By Campbell Clark
Amid the unprecedented uncertainty that has characterized human life in recent years, one thing remains clear: merger and acquisition (M&A) activity is accelerating. In 2021, for instance, total M&A deal value reached an all-time high of $5.9 trillion, with the value of strategic deals — including both corporate deals and add-ons — increasing 47% year-on-year to $3.8 trillion amid record deal valuations. Although M&A activity in 2022 has slowed since last year, recent reports project total deal value to reach $4.7 trillion by year-end, making 2022 the second-best year in history.
Many buyers were motivated by the abundance of attractive assets and low cost of capital available last year. In contrast, others adopted inorganic growth tactics by acquiring critical capabilities as their rivals’ pursued deals. Other companies, however, turned to M&A to enhance their existing environmental, social, and governance (ESG) imperatives while also creating economic value.
Since the acronym “ESG” was first conceived in 2005, companies have increasingly incorporated societal concerns into their major decision-making processes. The cosmic crisis associated with Covid-19 and Russia’s recent invasion of Ukraine have served to reshaped the role of corporations, which must now assume greater responsibility for the welfare of society, the environment, and the communities in which humans live and work — not just their shareholders’ short-term returns. While legislation and recent regulations — such as the SEC’s proposed Climate Disclosure Rule, for example — have enhanced companies’ compliance with ESG criteria, consumers’ choices are also changing.
PwC’s 2021 Consumer Intelligence Series survey found that 79% of consumers are more likely to buy from a company committed to ESG, while 84% of employees are more likely to work for such an enterprise. A similar study by IMB found that nearly 60% of consumers surveyed are willing to change their shopping habits to reduce environmental impact. Additionally, almost 80% of respondents indicate that sustainability is important to them. Of those who say it is extremely important, more than 70% report that they would pay a 35% premium — on average — for brands that are sustainable and environmentally responsible.
What does this mean for companies pursuing M&A deals? Are corporate buyers accounting for ESG in their M&A process? Bain and Company’s 2022 Global M&A report suggests that the answer is no.
While 65% of the 281 M&A executives surveyed expect their own company’s focus on ESG to increase over the next three years, just 11% of respondents report that they extensively and consistently assess ESG during the deal-making process. As an emphasis on ESG surges, corporate executives would be wise to incorporate an ESG perspective into the deal-making process to ensure they do not miss opportunities to create value or expose themselves to unnecessary risk.
By incorporating ESG into their deal thesis, companies can create value and establish competitive advantage while simultaneously enhancing their ability to meet their ESG goals. Through the strategic acquisition of firms or assets that enhance the buyer’s ESG proposition, for example, companies might establish trust with governments and legislative authorities, enabling them to exploit new markets or expand into existing ones. Acquisitions that fortify firms’ ESG profiles or provide capabilities that enable them to meet their ESG imperatives might also enhance consumers’ willingness to pay for the buying firm’s products and services, bolstering margins and improving profitability.
BMO Financial Group’s recent ESG-motivated acquisition of Radicle Group serves as an illustrative example. Established in 2008 and based in Calgary, Radicle Group is a leading developer of carbon offsets and helps organizations measure and reduce emissions. The acquisition will provide BMO with carbon credit development capabilities to accelerate its emission reduction efforts as part of the BMO Climate Ambition initiative. Such capabilities will also allow BMO to develop additional sustainability services and bolster its presence in the burgeoning carbon market by enhancing its ability to help clients understand and manage the risks and opportunities of the energy transition. Thus, social and economic value is created.
Even if ESG performance is not the primary motivator for M&A, firms should still incorporate ESG perspectives across the M&A value chain to mitigate potential risks. While conducting deal due diligence, for example, buyers could analyze the compliance of their targets with national and international regulations and non-codified ESG-related norms and expectations to mitigate internal costs. Buyers might also evaluate the ecological impact of their target’s business model, how their target interacts with key environmental stakeholders, and whether the target has established corporate codes of conduct and policies concerning human rights, labour standards, health and safety, diversity, and equal opportunity. While different industries affect the environment and stakeholders differently, the key takeaway remains: an ESG lens should be adopted during the due diligence process to mitigate risk.
Take Goodyear’s 2006 acquisition of Treadsetter Tyres Ltd., for example. Goodyear, one of the world’s largest tire manufacturers, began doing business with Treadsetter — a retreading organization that operates in Sub-Saharan Africa — in 2002 and acquired a majority stake in the firm in 2006 as part of its corporate strategy, integrating Treadsetter as a subsidiary. In 2015, however, Goodyear paid more than $16 million as part of an agreement with the Securities and Exchange Commission (SEC) that settled Foreign Corrupt Practices Act violations against Goodyear. The violations stemmed from the firm’s subsidiary, Treadsetter, which paid more than $1.5 million in bribes to employees of government-owned African entities to obtain tire sales. While Goodyear failed to implement adequate compliance training and controls post-acquisition, its major fault was its inability to analyze Treadsetter’s culture and social conduct during the due diligence process, which resulted in millions of unforeseen costs. While it is important to recognize that ESG was less of a corporate concern in 2006 when the transaction was completed, this example nevertheless illustrates the importance of incorporating an ESG perspective into the due diligence process of M&A strategy.
As various stakeholders increasingly scrutinize how companies address ESG, the importance of adopting an ESG perspective during M&A processes will increase. Firms can use M&A to acquire key capabilities that might enable them to capture economic value while simultaneously bolstering their ESG performance. They should also incorporate an ESG perspective while evaluating target companies and conducting due diligence to mitigate potential risks. More importantly, deliberately and consistently integrating ESG considerations as a core component of their M&A strategy will allow firms to evolve into more sustainable, socially responsible enterprises, improving the ecosystems, societies and communities of our increasingly unpredictable and uncertain world.