual companies’ existing interest payments. For example, if a company made
annual interest payments at 3.03 percent in 2023, a 50 percent increase would
raise the rate to 4.55 percent. A two-fold rate hike would increase the rate to
6.06 percent.

Our analysis found that, assuming no other changes to company performance, a 50
percent rate hike would lead to a 14 percent increase in the number of zombies
worldwide, turning close to seven out of every 100 companies in our dataset into
zombies. The effects of a two-fold increase would be even more devastating,
transforming 7.7 percent of companies into zombies, or close to eight out of
every 100 (see figure).



The results foretell what could be in store for companies that secured mid- to
long-term financing at low interest rates before and during the pandemic and now
are approaching a “maturity wall” when those fixed-rate loans and fixed-coupon
bonds are coming due.

Although the stress test results are hypothetical, they’re in line with past net
interest rate increases, which rose from an average 1.5 percent between 2015 and
2022 to 2.21 percent in 2023. As of this writing, key interest rates set by the
European Central Bank and US Federal Reserve range from 4.25 percent to 5.25
percent. The rates are worrisome for companies on shaky financial ground,
including current zombies. In addition to paying higher rates, they’ll also
likely pay a higher, risk-adjusted surplus on market rates than healthy
companies. Zombies’ obstacles to refinancing are further complicated by the fact
that they typically have less free collateral to offer against credit lines.

 * Last year, the infiltration was strongest in the Asia Pacific region, where
   zombie companies increased 10.7 percent, including a 27.2 percent uptick in
   China and 13.6 percent increase in Australia. Zombies also increased in North
   America (6.0 percent) and Europe (1.3 percent) but declined in South America
   (down 4.9 percent) and Africa (down 3.2 percent).
 * Inflation, rising interest rates, and economic instability affected the
   financial well-being of companies in the real estate industry more than
   companies in any other sector. By contrast, the post-pandemic return to
   normalcy for travel and tourism contributed to a net decline of zombies in
   the sector, from 14.7 percent to 9.7 percent.
 * Zombies have beset companies of all sizes. Last year, midsized companies had
   the largest increase (12.0 percent). However, the smallest, those with annual
   revenue of $500 million or less, continue to be the most affected. Although
   investors remain keen on zombies, buyers must beware. Zombie hunters must
   understand the risks involved in doing deals with the undead and take steps
   to mitigate them. One of the biggest risks is the relatively short window of
   opportunity investors have to bring zombies back to life in a way that adds
   value, increases growth, and allows them to outperform non-zombies before the
   benefits of a deal drop off. To alleviate risks, investors must ensure deals
   fit into their overall strategy, look for “deal jewels,” and take steps to
   capitalize on the value that deals generate as quickly as possible.

Zombies among us: more are taking over

The number of zombies worldwide reached 2,370 in 2023, compared to 2,206 in
2022. Last year’s total includes 234 companies that had not filed annual reports
by our May 25 research cutoff but that we expect to meet the Organization for
Economic Cooperation and Development (OECD) definition of a zombie based on the
proportion of zombies among companies that filed late annual reports in 2022
(see Methodology section).

The undead now make up 5.8 percent of the 45,000 active businesses in our
dataset, up from 5.0 percent in 2022. The uptick contributed to a worldwide
population of zombies that has risen by an average of 8.8 percent a year since
2010 (see figure 1).



Last year, 827 companies turned into zombies, including the 234 anticipated
zombies that had not filed annual reports by our research cutoff. New zombies
outweighed the 534 companies that were “resurrected” by an improved financial
picture. In addition, 127 zombies disappeared because they were delisted,
meaning they went out of business, went private on their own or after an
acquisition, or were acquired and their operations were absorbed. Another two
zombies were resurrected through an acquisition and remained listed.

The influx of new zombies is indicative of the underlying economic and
transformation issues affecting companies worldwide, including
inflationary pressures, shortages of critical supplies and other supply chain
disruptions, and a push to transform to stay competitive.

