ESG: A new necessity for the M&A agenda

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:

1. the future direction of a company;
2. creating a strong cultural and reputational position to attract capital and talent; and
3. creating additional value in a company.

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:

1. Seeking to improve their own ESG through focused acquisitions – e.g. improve carbon footprint;
2. Improving their supply chain – e.g. utilisation of waste products;
3. Innovation of business models, sectors that could become obsolete due to ESG issues; and
4. Creating value through additional income streams or margin improvement.

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.

ESG Sectors

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.

Value

From a value perspective, we have typically seen ESG focused companies commanding value premiums, primarily driven by:

1. the high growth nature of these businesses; and
2. current demand outweighing supply.

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.