M&A – An Essential Tool for a Green and Sustainable Economic Recovery
While the M&A market is regaining momentum following the disruption of the global pandemic, the profound impact of the crisis has clearly reshaped the market. In addition to the often-mentioned sector rotation, innovative transaction structure, the rise of SPACs, tightened FDI rules, among others – and while the world is learning how to co-exist with the virus – the market has largely prioritized transforming business resiliency, sustainability and green. The pandemic has served as a wake-up call to society on the importance of ESG (Environmental, Social and Governance) and has sped up the process of promoting a green and sustainable economic recovery. This transformational embracing of ESG has gradually become one of the central themes of most, if not all, stakeholders in the M&A community, including corporates, equity investors, financing banks, regulators, customers, employees. M&A, as an essential tool for a sustainably “green recovery”, is increasingly being influenced by ESG factors in both deal sourcing and execution process, and in post-deal management too.
ESG Factors in M&A Deal Making
From a deal sourcing perspective, industries and corporates with more “ESG positive” features will attract more attention in the M&A market, as the market in general, and its investors, are embracing and prioritizing ESG investments.
If we look at green sectors, renewables, for example, one of the key pillars to preserve our environment and support green economic growth, will remain active in future. Utilities players will rely on the acquisition of renewable assets and industry consolidation to meet the regulatory requirements, investor and customer expectations, and social responsibilities, which in return will result in long-term sustainable success and resilient profitability. Other “ESG positive” sectors that will also attract investor appetite include those which can contribute to an improved environmental outlook and more inclusive society, such as global carbon reduction, a decrease of waste and pollution, enhanced biodiversity suitability, supply chain technology upgrading, energy and infrastructure efficiency improvement, data security technology, sustainable and accessible healthcare and education. In the meantime, we will see a trend of non-ESG friendly assets being divested or spun-off.
On a corporate level, the rationale for companies to “green” themselves or become “ESG positive” is increasingly more compelling and of urgency, both organically and strategically. ESG is not only a potential risk to be managed in daily operations, but also a strategic consideration and core competitive factor for corporates’ future resilience and growth in terms of competition for capital, talent retention, branding value and strategic positioning. Targets seeking to be acquired will need to address their ESG positioning properly to attract potential investors, and buyers are increasingly searching assets which are “ESG accretive” to merge with. If certain ESG criteria are not met, buyside parties may abandon their potential transactions.
Financial investors in the M&A market are also embracing and prioritizing ESG investments. More and more pre-deal ESG screening criteria is being implemented in private equity firms and hedge funds’ investment policies, and ESG factors are increasingly being integrated into the entire investment process. There is a strong preference from fund managers and investors regarding ESG portfolio allocation, driven by factors including potentially better returns, regulatory requirements, value alignment with investors and brand image. With the recent heat of SPAC (Special Purpose Acquisition Company) related activities, we have also seen many de-SPAC transactions being done through mergers with high growth targets in green-tech or ESG positive sectors.
In short, ESG is becoming one of the fundamental considerations for all M&A deal makers.
The ESG Factors in M&A Deal Execution
The M&A market is responding to the ESG theme with ever more measured and innovative methods to both qualify and quantify the ESG impact. ESG is becoming a real driver of value creation, rather than functioning purely as a moral incentive or corporate image factor to be managed. ESG leaders will likely achieve premium valuation multiples and there is increasing proof and research papers to suggest a clear and positive correlation between EGS positioning and financial performance. The market has already started to recognize and pay for the qualified and quantified additional value generated from superior ESG status. This is leading to more resilient business models and improved growth opportunities in an unpredictable world, and we also see better employee engagement and job stability within companies, improved customer satisfaction and corporate branding attractiveness – a transformational value alignment of all stakeholders in the M&A society. Some of the ESG related factors, such as carbon emissions/tax, waste discharge, energy efficiency, product safety and cost of funding impacted by ESG status, may be directly reflected in revenues, cost items or capex projections, as well as the WACC calculation, during the valuation modelling process, while others, like leadership around ESG-related policies and technologies, effective and efficient of governance, inclusive culture and management/staff diversity, may be reflected in long term moral capital or brand value – a premium that bidders are increasingly recognizing and are willing to pay for.
