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Environmental, Social and Governance (ESG) is an issue that is playing an ever more pertinent role in the M&A agenda for corporates and private equity.
Over recent years, an ESG strategy has gone from being a “nice-to-have” to a necessity and has become an important strategic factor for corporates when considering:
If you are looking to attract external investment, be it from banks, private equity or via an IPO, a clear ESG strategy is key. All institutional investors have it high on their agenda and as such it should feature as a cornerstone of any strategic plan.
Whilst this can be delivered organically, we are also seeing an increasing focus on M&A in order to meet these ESG strategic goals. Whilst each corporate will have individual drivers behind using M&A to improve their ESG credentials, we typically see key drivers focused around both reputational and financial considerations, including:
A key focus for private equity
The high growth nature of many ESG focused sectors is particularly attractive to private equity and has led to the growth of buy-out impact funds, which are purely focused on investing in corporates with a strong ESG agenda. Significant levels of venture capital/growth capital have already been invested in earlier stage ESG focused companies as a result. Improving a company’s ESG position ahead of private equity exiting the investment, can provide an opportunity to create additional value and therefore improve returns.
High growth ESG sub-sectors are also seeing high levels of M&A activity. Emerging sectors such as sustainable food innovation, waste recycling and electric vehicle infrastructure are seeing and are seeing increasing levels of M&A activity which is expected to continue. This is primarily driven by the strong growth potential that they offer. Unsurprisingly, these sectors are attracting strong levels of private equity investment, whether directly, or via private equity backed corporates consolidating in the sector and expanding their skillset/service offering. They also provide an ideal opportunity for larger corporates to re-position their offering and help provide some futureproofing of revenues.
We very much expect this trend to continue, with innovation leading to an increasing number of emerging ESG focused sub-sectors that offer strong growth opportunities.
From a value perspective, we have typically seen ESG focused companies commanding value premiums, primarily driven by:
Sub-sectors where demand is highest, such as the energy sector, have been commanding the highest value premiums. This is very much evidenced in available market data which highlights increasing double digit Earnings Before Interest, Taxes, Depreciation and Amortisation (EBITDA) multiples for ESG businesses over the past two years, at levels above current mid-market averages.
This extends to broader corporates where investors and potential acquirers will be evaluating a company’s ESG strategy as part of their value positioning. Conversely, a company without a robust ESG strategy may require future investment to address this and may not have the same revenue opportunities of a peer, which inherently leads to a lower base valuation.
The impact on value is a trend that we expect to continue in the short to medium term, as ESG remains a key focus of the strategic agenda.
In summary, ESG is and will continue to be a key consideration and driver of M&A activity over the foreseeable future as companies look to raise external capital, innovate and create new revenue opportunities, whilst also addressing social, environmental and reputational considerations.
The need to create a more sustainable planet with a focus on carbon neutrality will require companies to pivot from their current operations, and M&A will continue to play a key role in delivering that change.
If you would like to discuss any of the points above or more broadly about the M&A market, please do not hesitate to get in touch.
Paul is a highly experienced corporate finance adviser. He has over 20 years’ experience and has advised on over 75 deals with a combined value in excess of £5 billion. Paul is also head of the building products and construction sector team at Deloitte. Recent deals include the disposal of the construction division of Shepherd Group to Wates, the sale of MCI Developments to Keepmoat, the disposal of various businesses out of Hewden, the sale of One Call to Duke Street and Searchlight and various disposals and strategic advice projects for Laing O’Rourke.
Dan Renton is based in the Leeds and Newcastle offices focused on Corporate Finance (Advisory). He worked for the firm for over ten years and has specific areas of interest as follows: - advising on transactions involving private equity (typically advising private equity Houses or transactions/companies seeking private equity investment) - other mid-market transactions, typically in the range £25m to £100m. Dan has a wide range of sector experience and as a trained manufacturing engineer has a particular focus on industrial companies alongside working on a national basis with companies operating in the employability and vocational skills space.