Creating value from environmental, social and governance (ESG) considerations has gained importance in M&A1. Companies are examining how they can leverage a target’s ESG strengths to promote revenues, profits and balance sheet efficiencies for the combined business. Such synergies often feature prominently in the equity story presented to investors, and can play a major role in boosting total shareholder returns.
Acquirers face numerous challenges, however. Although the quality of ESG reporting has improved among large companies over the past five years, the use of multiple standards and frameworks complicates efforts to understand and compare their ESG performance. Additionally, relatively few middle-market companies fully report their ESG performance. This makes it difficult to pinpoint ideal targets for bolt-on acquisitions, both from an immediate standpoint and with regard to long-term ESG-related value drivers, such as talent retention and brand visibility.
To overcome the challenges of unlocking ESG synergies, acquirers need to integrate ESG considerations throughout the M&A process, from pre-deal due diligence to post-merger integration.2
ESG synergies are often significant
Traditionally, acquirers have mainly addressed ESG during the risk assessment in their due diligence efforts, in order to mitigate the risks and preserve the target’s value. ESG risk mitigation continues to be a fundamental aspect of the pre-deal assessment. An acquirer needs to integrate targets into its ESG compliance and reporting standards, and avoid potential downgrades of the combined entity’s ESG score. It also must assess the impact on integration costs if the target does not comply with its ESG objectives.
But ESG synergies go beyond risk mitigation. They encompass the ways in which an acquirer can generate value for the combined entity by utilising its own ESG practices and those of the target, as well as by implementing new operating models and generating scale effects. This value can be quantifiable or nonquantifiable.
Quantifiable value is created by ESG synergies that directly affect the income statement. These include, for example:
• Driving recurring cost savings through measures such as enhancing operational efficiency in conjunction with decarbonisation,3 and implementing more sustainable procurement and supply chains.
• Increasing revenue, such as by overcoming regulatory barriers to access new markets, increasing customer engagement or raising prices.
• Improving the cost of capital, such as by mitigating risks, gaining access to alternative funding, or optimising capital expenditures, investments and assets.
Nonquantifiable value arises from the impact of ESG synergies on the acquirer’s equity story and total shareholder return (TSR). A BCG study4 found that deals emphasising ESG considerations tend to outperform other deals, in terms of cumulative abnormal returns upon announcement and two-year relative TSR.
For example, enhanced ESG scores and ratings may lead to higher valuations by reducing the cost of capital and facilitating better access to capital markets. Moreover, if an acquirer materially improves its ESG performance by integrating a target, it may attract new types of investors and broaden the investor base, leading to further capital-raising opportunities and long-term growth.
Addressing ESG synergies in three phases
Acquirers can extract maximum value from their ESG investments by utilising a traditional approach to synergies. The following steps serve as a guide for unlocking ESG synergies.
- Conduct ESG due diligence before signing the deal
Before the due diligence phase or the initial stages of public takeovers, it is vital to pinpoint the most significant ESG factors for both the target company and the potential combined entity. Utilise publicly accessible data to perform an outside-in assessment of material ESG-related risks and opportunities. Gain a clear understanding of the most important sustainability issues in the industry, along with the trends and technologies that should be prioritised and accelerated. If ESG presents substantial risks or is central to value creation, leverage data from the target during the due diligence process to evaluate risk exposure, identify mitigation opportunities, and formulate preliminary synergy hypotheses.
- Validate ESG risks and opportunities between signing and closing
After signing the deal, use the additional information available to validate the assessment of ESG-related risks and opportunities, describe the synergies in detail, and develop an implementation plan. Support from a “clean team” composed of third-party personnel is valuable during this stage. Although antitrust laws prohibit merging companies from sharing sensitive information before the closing, the clean team can analyse data from both companies and share sanitised, interim results with both integration teams.
The validation process includes collecting data, harmonising ESG metrics and taxonomies, consolidating ESG baselines, and synthesising hypotheses. The output is a prioritisation of material ESG factors, along with initial estimates of savings potential. Substantiate synergies by having the clean team conduct initial analyses, and refine top-down synergy targets derived during due diligence. This phase also includes prioritising ESG initiatives by materiality, assigning and communicating targets, and refining integration costs.
Finally, plan the execution of ESG synergies. Start by validating bottom-up synergy targets with functional teams from, for example, finance, procurement, sales, marketing and HR. This provides the basis for prioritising longer-term opportunities and aligning on new or renewed ESG priorities and ambitions to include in detailed implementation plans.
- Implement ESG Synergies from Day 1
After the deal closes, start implementing ESG synergies right away. To obtain comprehensive data about the acquired company, engage in open-book discussions, town hall meetings or small group sessions. Use this detailed information to validate targets and plans developed in earlier phases, execute risk management and savings initiatives and, if necessary, reprioritise longer-term opportunities. The execution phase is also the time to fine-tune the new or renewed ESG priorities and ambitions for the combined entity, as well as to define a roadmap for capturing the value. Finally, create a culture of collaboration among teams from acquirer and acquiree so that they can pursue shared goals aimed at enhancing the combined entity’s ESG performance and unlocking further value.
As ESG topics gain importance as motivations for M&A, acquirers should determine the forward-looking actions that the combined entity can take to generate value through ESG synergies. Acquirers that succeed will promote sustainability goals and ensure that the combined entity’s performance is more than the sum of its parts.
1 https://www.bcg.com/publications/2022/green-deals-on-the-rise-according-to-the-latest-mergers-and-acquisitions-report
2 https://www.bcg.com/publications/2023/keeping-esg-top-of-mind-during-post-merger-integration
3 https://www.bcg.com/publications/2023/lowest-cost-path-to-achieving-net-zero-emissions
4 https://www.bcg.com/publications/2022/green-dealmaking-helps-create-value
Alexis Bour is Managing Director and Partner | Boston Consulting Group, Johannesburg.
This article first appeared in DealMakers, SA’s quarterly M&A publication
DealMakers is SA’s M&A publication.
www.dealmakerssouthafrica.com
