The environmental, social and governance (ESG) agenda now permeates all aspects of business, and defence & manufacturing organisations are increasingly factoring it in when approaching and evaluating deals. It has become a key driver in itself of M&A activity as businesses look to make their supply chains more resilient from a sustainability perspective. It is also triggering a surge in debt financing deal activity, and we are seeing businesses with a strong ESG story attracting premium valuations in M&A transactions and driving greater lender appetite in financings.
Of course, the governance pillar in ESG has been a focus for organisations for some time already – what’s making the difference now is that the other two components have really shot to the fore. Carbon footprint and social purpose have become key watchwords. They’re being increasingly put at the heart of strategy and this is crossing over into the M&A approach too.
ESG as a filter in M&A
What this means in practice is that we are seeing companies reset their M&A focus and filtering process to consider the purpose of targets and how these fit their own strategic purpose. For example, a business may have reservations about further investment in industries linked to fossil fuels but be attracted to a deal in the sector which is related to increasing safety standards or reducing environmental harm. They’re taking a very granular approach.
Another trend we’re seeing is that technology is very much at the centre of M&A – and this is producing a crossover with ESG aspects. Technology, particularly digitisation, is seen as transformative and an enabler for many industrial clients to move closer to their customers and evolve into becoming a service provider. This links to customers wanting to understand their own operating footprint and how, through lower emissions and efficient operations, they can reduce their carbon footprint and save costs. This is where we’re increasingly seeing a close correlation between ESG and technology in M&A. Interestingly as a result, we’re also seeing Chief Technology Officers (CTOs) getting more involved in M&A strategy, not just CFOs or M&A directors.
Financing: No ESG, No Capital?
But what of access to debt financing and capital? Here again, the profile and weighting accorded to ESG issues by banks, credit funds and capital markets investors has significantly grown.
A few months ago, colleagues in our Debt Advisory practice coined a motto that they said was a “directional trend”: No ESG, No Capital. But now, that’s actually become more than the direction of travel – it’s arrived the here and now. We have begun to see lenders refuse to participate in industrial and automotive deals where they consider the company’s planning on ESG should be more developed. For example, we recently saw a lender refuse to back a refinancing for an industrial business whose vehicle fleet ran on diesel, with no developed plans to transition to electric or hybrid vehicles instead.
On the positive side, we are seeing strong competition amongst lenders to finance strong ESG propositions leading to better terms and a lower cost of capital. And the external accountability that comes with making ESG commitments to lenders can drive wider business value, by bringing greater focus on ESG delivery within the business, as well as evidencing to customers, suppliers, employees and regulators that the business takes ESG seriously.