Zombies’ companies: Opportunity or Dead Weight II

In our previous article we saw the number of zombie companies that exist in Spain and are doomed to disappear.

In this article we will consider whether there can be value in them for a potential acquisition.

To illustrate the point, we propose to analyze the evolution of IBEX companies that were considered zombies three years ago. Although the analysis period is short, the studied sample is small, there is a bias due to them being listed, the available data are for public prices and not for concerted prices, etc., at least it will give us an idea of the potential attractive of these companies:

In March 2018 there were a total of twenty zombie companies on the IBEX with financial results which exceeded their EBIT for more than three years.

Let's see their evolution in the period March 2018-March 2021:

Share price evolution:

ü The set of zombie companies shows an average devaluation of the share value of -18.3%, reaching -44% if we exclude the one with the best performance (Pharma Mar). On the contrary, the IBEX Small Cap had a revaluation of 21.8%. Furthermore, the 9 zombie companies that are still in this index, out of the 29 companies that currently comprise it, have had an average loss of -53%. In other words, the healthy Small Cap have performed very well and the zombies very poorly, both in terms of profitability and the profitability / risk pairing.

Sales:

ü The vast majority of zombie companies have dropped their sales, with the exception of Pharma Mar, Deoleo, and Urbas. Three other show a not very significant evolution of sales: GALQ, Oryzon Genomics. Deoleo has increased from € 605 to € 665 million, although in the meantime it has left 12,000 shareholders out as well as having to make a capital increase of more than € 250 million to stabilize its balance.

Pre-tax benefits:

ü This item has only increased in construction companies (Urbas, Montebalito, Aedas Homes), in Pharma Mar and in GALQ. The other 15 zombie companies have lowered their EBT considerably.

Financial debt and equity:

ü These items have had dramatic movements in almost all companies. For example: On the positive side, Pharma Mar went from € 17 million in equity to € 102 million, although its NFD increased by € 20 million. GALQ has also strengthened the balance sheet, which presented negative equity in 2018 and in 2020 it stands at € 81 million, after the capital increases carried out by the new shareholders and the negotiation of the bank write-off. Aedas Home, on the other hand, has shot up its debt by € 200 million. And the up and downs go on when we look at these financial items.

At a more general level, we could say that zombie companies have required major restructuring efforts, increases, capital reductions, debt capitalizations, write-offs, lawsuits, layoffs, etc. from their reference shareholders, movements and efforts that have been generally risky and have implied sacrifices.

Many zombies have disappeared, entered bankruptcy or had to be rescued, such as Abengoa, Uralita, Sniace, Pescanova, Duro Felguera ... Others, such as Nueva Expresión Textil, OHL, Quabit, have meant for their shareholders the loss of more than 80% of their capital.

Most of the zombies of 2018 are companies which do not present a healthy balance sheet or encouraging prospects for the future.

There are exceptions that point to a departure from being considered a zombie, but this has yet to be confirmed: The construction companies Urbas, Aedas Homes and Montebalito; Pharma Mar, the most successful one by large; Ezentis, which still shows losses; GALQ, which must obtain benefits that justify its value on the stock market; Deoleo, led by CVC; and perhaps Adolfo Domínguez and Service Point. As for Oryzon Genomics and Berkeley, both with business models that must demonstrate recurring positive cash flow, it would have been more correct to have considered them start-ups at the time.

Another issue that makes it difficult to acquire zombie companies is the current bankruptcy legislation. Several authors warn of the malfunction of bankruptcy proceedings, basically because the relevant courts are just a few and they are overloaded, making bankruptcies slow and cumbersome (lasting 40 months, on average).

In any case, regulation is more practical for large companies than for micro companies, which also have to bear the cost of expensive lawyers and are not pushed ahead and prioritized in court. In addition, small zombie companies do not have economies of scale, they depend on individuals, and are more likely to disappear.

All the above suggests that investing in Spanish zombie companies has turned out to be bad business, highly risky, with sudden movements, and it has been worth it only in a few cases. The purchase of insolvent companies in Spain must be reserved for those investors who have evident synergies with their other businesses, the ability to transfer know-how, those who can provide management, who are open to going to court if necessary and, above all, who have enough money and patience to play long-term.

In addition, when compared to what it would have been to invest in an IBEX Small Cap with a healthy balance, the conclusion is even stronger: No to zombie SMEs, with few exceptions. Yes to healthy SMEs.