In good times and in bad, mergers and acquisitions (M&A) play a vitally important role in the health of your business. M&A can make your organisation more resilient, accelerate transformation, and drive growth.
However, there is a new factor in play in these deals that is proving make or break for all stakeholders – environmental, social and governance (ESG).
It’s becoming abundantly clear that climate change will be a defining issue for both governments and businesses for the foreseeable future. The global transition to a low carbon economy is already well underway. Governments are mandating compliance with emissions-reduction targets, and investors are holding organisations accountable for their performance on ESG.
Add to that changing consumer demands (with 90% of Millennials and Gen Zs looking to reduce their impact), not to mention B2B pressures across the value chain, and it’s clear to see that the time to act on ESG is now.
Tackling climate change and making your business not only compliant but also competitive and attractive to both customers and investors is crucial. So how to go about it?
- Product plays – investing in businesses whose core product and services drive ESG improvement, such as waste management
- Infrastructure plays – investing in companies that provide the underlying infrastructure for sustainable solutions, such as those in vertical farming
- Technology plays – investing in businesses that are using disruptive technologies to displace the market by creating new product categories, such as those cultivating meat in laboratories
“Following the uncertainty of the last two years, where markets and the world were heavily impacted by COVID-19, we've seen just how important M&A can be in the good times and the bad,” Hoffman tells Business Chief.
“Today, market conditions are fluctuating once again, with economic headwinds and geopolitical tensions. During times of uncertainty or 'crisis', M&A is an effective tool for safeguarding for the future. The right deals can help to defend against threats in the market, whilst building the agility and preparedness required to effectively manage future challenges.”
Taj Lalli, Corporate Finance Director at KPMG UK believes M&A is crucial right now to deliver growth. Business owners and managers are dealing with constraints on a daily basis, be that input challenges from a recovering supply chain, people issues due to well publicised recruitment and retention problems, or global energy constraints. All of this puts pressure on delivering organic growth.
Lalli says despite recent negative economic news, the equity and debt markets remain supportive and there is plenty of capital to support M&A strategies that deliver on the strategic imperative to achieve net zero, accelerate growth, or provide access to new technology, supply chains and geographies.
“Change is being driven from all sides,” says Lalli. “In the financial markets, lenders and shareholders are actively seeking ESG opportunities, and crucially, presenting companies with the opportunity to reduce their cost of capital.
“Within organisations, corporate values and purpose are also driving change. We’re seeing that as a key battleground in the recruitment and retention of staff.”
M&A can be an accelerator for improving a company’s ESG profile and taking advantage of the current ESG tailwinds, according to Hoffman.
“This can be the case when M&A activity positions the company with access to new capabilities and assets to grow products / services in markets that are positioned to thrive in a low carbon, sustainable economy,” she says.
“Mergers also have the potential to result in opportunities to deliver on operational and financial synergies, which can also lead to carbon footprint (amongst other ESG) synergies for the MergeCo. M&A activity is also increasingly serving as the impetus for the new combined entity or separated entities to redefine (and increase) the level of ambition of their ESG commitments.”
Understanding what ESG means is crucial to success
One of the issues with ESG is a clear understanding of what ESG actually means – and this varies depending on the business.
“ESG is a very broad term and how it applies to businesses will depend on the sector they operate in,” adds Lalli. “For example, energy and resource efficiency are likely to be high priorities for manufacturers, but for knowledge-based employers, skills development, diversity and shared prosperity are likely to deliver sustainable benefits.
“Once the ESG priorities are understood, the next stage is to start measuring current performance and identify gaps where M&A can accelerate change. We’re starting to see listed companies lead in this area, and ESG due-diligence is now becoming a routine part of assessing potential acquisition targets.”
Regional variation in ESG expectations and strategies
Geography also plays a hand, with regional variation in ESG expectations and strategies. Europe, for example, had barely begun to recover from the pandemic before the war in Ukraine added extra levels of shock and risk to navigate. From severe disruptions to food supply chains to economic sanctions impacting soaring energy prices, businesses are facing unexpected shocks and see M&A as a potential safety net.
Christof Huth, partner at global consultants Roland Berger, says companies in Europe are looking to strengthen their core business to become less susceptible to these kinds of shocks. “Times like these show how resilient the business model really is and companies may need to reshape themselves – one important tool to become more resilient to crisis is M&A activity.”
