The Relationship Between M&A and ESG
2022 has not seen the same start in terms of M&A activity as 2021, with issues likely to continue for the industry. Whilst deal values have still surpassed $2 trillion, the overall value still represents a 21% drop from H1 2021. Factors such as rising rates, killer inflation, tighter regulation and taxes coupled with supply chain disruption and a volatile geopolitical landscape do not make for the most nurturing of environments. In saying that there is still a case for remaining optimistic about global M&A activity.
The need for industrial transformation will continue to drive deals, even in challenging sectors. In sectors such as the automobile sector, there is still a need for new technology as the push toward electric vehicles continues, and whilst consumer markets are dampened by rampant inflation, the requirement to adapt to evolving consumer behaviour and rising concerns surrounding the ethical nature of firm’s operations. Capgemini estimates that 79% of consumers are changing buying habits due to inclusiveness, social responsibility or environmental concerns. In a more general sense, all companies, even in such harsh conditions will need to optimise their portfolios and divest assets which are not central to business operations.
What is more is that private equity has but an abundance of capital ready to be deployed, and those firms are also heavily interested in ESG goals. It is no longer the case that ESG can be but a tick-boxing exercise. Greenwashing in particular is beginning to be punished by regulators, with the SEC currently investigating Goldman Sachs. Businesses will need to reach net neutrality by 2050 in developed markets such as Europe. Therefore, it is a requirement for businesses to build M&A competencies to meet regulatory requirements, and also indeed create value and capital attraction.
With all of this considered, it is clear that M&A is likely to play an increasingly important role in corporate strategies and the retention of talent. 71% of CEOs who have pledged carbon neutrality or to reach net zero say the decision was significantly influenced by the need for talent retention. In essence, this means that sustainability will begin to become part of any potential deals’ thesis. Beyond anything else, a 2020 McKinsey Global Survey indicated that C-Suite executives would be willing to pay a 10% premium for a company with a positive ESG record. Indeed, average EBITDA multiples in renewable asset deals rose to 15.2 in 2019-2020 and sustainable AUM has risen drastically, topping $1 trillion in 2020.
Figure 1: sustainability related AUM has exceeded US$1 trillion
What is however clear is that ESG is not, and should not, be the main driver for every single deal. What is therefore important is that there is a differentiation between ESG-conscious and ESG-motivated deals. Bain, in their 2022 M&A Report defines ESG-motivated deals as those that are specifically undertaken to advance the ESG agenda of the firm. The most obvious example would be the need for firms within the energy sector to transition in order to meet emissions targets. Contrastingly, ESG-conscious deals are those that simply incorporate the values of ESG into the due diligence of the deal, for example checking the carbon emissions of a target as part of the due diligence process.
ESG is gaining more and more popularity amongst investors and is a powerful driver of value creation. One sector which will remain particularly important in future M&A activity is private equity (PE). Currently, many see it as an industry that is abundant in capital but withholding due to the various risks in the current economic and political climate. With that being said, PE is anticipated to achieve a CAGR of 11% in 2025. PE firms are embedding ESG into their strategies, with 80% of limited partners citing ESG as an important factor when deciding where to distribute capital. This is clearly visible from the growth of sustainable financing, which as a market increased to $1.6 trillion in 2021. As investor mindsets towards ESG are rapidly changing, and when coupled with government regulation, PE houses are developing and standardising KPIs to improve ESG reporting. The influence of the industry is growing faster than could have been imagined, and their commitment to creating value through ESG will transform the operations of several companies and ESG will likely be incorporated into the end-to-end M&A process.
It is clear that everyone- consumers, businesses and governments- expect companies to play their part in creating a fairer world. ESG is responsible for profoundly reshaping business models across the globe, and in the coming years, those principles will be embedded across M&A; it is these principles that will set companies up to make the M&A moves that will boost their performance.