Zombies, apes, and beyond -- Oh my!
Rising rates crush Bed Bath & Beyond cultists
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Markets gained last week on signs that the central bank tightening trend may be reaching a crescendo. The U.S. Federal Reserve raised rates by only a quarter of a percent -- less than any other hike since they began the process 11 months ago, while the Bank of England said that inflation had “turned a corner” in Britain.
But any loosening is likely to come too late for one endangered group: zombie companies. Kept afloat on a sea of easy money for years on end, tough monetary policies have pulled the drain plug for some of the biggest zombie firms. Just about the only group that hasn’t given up on them: meme stock obsessives, who now seem to have totally lost their minds.
Altogether the entire phenomenon falsifies any lingering pretense that markets have some divine insight or rationality beyond the avarice of their most powerful players.
We have talked about zombie firms in the past, but by way of a refresher a zombie company is one whose income is insufficient to cover its debts, with no long-term chance of real profitability.
The zombies avoid defaulting on these debts and going bankrupt by taking out new debt -- either loans or bonds -- or sell equity to raise the cash to keep running. Why would anybody lend to them or buy their bonds or equity? Because negative interest rates -- either in real (inflation-adjusted) or nominal terms -- make their high-yield debt look like a good deal as long as you assume someone else will give them money to cover your “investment.” And if capital is free, you can presume they will find it somewhere.
Between 1990 and 2020 the number of zombie firms increased nearly 500%, with more than 7% of all public companies meeting one definition. Now, however, a sharp reversal in interest rate policy threatens to upend the trend, with some high-profile zombies already starting to fall.
New Jersey-based retailer Party City, for example, filed for bankruptcy in January -- the company sold $750 million in junk bonds in February 2021, with the cash going to pay other, earlier debts, the definition of a zombie firm. Online auto-seller Carvana is close to bankruptcy after a 99% stock decline in 2022 -- the company has $7 billion in debt and has only turned a “profit” on an “adjusted EBITDA” basis a couple of times. Last year the company took out $3.4 billion in debt to pay off $1.5 billion in short-term debt (and expand some operations). Again -- taking out a loan to pay off a credit card.
But neither of these are the most ridiculous example of all: that distinction belongs to Bed Bath & Beyond (BBBY). The homegoods retailer warned in January that not only is it nearing bankruptcy, but that its survival as a “going concern” is in jeopardy -- unlike Party City which will restructure its debts and survive to sell balloons for another day, BBBY is likely to liquidate and disappear. Shelves have emptied as suppliers don’t expect to get paid, and it has now defaulted on two rounds of debt payments.
The company is a classic zombie -- it had to borrow $925 million in 2022 just to stay open. But it has also been a meme stock for some time, as Reddit investor folk hero Ryan Cohen bought a stake in the company in March 2022. Five months later, Cohen dumped all of his shares, pocketing $68 million in “ape” money. The speculators have stuck to their guns, however, pushing the stock up 68% AFTER the company warned that it was about to die. True believers have now turned to QAnon-level conspiracy theories, arguing that the company’s default announcements are actually fakes created by hackers from hedge funds trying to keep all the BBBY riches for themselves.
What the hell is happening here? The meme stock subculture started when some savvy speculators noticed that large investment funds had leaned too far over their skis shorting a few key stocks and were susceptible to a social media-organized squeeze. Now it has become something akin to a cult -- how?
One theory: in the United States, middle-class men -- the humor on “ape” subreddits suggests very few women belong to the subculture -- have benefitted from centuries of subsidization. Unpaid labor and forcibly extracted resources have meant that no level of mediocrity was too low to guarantee a comfortable lifestyle, with schools, parents, and culture assuring each of them that they had earned it.
The 2008 economic crisis and the long slog pseudo-recovery that followed put a huge dent in this subsidy -- hence the surge in “deaths of despair” among white men (Native Americans saw much larger increases in mortality). The very zero-interest-rate policies that helped Wall Street to an historic rally after the crash, however, created opportunities for some of these men to make up the shortfall through speculation. Even more heard about the opportunities and piled in after all the good money had been made. Now that central banks have turned off the tap, they are losing money fast.
But it can’t be because they’re all suckers -- everybody has always assured them that they are very smart. There must be a conspiracy. And every compulsive gambler falls victim to the sunk cost fallacy -- if only you hold on, you’ll eventually break even. Add it all up and you have apes convincing each other that BBBY will fill its multi-billion dollar hole out of thin air any day now.
In the meantime, they all provide a little bit of precious exit liquidity for the real capitalists. Rising rates or falling, zombie apocalypse or just a system in inexorable decline, that’s who always seems to clean up.
Our only investment advice: Get very into CJ the X.
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