Zombie Companies May Finally Succumb to Bankruptcy on BOJ Hikes

(Bloomberg) — After three decades of ultra-loose monetary policy, even small hikes in interest rates by the Bank of Japan are poised to fuel an increase in the number of zombie companies that could be tipped into insolvency. 
Bankruptcies topped 5,000 cases for the first time in a decade between April and September, a report by Tokyo Shoko Research showed earlier this month. Those 5,095 firms collectively account for almost ¥1.38 trillion ($9.2 billion) yen in debt, with the largest slice coming from the service industry.
Defined as businesses that struggle to pay the interest on debt from operating profit alone, zombie companies have survived for years in Japan thanks to low rates and government support. Unable to invest or hire, they’re stifling the emergence of new enterprises and preventing job mobility. Clearing them out may not be such a bad thing, and make way for new, healthier enterprises, according to Nicholas Smith, strategist at CLSA Securities Japan Co. 
“None of them will be missed,” Smith said. “We’ve got to a situation where we are not concerned about unemployment in Japan. In fact, what we’re most concerned about is a severe labor shortage.”
A 0.1 percentage point rise in the benchmark rate could boost the number of these corporate zombies, which spend most of their profit paying down debt, to around 632,000 from around 565,000, according to a report earlier this year by the research firm.
One of them is HIS Co., one of the country’s largest travel agencies. The Tokyo-based company posted ¥1.4 billion in operating profit in its latest fiscal year, which ends in October, but spent ¥1.5 billion on net interest expenses. 
Known for its low-cost package tours, HIS has been struggling due to the dearth of post-pandemic outbound travel from Japan, in contrast to the flood of tourists visiting the country. That’s partly due to the weak yen, another legacy of decades of low interest rates. HIS took on more liabilities after 2020 and now holds ¥30 billion in debt, according to data compiled by Bloomberg.
The company declined to comment.
The term “zombie company” was coined in 2008 by three professors, including University of Tokyo Professor Takeo Hoshi. He defines a zombie as a company that hasn’t addressed operational concerns, but has avoided bankruptcy thanks to the financial support of the government or creditors. 
The Bank for International Settlements, on the other hand, defines one as a firm founded more than 10 years ago that has logged an interest coverage ratio lower than 1 for more than three years.
One of the biggest bankruptcies this year was MSJ Asset Management Co., which held ¥641.3 billion when it was liquidated by Mitsubishi Heavy Industries Ltd. after its failure to enter the domestic jetliner business. 
Others include the plastics recycling company Eco Research Institute Ltd., medical device supplier Hokushin Medical Co. and Asahi Food Create Ltd., which sold pre-prepared food.
Besides banking and insurance, every sector and region in Japan saw an increase in bankruptcies during those six months. As interest rates are hiked and major industries like transportation, artificial intelligence and software see aggressive competition from global players, that number is set to keep growing.
Even Japan’s larger companies aren’t immune to the prospect of insolvency anymore. Panasonic Liquid Crystal Display Co. topped the nation’s list of bankruptcies in 2023. Competition made the LCD panel business shift its focus to the automotive and industrial sectors, but trade tensions between the US and China led its parent company to shutter the business. 
Panasonic Holdings Corp. decided to liquidate the unit’s assets and waive the ¥583.6 billion it owed in loans to another one of its subsidiaries. The electronics maker’s move in 2021 to adopt a holding company structure sought to improve the accountability and profitability of each division. In May, Chief Executive Officer Yuki Kusumi said he’ll seek to improve underperforming units by finding their “best owner.”
Debt-laden companies in Japan are rapidly growing in number, in some measures even faster than in 1992 after the collapse of its asset price bubble. Zombie companies accounted for 14% of listed firms in Japan, according to Tokyo Shoko Research. 
Zombies are found concentrated in Japan’s sectors where the labor shortage is most prominent, namely restaurants, hotels, transportation and tourism. 
An unproductive company can’t maintain employment or competitiveness, it can’t buy or sell and it surely can’t turn a profit. Especially outside of metropolitan population centers, persistently struggling companies make investment difficult.
But decades of cheap credit and generous handouts have bred a generation of unproductive companies with teetering balance sheets. During the pandemic, the Japanese government funneled trillions into these kinds of businesses — some experts believe those “no interest, no collateral” loans may have been a major catalyst for the recent spike in bankruptcies.
When a small or mid-sized firm goes under, their employees are let loose, free to find work elsewhere, hopefully at a company that’s more profitable, productive and better at balancing its books. If anything, it’s a natural if not intended byproduct of the BOJ’s rate hikes, one could that help counteract an ongoing labor shortage as the country’s population ages and shrinks. 
“Japan’s economy is reaching a turning point and we need a change in mindset,” said Naoki Hattori, senior economist at Mizuho Research & Technologies Ltd. 
An increase in bankruptcies is inevitable, Hattori said, but that doesn’t mean all of these companies should be left to their demise. The challenge is deciding which companies can be helped, and how, he added. Each one is a unique operation that needs a tailored approach, and some experts argue that local financial institutions are in the best position to do it.
“The goal isn’t to increase bankruptcies. The goal is to reduce debt,” said Mitsuhiro Harada, director of research at Tokyo Shoko Research. “To a large extent, this is about protecting our way of life.”
So far, it doesn’t appear likely that the BOJ will be in a hurry to hike interest rates. Although the BOJ kept monetary policy in place last month, Hattori expects the BOJ to raise rates to as high as 0.5% sometime between January and March. That would be its highest since the early 1990s, and could push many companies further into debt or into bankruptcy.
As rates go up, the yen strengthens and brings down inflation to give consumers some respite, CLSA’s Smith said. 
“Of course, it’s stressful, but the rest of the world has to deal with it,” Smith said. “The economy, as a whole, does a lot better with higher interest rates.”
More stories like this are available on bloomberg.com
©2024 Bloomberg L.P.