As the MSCI index makes clear, global equities markets continue to soar even as
zombies’ ranks multiply. The disconnect between corporate profitability and
share price isn’t unusual. Historically, markets and share prices are influenced
by factors other than company performance, including R&D breakthroughs, new
products, and improvements in other corporate fundamentals.

Zombies as investments: speculating on the undead

Investors are hunting zombies. But despite investors’ willingness to pay
premiums to close deals, zombies don’t appear to create sustainable long-term
value for their buyers.

To understand zombies’ appeal and the outcome of investing in them, we studied
7,710 mergers and acquisitions that involved 5,636 companies in our dataset. Of
the M&A activity we analyzed:

 * Zombies accounted for less than 5 percent of all M&A deals involving publicly
   traded companies.
 * There were 294 zombies involved in 388 deals, meaning some zombies were fully
   or partially acquired more than once.
 * Of all zombie M&As, 19 percent involved zombies that were traded more than
   once.

The finding that some zombies trade hands multiple times indicates that
investors can’t always absorb or turn them around, and when that happens, undead
companies wind up back on the market. It highlights the extreme challenge of
integrating a company facing significant financial headwinds. Even so, investors
continue to perceive zombies as having higher than average potential to create
value compared to more financially stable companies—so much so, they’re willing
to pay more as a result.

Strategic investors commonly pursue underperforming companies that could tie
into the acquirer’s existing business, or because a zombie controls assets that
fit into its strategic objectives. Zombies’ “deal jewel” assets could be R&D,
new products, or in the case of energy or natural resources companies, newly
discovered physical assets. In the pharmaceutical industry, for example, global
players commonly acquire biotech zombies for their R&D.

Zombies are worthwhile investments, at least in the short term. In the first
year after a deal, the value that zombies create for buyers is more than double
the market average, as measured by total shareholder return (TSR), 14.6 percent
vs. 5.8 percent (see figure 2). That value even outpaces MSCI global equity
market performance. But the good times don’t last. In short order, zombie
buyers’ TSR declines even more than the market average, to a 14.1 percent TSR
deficit three years after a deal, compared to a 13.2 percent deficit for all
M&As, and an MSCI market performance increase of 7.6 percent.



Zombies’ rapid drop in value highlights the need for investors to maximize
pre-close planning and pursue a robust integration strategy to maximize the
benefits of synergies that spring from a deal.

Zombies by region: diverging fortunes

Last year, the effects of global economic trends played out differently
depending on the region. Some continents and countries witnessed a sharp
increase in the number of undead companies while others saw their zombie
populations shrink (see figure 3).



Zombies by continent. The Asia Pacific region had the most significant upsurge
of zombies, including a 10.4 percent increase in Asia and 13.6 percent uptick in
Australia. The zombie increase in Australia is in line with the country’s
wavering economic performance, as indicated by a dip in GDP growth from 4.27
percent in 2022 to 3.02 percent in 2023, according to the World Bank. That could
help explain why the Asia Pacific region’s zombie population multiplied despite
an overall improvement in GDP from 4.5 percent in 2022 to 4.8 percent in 2023.

Zombies also rose in North America (6.0 percent) and Europe (1.3 percent), but
fell in South America (4.9 percent) and Africa (3.2 percent).

Zombies by country. Continuing hard times in the global real estate industry,
which we first documented in our 2021 zombie report, exacerbated the zombie
outbreak in Asia. China has been especially hard hit by the real estate sector
downturn, which contributed to a 27.2 percent increase in zombies there.
Although the increase brought the total portion of zombies among Chinese
companies to 3.4 percent, it’s still well under the 5.8 percent global average.

The portion of zombies increased in all G7 countries (see figure 4). Within that
group, the countries that experienced the most significant growth in zombies
were Italy (25.9 percent), Germany (23.7 percent), and Japan (23.2 percent).
Germany has officially entered a recession caused by a slowing economy that’s
been affected by inflation and declining exports. The related zombie increase
led the portion of German zombies in our dataset to reach 6.7 percent.



The United States recorded only a slight increase in the undead (2.8 percent),
and total zombies remain just shy of 5.9 percent of all companies based there.

