Companies are increasingly looking towards mergers and acquisitions (M&A) as a means of improving their sustainability credentials. This means that a solid environmental, social and governance (ESG) performance in the target company may often be what seals the deal, as companies seek a sustainability dividend as part of the transaction.
A recently, published global survey carried out by KPMG found that more than two-thirds of organisations would be willing to pay a premium for a target that demonstrates a high level of ESG maturity – almost one-in-five said they would pay a premium of 5 per cent or moreand half were willing to pay between 1 per cent and 5 per cent.
“We’re seeing sustainability and ESG become an increasing focus for investors from a variety of pools of capital, in particular private equity and pension funds,” says James Delahunt, partner, corporate finance with KPMG.
Matthew Cole, corporate partner at DLA Piper, agrees. He says the perspective on ESG and sustainability in the M&A context has undergone a huge shift.
“It is starting to be seen less through the lens of risks to be identified and mitigated and more of an opportunity to create value through the right acquisitions,” he says. “Most sophisticated buyers will incorporate ESG-related metrics into their valuation models and there is no doubt that strong sustainability credentials can make a target more attractive and more valuable. Conversely, ESG or sustainability problems can scupper a deal or lead to a reduction in price.”
To satisfy this growing demand, DLA Piper has partnered with ESG risk-management platform Datamaran to offer an innovative integrated ESG due-diligence product that Cole says “sits alongside and complements” the more traditional due diligence process. “We saw that there was a demand for a product like this but even we have been surprised by the level of take-up from clients,” he says.
The hunt for attractive ESG targets is being driven by the fact that ESG has become a key issue in the boardroom, partly because of pressure from shareholders and funders but also influenced by growing legislation in the area.
“As corporates develop their own ESG strategy and culture they need to be very conscious of whether a target’s ESG credentials will be consistent with that and whether it might enhance it or detract from it,” Cole says.
One of the most active areas, he says, is where corporates are diversifying towards investing in renewable energy, either through direct acquisition of projects or through a corporate power purchase agreement. “In this regard, we saw AIB announce a deal with NTR plc in October 2022 to buy the energy from two solar farms to be built in Ireland’s southeast which will provide 80 per cent of AIB’s energy requirements.”
Outside of renewable energy transactions, David O’Kelly, partner, head of M&A at KPMG says there is growing interest from acquirers in understanding the ESG journey of targets. “In a recent logistics transaction, investors were impressed by the target’s use of solar energy, water recovery and low-carbon vehicles to reduce its environmental impact and meet certain customers’ requirements,” he says. “Ultimately companies that do not recognise the importance of ESG may end up with fewer funding options and reduced exit options.”
Sustainability is still far more central to the appraisal of targets than in their initial identification, however, says Cole. “While ESG factors are an increasingly important factor in identifying targets, particularly for private-equity buyers, ESG factors alone are rarely the initial primary driver of a typical M&A deal – large international energy deals are an obvious exception.”
Yet he points out that buyers have always taken general and industry-specific ESG factors into account when appraising a target business, long before they would have been labelled as such. “For instance, when looking at a manufacturing target a buyer would always carry out extensive environmental due diligence and seek financial protections in the transaction documents,” he says. “Targets, particularly operating in higher-risk jurisdictions, would be evaluated for compliance with anti-bribery laws. A buyer in any sector would usually look at employment patterns – for example, a high turnover of staff might indicate a poor corporate culture or concerning employee conditions.”
In recent years, however, buyers have been taking a “more holistic and much more sophisticated approach” to ESG due diligence and drawing all of these traditional strands together and adding new ones, Cole says. One particular due-diligence trend that he frequently comes across on larger international deals is careful modelling of the impact of climate change on a target – “For example, looking at what the effect of a 1 per cent increase in temperature or a rise in sea level would be on an infrastructure asset.”
Supply-chain due diligence is also of increasing importance, he says. “Traditionally this might have been limited to looking at bribery and corruption. Now buyers will look at working conditions, human rights and environmental impact in supply chains.”
Post-completion integration is also a consideration, says Cole. “Buyers will gravitate towards target companies with similar ESG/sustainability strategies, processes and cultures as it will be far easier to bring them into the fold,” he says.
Attractive targets are ultimately those who have already put time and effort into their own ESG and sustainability processes and policies, Cole says. “For instance, it’s far better to have examined, understood and remediated any supply-chain issues before a buyer does. This isn’t just a case of defensive risk mitigation though – the bottom line is that strong ESG performance creates value.”