Fellow partner at Roland Berger, Sven Kleindienst, says ESG will be just as important as traditional motives, such as geographical or product expansion, digitalisation and cycle resilience, in the next five years. He says the European market is a clear frontrunner in this drive towards ESG.
“ESG is already playing a large role in companies' target selection processes and due diligence and it is expected to further increase,” says Kleindienst. “Transforming your own company towards being more sustainable is not easily done. Acquiring the knowledge and processes from a company with an advanced ESG and managing system or a more sustainable product service offering can strongly accelerate the transformation compared to developing everything in-house.
“Having a superior sustainable offering and fulfilling further ESG criteria is increasingly valued by the acquiring strategic or financial investors.”
The APAC picture includes a “wide range of attitudes” according to Will Symons, Climate & Sustainability Leader, Deloitte Asia Pacific, who says the ‘E’ in ESG can be a risk exercise to appease global investors and pension funds.
“This is partly rooted in the context that APAC differs from the EU and US in that ESG has not been driven by extensive country regulation,” says Symons. “Instead, there is a growing appreciation across APAC that ESG risk can materially impact business value, serve as a source of value creation and provide access to international markets and competitive green capital within and outside APAC.”
ESG should be embedded into core business
Understanding the value creation opportunities that exist in relation to ESG across different sectors is also driving the integration of ESG into M&A decision-making. ESG is increasingly being used as a lens to identify new sources of growth and competitive differentiation, with M&A being an accelerator for delivering on such strategic priorities.
And this is surely the crux of the matter. Investors (and consumers) are increasingly savvy when it comes to ESG or potential greenwashing, and demand the highest standards. So how can companies ensure they position themselves correctly during M&A?
“The businesses that succeed with ESG in their M&A cut through the hype and focus on strategic alignment, due diligence, execution, and value creation,” says Symons.
“Companies navigating this during an acquisition should embed all aspects of ESG into long-term growth strategies, making it core to their business strategy and not a separate topic. They should use well-referenced frameworks and guidelines and may also want to consider external assurance to back up commitments and progress against ESG goals.”
KPMG’s Lalli adds that shareholders and management should be clear on the ESG strategy prior to launching a process, and crucially, they should identify the key ESG priorities and how they will be measured.
“Being able to demonstrate progress against targets will be important to acquirers and their lenders, and the longer the period that metrics are measured, the better,” he says.
Christof Huth also emphasises the need to have meaningful data to convince investors. "In times where it is extremely important for companies to be ESG compliant, greenwashing has become a problem – also for investors, making it more difficult to distinguish between actual sustainability leaders and those just claiming to be,” says Huth.
“Against this background, it is imperative to have data ready to back up the ESG claims made during the M&A process. Having an accurate picture about relevant environmental, social and governmental impacts of business activities, and benchmarks against the industry and competitors is mandatory to convince potential investors."
Scrutiny and due diligence in ESG M&A
Given the incredible impact ESG issues can have on a company’s valuation, the level of scrutiny should be as high, if not higher, as the attention given to its financials. Symons says Deloitte recommends an end-to-end ESG M&A approach from strategy and deal origination, through to due diligence, announcement, and integration onto post-deal, long-term value creation.
This is a sentiment echoed by Kleindienst at Roland Berger, who says the guidelines should not only be set for a successful acquisition but also for a successful holding period or post-merger integration. He says this is not always the case.
“Currently, we still see a divide in the way ESG is reported, ‘lived’, and most importantly further developed across organisations,” he says. “While many still see it as more of a regulatory mandate, a growing number of investors are starting to see the ESG space as a chance to create additional value. Proper ESG due diligence lays the groundwork for a successful investment and it enables the investor to understand the status-quo as well as the ESG potential of the company."
New opportunities in ESG
So what should companies consider when looking for ESG-focused M&A opportunities? Hoffman advises corporates to start with their overall strategic priorities, where they want to expand, the gaps they have and then consider how to further accelerate this through M&A.
Companies should use a combination of defensive and offensive M&A strategies to capture the full spectrum of ESG opportunities. This will involve asking themselves key questions such as what demand for their products and services will look like in 5-10 years, how can they pivot their business strategy to deliver value while gaining a competitive edge, and how embracing ESG in M&A could enable them to grow sustainably.