Switzerland experienced the largest proportional drop in zombies of any country
we studied (30 percent). Last year, the zombie contingent among Swiss companies
dropped to 3.6 percent from 4.6 percent in 2022.

Zombies by industry: travel and tourism rebounds as real estate flounders

Multiple economic and geopolitical factors affected the performance of
industries across the globe, leading the zombie population to shrink in some
sectors and grow in others (see figure 5). The factors included a post-pandemic
bounce that lingered into 2023, inflation that lifted share prices but caused
companies in some sectors to pass on higher prices to customers with adverse
financial effects, and ongoing semiconductor shortages and geopolitically
related supply chain risks.



The travel and tourism industry rebounded from 2022, when airlines were the most
affected subsector of any we studied. Travel trends that started shifting in
2022 continued last year. It contributed to a net decline in total zombies in
the industry, from 129 that year to 83 in 2023 (14.7 percent to 9.7 percent). In
2023, 70 former travel and tourism zombies returned to financial good health,
while only 27 companies turned into zombies, and three were delisted.

The population of undead companies remained relatively unchanged in automotive,
consumer goods, energy and utilities, machinery, and telecommunications and
media.

The higher interest rates that affected all industries were especially damaging
to the real estate sector. The total number of real estate zombies grew from 173
in 2022 to 210 in 2023, increasing the portion of zombies in the industry to 11
percent. The 36 real estate zombies that returned to financial health during the
year were outnumbered by 81 companies that became zombies and eight that were
delisted.

Higher interest rates could turn even more real estate companies into zombies
because of the industry’s need for capital and the highly leveraged nature of
the business. According to our stress tests, a 50 percent increase would drive
up the portion of undead companies in the sector to 13.3 percent. A two-fold
increase would lead to 16.2 percent of real estate enterprises becoming zombies,
one of the highest rates of any industry we studied.

Zombies by company size: bigger is better

Although the number of zombies among companies of every size rose again for the
third year in a row, smaller companies continue to be more affected than any
other group.

In 2023, the number of zombies among companies with annual revenue of $500
million or less grew close to 9 percent, causing the portion of the undead among
that cohort to increase from 6.2 percent in 2022 to 6.7 percent. Smaller
companies are more susceptible to becoming zombies because they typically have
less access to attractive refinancing options or capital markets. They’re also
more likely to have weaker processes and governance than larger companies and
are more exposed to external shocks (see figure 6).



Other findings:

 * Midsized companies with annual revenue of $500 million to $1 billion had the
   highest zombie growth rate (12.0 percent). However, the portion of zombies
   among them is still relatively small, 1.6 percent in 2023 compared to 1.4
   percent in 2022.
 * Large companies with annual revenue of $1 billion to $10 billion had the
   slowest zombie growth rate of any group, an increase of 7.8 percent. The
   portion of zombies in this cohort also remains very small, 1.4 percent.
 * Last year the zombie growth rate among companies with more than $10 billion
   in annual revenue surpassed 11.1 percent. But that cohort remains relatively
   zombie free, with a rate under 1 percent.

Considerations for zombie hunters

Zombie hunters are a rare breed. Although zombies make up close to 6 percent of
all publicly traded companies worldwide, they account for less than 5 percent of
the M&A deals we studied—meaning that interested investors are few and far
between.

Even so, the strategic investors that comprise the vast majority of zombie
hunters pay handsomely to acquire them. They see the potential that financially
distressed companies represent—potential that others overlook.

Based on our analysis, they’re on to something. Buyers’ TSR in the first year
after acquiring a zombie is more than double the average. But after
that—poof—zombies transmogrify from creating value to destroying it.

Given the circumstances, it behooves investors considering zombie deals to
proceed with caution.

Do the math. Determine the maximum price you’re willing to pay based on TSR
that, if it follows the average, will likely peak at the one-year mark. Be ready
to take whatever actions are required to transform an acquired zombie and cash
out before the value they deliver starts to crumble.

Find and secure zombies’ deal jewels. Investigate and identify the R&D, new
products, or other assets that make a zombie attractive before striking a deal.
Plan how to capitalize on the surplus valuation that a zombie’s deal jewels
represent.