On the financing side, ESG related financings are also gaining traction, with significantly increased activities around green/blue bonds, sustainable financing solutions, and other ESG KPI linked products. ESG factors are progressively more reflected and priced into credit markets, which means ESG positioning will not only influence funding feasibility and cost at corporate or asset level, but also become a key fundamental competitive factor for the M&A process – the competitiveness of buyers’ bidding offer for equity due to the cost of funding, and the attractiveness of seller positioning as a result of future financing solutions and impact on returns.
ESG is no longer just a risk factor to be mitigated or a check-the-box exercise for due diligence processes in certain environmental related sectors – it is now a key due diligence focus, a valuation driver, a consideration of Condition Precedent terms in legal documentation, a factor in warranty and indemnity insurance for ESG related risks post-closing, a transaction structuring element (for example, earn-out structure can be designed for ESG-linked considerations), as well as a key factor impacting post-deal performance. The M&A execution process itself also evolved to be more sustainable during the pandemic, with more and more transaction execution processes being done remotely, thanks to the new technology initiatives and the expertise and dedication of M&A professionals.
Our commitment to support our clients on M&A related ESG initiatives
At Natixis, we are actively supporting our clients in their ESG strategies. Over the past few months in Asia Pacific, we have engaged in multiple green or ESG related M&A transactions. For example, Natixis APAC M&A advised China Merchant Union, an overseas investment platform dedicated to support international expansion of China Merchants Group, one of the largest and most influential state-owned conglomerates in China, on its strategic investment into Goodpack, a KKR portfolio company. Goodpack is a global logistics provider servicing industries that require supply chain solutions and it operates the world’s largest fleet of steel Intermediate Bulk Containers (“IBC”), a packaging solution with responsible design concepts by replacing common, single-use packaging materials with reusable, more sustainable materials, such as durable steel; the company also promotes efficient logistics management to reduce its environmental impact, generate fewer carbon emissions, and save trees that would be used by other shipping alternatives.
In August 2021, Natixis, together with its affiliates Vermilion Partners and EFG Hermes, acted as exclusive financial advisor to a consortium led by China Three Gorges South Asia Investment Limited on its acquisition of Alcazar Energy Partners, one of the largest independent renewable energy companies in Middle East and North Africa (MENA). China Three Gorges, China’s largest clean energy group and the largest hydropower enterprise in the world, is a strategic SOE supervised by Central SASAC (State-owned Assets Supervision and Administration Commission) in China. This transaction is its first investment in MENA and represents a landmark development in its international growth ambitions. Natixis also provided financing support in relation to this transaction.
In June 2021, our Australian boutique, Azure Capital advised Banpu Energy Australia on its acquisition of the Beryl and Manildra solar farms located Central West New South Wales from New Energy Solar. Azure Capital is also active in providing advice to several Australian mining and exploration companies that are operating and/or developing mines to supply raw materials for electric vehicle batteries, such as lithium, nickel, cobalt and manganese. In August 2021, Azure advised Core Lithium on a A$140 million equity capital raising to fully fund development of its Finniss Lithium Mine, located near Darwin in the Northern Territory. This included a A$34 million equity investment and offtake with Ganfeng Lithium, one of the largest producers of lithium chemicals globally. Azure Capital and Vermilion Partners are also collaborating to run a partnership process for Prospect Resources, an ASX-listed company developing a large lithium project in Zimbabwe, with several large Asian groups competing for the opportunity to secure supplies of lithium feedstock through that process. Vermilion Partners is also actively involved in M&A activities in ESG related sectors, including hydrogen – an area that potentially to play a significant role in transition to a carbon neutral economy.
ESG factors will continue to be more and more integrated into the overall M&A deal sourcing and transaction execution process, as well as the post deal management, and M&A itself is serving as an essential tool to create value in a sustainable way for corporates and overall economy recovery though a green path. Natixis is committed to leveraging our M&A networks to support our clients in their ESG initiatives and to contribute to an on-going green recovery for our economy.