- Metrics offer risk assessment and business opportunity
- Lack of standardization makes diligence harder
- Companies increasingly mention ESG in deal announcements
Strategics and financial sponsors are increasingly taking into account environmental, social and governance concerns when pursuing M&A as part of a broader shift in the market.
While ESG factors have long come up as a due diligence point, legal and financial advisors said that companies’ investors, lenders, regulators, employees, interest groups and members of the general public are now scrutinizing corporate decisions through the lens of ESG.
“We are at a tipping point in terms of accountability,” said Radha Curpen, co-head of environmental and aboriginal law at Bennett Jones in Vancouver. Stakeholders’ heightened interest in the issue like climate change and diversity comes at the same time as more information on ESG is publicly available, she noted.
In response, executives and boards need to examine how a transaction will impact stakeholders beyond just shareholders and be prepared to explain their decision making internally and externally, advisors said.
“If a company has determined that ESG is a strategic imperative and they want to be a leader, they need to look at acquisitions with a focus on ESG,” said Andy Brownstein, co-chair of Wachtell Lipton Rosen & Katz’s corporate group.
ESG is a macro-economic risk that companies need to take into account and a business opportunity that can be a motivation for some deals, Brownstein said.
Alternatively, a company facing a hostile bid or activist can use ESG as part of its own offense and defense, said Sabastian Niles, also a partner at Wachtell. “A buyer’s reputation and profile can become relevant issues, especially if stock is part of the currency,” he said.
Index-fund giant Vanguard Group has said that when deciding how to vote on mergers its funds will take into account the governance profile of a pro-forma company and the effect a transaction will have on stakeholders “if relevant to long-term value.”
Some other major institutional shareholders who have been vocal about ESG principles have not directly highlighted stakeholder concerns as a factor they take into consideration when making M&A related voting decisions.
BlackRock’s [NYSE:BLX] 2021 proxy voting guidelines indicates that its “primary consideration” is the long-term economic interest of its clients as investors. State Street’s [NYSE:STT] 2020 guidelines say it would generally support transactions that maximize shareholder value.
ESG considerations come into play in both strategic and tactical decision making in transactions, said Credit Suisse managing director Tom Greenberg, who heads a new ESG advisory group formed by the investment bank last year.
As an example, a consumer company looking to acquire an apparel brand needs to understand if the target aligns with its views on sustainability and social issues, Greenberg said. It also has to scrutinize the target’s supply chain to make sure there are no red flags.
ESG on a tactical level is primarily focused on due diligence. Several attorneys said ESG due diligence can be challenging to conduct given that ESG metrics are not standardized and most companies have few contracts to review that can be used to validate ESG policies.
Wachtell partner David Silk said it remains an open question whether the SEC will impose a standard policy for ESG disclosure or if companies and other stakeholders will settle on a unified disclosure system without government intervention. Once there is a standard, ESG-driven M&A will accelerate, he said.
Already companies are taking ESG concerns into account when thinking through how to publicly roll out a deal announcement, advisors said. This can come with direct mention of ESG benefits in a press release to being cognizant of the potential costs a deal may impose on stakeholders like employees.
Brownstein said an emerging trend he sees is merging companies being very cautious about establishing overly aggressive synergy commitments in light of the current environment.
In the past year companies have faced pressure to take public stances on ESG issues ranging from climate change, to rising economic inequality made worse by the coronavirus pandemic and protests against racial injustice.
Over 58 companies directly mentioned ESG in deal announcements for targets based in North America last year, according to Mergermarket data, compared to 20 in 2019 and just 2 in 2018.
Energy companies have been most vocal in highlighting the positive impact of mergers.
Texas energy groups ConocoPhillips [NYSE:COP] and Concho Resources [NYSE:CXO] touted their commitment to “ESG excellence” and adoption of a climate strategy aligned with the Paris Agreement when they announced plans to merge. Smaller oil and gas firms made similar ESG comments in 2020 press releases.
German exchange group Deutsche Borse [ETR:DB1] and US credit ratings and data provider S&P Global [NYSE:SPGI] said they were buying Institutional Investor Services and IHS Markit[NYSE:INFO], respectively, in part to expand their ESG data and analytics capabilities.
The ESG trend is not limited to public markets, several advisors said. Private equity firms are taking ESG into account in part due to pressure from their limited partners and it is an emerging issue for privately held companies.
Large financial sponsors are interested in buying companies that they can help transform in areas like carbon reduction, said Greenberg. The goal is to put a business on a more sustainable path and offer the sponsor a “huge opportunity for value creation” when they exit the investment in the future, he said.
There also is a trend of private companies preparing to sell drafting business plans that include sustainability opportunities that can be pitched to potential buyers, Greenberg said.
The focus on ESG in M&A comes as a broader debate plays out between proponents of shareholder capitalism that argue companies should primarily focus on maximizing profits and stakeholder capitalism who push companies to consider the wider community.
Advisors said the two sides may be more aligned than it first appears as decisions that boost a company’s ESG standing increasingly also benefit the firm’s long-term valuation. Factoring in ESG into M&A deliberations likewise does not mean forgoing a duty to shareholders.
Since the famous BCE decision in 2008, Canadian law has required boards to take stakeholders’ interests into account when making material decisions like whether to sell a company.
Jeremy Fraiberg, chair of Osler’s M&A group, said this approach may not change the outcome of deals but does require a board to carefully think through the implications of a transaction and how to fairly resolve potential conflicts between stakeholders.
“It can be a useful exercise for directors in M&A deals to turn their minds to this and it may improve the quality of their decision making,” he said.