For a company to realise potential increased valuations in M&A, the key areas that Deloitte advise clients to focus on from an ESG perspective are:
- Gain an understanding of what ESG means for the company’s strategic priorities (this will be different for each company and each sector)
- Develop and execute an ESG strategy (ideally embedded in the corporate strategy)
- Set appropriately ambitious and credible ESG targets and align incentives to these targets
- Remain cognizant of the fast-evolving stakeholder expectations, particularly from customers, investors, employees and regulators
“The structural adjustment and value creation that will occur in response to climate change will be the business of this decade,” concludes Symons. “As markets and private equity (PE) firms become more competitive to ESG performance, driving returns through ESG performance improvements will be a significant opportunity for the PE market.”
Making your company more attractive to investors and potential suitors all comes down to ESG, and it is important that executives see this as a value and growth driver, not just a regulatory hurdle, says Kleindienst.
“We see great potential in the ESG-focused transformation of companies from a value perspective – already, certain PE investors are leading the change in this and strongly focusing on implementing ESG initiatives for this reason,” he says. “Incentives need to be provided based on ESG targets and not only on short-term profits to be able to realise this potential."
Rochel leads Deloitte Australia’s ESG M&A practice, working with private equity and corporate clients to embed ESG across the deal lifecycle to drive enhanced value and to ensure alignment with investor expectations. Rochel has over 10 years of ESG experience delivering ESG advisory services across a wide range of sectors.
Will leads a group of climate and sustainability practitioners across the region in helping clients solve their complex problems, manage uncertainty and respond to rapid change. He has more than 20 years of international experience, working across all infrastructure classes, leading national-level climate risk assessments, delivering adaptation strategies and advising government agencies on how to align regulatory arrangements to drive more effective climate risk management.
A director within the M&A team, Taj specialises in UK and mid-market transactions and has worked across a range of sectors, advising on acquisitions and disposals, management buy-outs (buy and sell side) and joint ventures. At KPMG, he has worked across the full deal spectrum in the UK, US, Canada and across Europe.
Christof heads the firm’s activities in the DACH and CEE region, working with private equity and corporate clients to solve issues relating to commercial due diligence and value creation. He has led more than 500 buy-side and sell-side commercial due diligences for financial and strategic investors.
Sven focused on investor support and assists both private equity and corporate clients in commercial due diligence work, as well as on strategy and value-creation projects. His experience specifically covers the automotive, mechanical engineering and MedTech industries.
M&A drivers – the Asia-Pacific view
In the APAC region, we're seeing a few consistent drivers of M&A. Most notably, CEOs are continuing to pursue intentional growth – that is, setting and executing their own agendas for inorganic growth, rather than being forced into doing deals in response to market conditions. Business transformation, including digital transformation and the energy transition, are also dominant drivers, along with the influence of ESG itself. And private equity continues to have significant levels of dry powder, both globally and within AP, combined with a strong appetite to deploy that capital into the market.
In relation to the energy transition, we’re seeing oil and gas and energy-intensive industries particularly looking to shift their portfolios and processes towards clean energy growth areas such as carbon capture, hydrogen, renewables, and other clean technologies.
We’ve recently seen a sharp rise in the number of clients across AP and we’re helping them scan the market, transact, access green capital, or set up deep ecosystems to leverage green energy and technologies. Examples include BHPs recent attempt to take over OZ Minerals6 as they look to secure assets for a shift into clean energy and electric vehicles (EVs).
Our 2022 Heads of M&A survey in Australia and New Zealand found that almost 50% of respondents have or are planning to re-evaluate their portfolios to acquire or divest through the lens of ESG.
M&A drivers – the European view
According to Sven Kleindienst, Partner of the Restructuring, Performance, Transformation & Transaction team at Roland Berger, add-on acquisitions for geographical or product expansion, digitalisation and cycle resilience are seen as the most important factors for M&A. But ESG is expected to become just as important for M&A in the coming five years, as ESG will be one of the key market drivers next to digitalization, he says.
“The European market is a clear frontrunner with regards to this! Currently, M&A activity in Europe is centered around companies from the segments of technology, pharma & healthcare, and business services & logistics, especially due to the strong growth outlooks as well as their expected resilience to economic or political crisis."