The zombie companies

Episode Summary

Executive Summary: This episode of Unhedged discusses 'zombie companies'—firms with unsustainable business models kept alive by cheap capital—and the risks they face as the Federal Reserve raises interest rates. Hosts Ethan Wu and Katie Martin analyze the broader implications of higher rates on corporate debt, defaults, and potential systemic risks, particularly in private equity and biotech. They also touch on the OpenAI governance crisis and Katie's personal COVID experiences.

Main Topics: Zombie Companies and Interest Rates (Priority: 5/5): Definition of zombie companies and how rising interest rates threaten their survival, with WeWork as a prime example. Corporate Debt and Defaults (Priority: 5/5): Analysis of rising defaults, distressed exchanges, and selective defaults as companies struggle with higher borrowing costs. Systemic Risks from Private Equity (Priority: 4/5): Concerns about private equity portfolios holding weak companies with floating-rate debt, potentially causing broader financial stress. Biotech Sector Vulnerability (Priority: 3/5): Biotech firms are highlighted as particularly exposed due to their speculative nature and lack of profits. OpenAI Governance Crisis (Priority: 2/5): Ethan Wu criticizes the chaotic firing of CEO Sam Altman and the lack of stakeholder communication. COVID-19 and Personal Anecdotes (Priority: 1/5): Katie Martin shares her experience with multiple COVID infections, adding a lighthearted tone.

Key Arguments: Zombie companies are at risk due to the end of cheap capital and rising interest rates, making debt servicing and refinancing more expensive. Defaults are increasing but may represent normalization rather than a systemic crisis, though private equity poses a potential systemic risk. The biotech sector is particularly vulnerable to defaults, but its failure may not have wider economic implications. The OpenAI situation highlights poor governance and lack of transparency in tech companies.

Data Points: Percentage of Russell 3000 companies unable to cover interest expenses: Nearly a quarter - Ethan Wu notes that many companies in this broad index cannot cover interest payments with cash flow. Number of debt defaults in September: 118 - Katie Martin cites S&P data on defaults, including distressed exchanges and selective defaults. Interest rate increase from COVID-era levels: From 2% to 6-9% - Katie Martin explains that refinancing costs have risen sharply for companies that borrowed cheaply during the pandemic.

Pivotal Quotes: "If rates jump, bubbles and zombies will go from being a negative but manageable policy side effect to a pressing threat to stability. The bubbles would burst just as the zombie hordes were forced into a rush of disorganized reorganizations and liquidations." — Robert Armstrong (quoted by Ethan Wu): Ethan Wu reads a prescient column from February 2020 warning about the risks of rising rates. "Money is not free anymore, and that means that some companies are going to make it and some of them aren't." — Katie Martin: Katie summarizes the new reality for corporate borrowers in a high-rate environment. "Can we just handle this like adults? Like, just give people a heads up, like, call them beforehand. Have a Zoom." — Ethan Wu: Ethan criticizes the OpenAI board's handling of CEO Sam Altman's firing.

Implications: Listeners should expect continued corporate defaults and stress, especially in private equity and biotech. However, this may be a normalization rather than a systemic crisis, unless a recession materializes. The OpenAI saga underscores governance risks in high-growth tech.