M&A outlook: Responding to stranded asset risk with M&A
Winter 2023
Authors: Philip Parnell, Poppy Harris, Dan Brooks
Notwithstanding the alarmist phraseology, “stranded asset” risk presents opportunities as well as challenges for both future M&A activity and investor decision-making. In our latest sustainability and climate-focused M&A outlook, we look at the types of stranded asset risks organisations should be aware of and how these can be harnessed to unlock M&A opportunities across the full spectrum of asset classes and industries.
Breaking down key sources of stranded asset risk
The most recognisable of stranded asset risks are ‘physical’ risks arising from climate change, such as heat stress and extreme weather. The exposure of assets to climate change challenges is driving the development and implementation of adaptation strategies to address resilience. This inevitably poses challenges regarding the prioritisation and justification of capital investment into potentially exposed assets and long-term asset management decision-making, as investors weigh the costs of building resilience against the risks to returns of not doing so.
Transition risks also contribute to stranding risk; the most recognisable examples include natural resources assets that will be challenged by the energy transition (e.g., coal, oil, and some metals). As the energy transition continues, we anticipate it to cause market disruption and drive deals – especially in energy, power, and renewables industries.
However, large, systemic changes often present new hurdles that must be managed. For example, investors and strategic buyers must now contend with the different speeds and direction of governments and regulators, as they respond to macro ESG challenges by proposing and implementing new rules and regulations. In some cases, new rules present further causes of stranded asset risk, such as minimum Energy Performance Certificate ratings for commercial property. However, just as investment is required to build resilience to ‘physical’ stranding risk, so is it required to bring real estate up to minimum standards.
As the energy transition continues, we anticipate it to cause market disruption and drive deals – especially in energy, power, and renewables industries.
Changing stakeholder expectations can lead to stranding risk
In addition, a wide range of evolving stakeholder expectations give rise to further sources of stranding risk. Ever-changing consumer preferences and societal expectations are leading to the revaluation of certain sectors and markets. Activities perceived by some to be misaligned with these developments, such as animal agriculture, tobacco and single-use plastic, are exposed to stranded asset risk.
Intangible assets are also subject to stranding risks. While these are harder to identify, they can still have a material impact on a business, for example intellectual property (IP), ecosystem services and brand value. Investors and vendors should look to understand and quantify these ahead of deal-making.
Ever-changing consumer preferences and societal expectations are leading to the revaluation of certain sectors and markets.
Stranded asset risk can present M&A opportunities
As a result of stranding risks, we expect to see more assets being repurposed to meet evolving systemic challenges, which may present opportunities in M&A markets as mismatches emerge between assets and the risk appetites of their owners. For example, liquidity constrained asset owners may prefer to divest rather than repurpose or enhance. Alternatively, investors with longer time horizons, such as pension funds, may favour this sort of opportunity more than investors with shorter time horizons, for example Property and Casualty (P&C) insurance and some private equity strategies.
Asset owners already experiencing financial stress caused by stranded asset risk need to identify the scale of the impact, through valuation scenario testing, cash flow profiling, and exposure timelines, so that mitigation options can be properly assessed from both a cost and value perspective. However, before this can be done, it’s critical to first identify the stranded asset risk through asset and portfolio diagnostics. This key step can support those on the sell-side of transactions to articulate their stranded asset risk, present to bidders the mitigation actions they have taken in response, and avoid stranded asset risk becoming a topic of heightened scrutiny during due diligence.
Organisations should consider stranding risk as part of their M&A strategy
Stranding risk is a source of market disruption, which presents opportunities as well as risks for organisations and investors. In order to harness these opportunities and mitigate risk, dealmakers must recognise and embrace the challenge early in the transaction process.
Get in touch with a member of our team to find out more or discuss your organisation’s M&A agenda. You can also explore our other M&A market outlooks for 2023/24.
Key contacts
Philip Parnell
Partner, Head of Real Estate Valuation and Sustainability & Climate Lead
Poppy Harris
Assistant Director, Real Estate ESG
James Hilburn
Partner, Financial Advisory
Dan Brooks
Manager