Look for bargains. Economic trends have been kinder to some regions and
industries than others. The upshot: there are bargains to be had in areas and
sectors where zombies are prevalent.

Take size into consideration. Our data shows that zombie hunters’ average annual
revenue is five times larger than their targets, and their market capitalization
is 5.7 times larger. In that regard size matters, because the closer in size a
zombie is to an investor, the greater the risk that it could affect its new
owner.

Make sure a deal fits into your strategy and goals. Understand the upsides a
zombie M&A target represents and how it fits into your long-term corporate
objectives and M&A strategy. A pharma company may stand to gain from buying a
biotech zombie with a breakthrough drug, or a tech giant may gain from buying a
money-losing challenger with more advanced R&D capabilities.

Develop a post-deal plan. Zombies don’t add value for long, so come prepared.
Have a robust integration strategy plan in place that accelerates capturing the
value from a deal. Actively manage the acquired company to capture benefits from
the investment as quickly as possible.

Conclusion

The tide of zombies continues to rise, with the primary increase coming from
financially unstable companies in regions such as Australia and Germany that
have been hard hit by economic slowdowns, higher interest rates, and global
supply chain challenges. The zombie horde is also growing in industries such as
real estate that face substantial challenges from being exposed to capital
markets. Smaller enterprises remain more at risk of becoming a zombie than
larger listed companies. Even so, investors see zombies as opportunities to add
value, and are willing to pay more than the market average to acquire them. But
without a smart plan that takes into account the relatively short window of time
that zombies add value, they might not get their money’s worth.

Methodology

To understand the current state of zombie companies, we analyzed a dataset
dating back to 2000 with more than 5.5 million data points on close to 76,000
publicly traded companies across 154 industries and 152 countries, including
45,000 companies active in 2023.

We used the OECD’s internationally recognized definition of zombie companies to
ensure consistency and comparability. The OECD classifies a company as a zombie
if it:

 * Has been active in the market and had revenue of greater than zero for 10
   consecutive years, demonstrating ongoing activity in its industry and that it
   is not a start-up.
 * Has not been able to meet its interest obligations through operating profits
   for three consecutive years.

In addition, we define a company as no longer being a zombie if it recovered
financially, became insolvent and went out of business, or was acquired.

We used the aforementioned criteria to review each company’s performance as
outlined in their publicly available annual report. Because some zombie
companies did not release year-end reports by our May 25 research cutoff, we
used the number of companies that met our definition of zombies in 2022 to
calculate the additional percentage of zombies among all companies that hadn’t
reported year-end results by our cutoff date and added that to our total. In
2022, the number of zombies among companies we studied totaled 2,206, of which
approximately 10 percent filed year-end reports after May 25. Based on that, we
forecast the total number of zombies for 2023 to be 2,370, including an
estimated 234 we expect to file year-end reports late.

When analyzing M&As that involved zombies, we defined strategic investors as all
investors other than private equity funds, sovereign wealth funds, pension
plans, or similar financial companies.

When analyzing zombies by size, we divide companies into the following
categories by annual revenue:

 * Small – less than $500 million
 * Medium – $500 million to $1 billion
 * Large – between $1 billion and $10 billion
 * Very large – more than $10 billion

By adhering to rigorous data collection methods and accounting for the
aforementioned considerations, we believe we provide an accurate, insightful
analysis of zombie companies’ presence in the global business landscape.

The authors wish to thank Jonathan Thaysen, Heike Hofmann, and Tobias Schmidtke
for their valuable contributions to the data analysis, which was instrumental in
compiling this report.


Interested in learning more about our mergers and acquisitions expertise?


Learn more





--------------------------------------------------------------------------------

Authors

Nils Kuhlwein von Rathenow

Partner

Christian Feldmann

Partner

Vincenzo Sposato

Partner

Anton Chircorovici

Principal

Nils Kuhlwein von Rathenow

Partner

Christian Feldmann

Partner

Vincenzo Sposato

Partner

Anton Chircorovici

Principal

--------------------------------------------------------------------------------

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