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Companies have traditionally viewed environmental, social, and governance (ESG) issues through a risk mitigation lens. But ESG is increasingly recognized as a value creation lever that can drive value for a business and society. Reporting, which facilitates comparability across companies on ESG metrics, and stakeholder pressure will likely accelerate this shift from risk to value.
Dealmakers need to pay attention to ESG initiatives — major commitments on climate, data security, diversity and inclusion, and related issues — because they figure prominently in value creation. ESG leaders in the deal space look for assets and business partners who can accentuate their leadership, while companies lacking a strong ESG portfolio will likely seek out acquisitions with a robust ESG program. And, organizations will likely communicate how a transaction adds ESG value in order to build trust in the marketplace.
ESG actions have often been seen as protective measures. There are many high-profile examples where ESG-related issues diminished a company’s value. For instance, a longtime California utility company sought bankruptcy protection due to significant liabilities and an equally significant number of lawsuits stemming from wildfires caused by a combination of power line maintenance issues and drought conditions exacerbated by climate change. The company’s market value plunged as the risks to business materialized from climate events. This represents a new development: Power and energy companies once tended to view climate change risk strictly through the lens of regulatory action regarding standard operations. Now, they see that climate risks can affect the business and its operations directly.
In the past, pressure from regulators was often the key driver of ESG action. Now, pressure from stakeholders — customers, employees and investors — is strong enough to lead to value destruction in an enterprise. The cost of ESG inaction exceeds the cost of action in many cases.
ESG-related impacts companies have experienced in the past few years include:
ESG-related efforts can potentially undermine an organization and any transaction involving it. In one PwC M&A study, nearly two-thirds of executives told us cultural issues hampered value creation in their most recent deal. Culture — an organization’s shared beliefs and values — is not the same as ESG, but is often correlative, and culture and ESG are closely tied in improving talent retention and recruitment.
There is significant room to address cultural blind spots. In our 2020 M&A Integration Survey, only half of respondents said culture was part of their change management plan. Meanwhile, media coverage regularly highlights how ESG-related issues have diminished companies’ value by tarnishing their brand, prompting legal or regulatory action or threatening the long-term sustainability of the core business.
This is a hinge moment for ESG. Companies ignore these issues at their peril, while those that focus on them can create new value pathways. As a result, management teams recognize the benefit of taking action. This is relevant to dealmakers because there are uncovered risks in deals, opportunities to create value and more stress ahead, given the reporting requirements.
Forward-thinking companies are taking ESG-related action to: produce operational efficiencies (such as reduced transportation costs resulting from lighter, more environmentally friendly materials); improve retention rates, reducing employee churn and the costs associated with it; and bolster the brand loyalty of customers, which helps drive sales.
United Airlines continues to refresh its fleet to reduce carbon emissions. The company also is increasing its use of sustainable aviation fuel (SAF), which isn’t carbon-based and therefore burns much cleaner than regular fuel. United has launched its Eco-Skies Alliance initiative to get corporate partners to help invest in and offset the cost of SAF.
Clothing company Patagonia has long embraced an ESG-related mission with a focus on environmentalism. In an effort to promote the circular economy and address the problem of discarded clothing in landfills, Patagonia offers its customers a voucher toward a future purchase if they returned a used piece of Patagonia clothing. The used clothing is refurbished and resold, often at a higher price than the cost of the voucher — creating both a source of revenue and a valuable proof-point for the company’s environmental commitment.
Private equity firm CVC Capital Partners adopted a new approach to long-term value creation by increasing its focus on customer loyalty and employee satisfaction. In 2017, it acquired a foreign convenience store chain and undertook substantial ESG-related efficiency/savings efforts — replacing carbon-intensive refrigerants in many stores, reducing the weight of packaging, and setting annual carbon emission reduction goals. The investments resulted in a larger brand shift toward customer health, environmental friendliness and animal welfare.
ESG reporting trends may force companies to act due to the added transparency provided to stakeholders. While reporting was long voluntary, it may eventually be required in some cases. The regulatory reporting landscape is quickly changing in both the US and abroad. For example, in early 2022, the SEC announced proposed climate-risk disclosures by public companies that would be included in 10-Ks and they are expecting to finalize those disclosures in the first quarter of 2023. However, the political landscape in the US may result in scaled-back disclosures from what was originally proposed. The SEC is also working on enhanced disclosures on human capital. Additionally, the European Financial Reporting Advisory Group (EFRAG) has finalized new, expansive ESG reporting requirements under the Corporate Sustainability Reporting Directive (CSRD) that will be required for EU-listed companies and non-EU-listed companies with large subsidiaries in the EU. Even in private company settings, there is more desire for transparency about how companies are impacting the world, which leads to a focus on data collection and analysis. Private companies in the value chain of public companies are also feeling the pressure from the proposed regulatory changes that require Scope 3 greenhouse gas disclosures.
Comparability allows leaders both to understand an ESG problem and to determine how to address it. Comparability provides the ability to quickly assess an organization’s ESG profile and detect major gaps. Then executives can recommend specific investments and policies that will help organizations move forward in deals, confident that they can create value.
Given how reporting is acting as an accelerant, deals teams need to account for ESG attributes and value creation opportunities on the front side of a transaction. PwC is helping buyers assess ESG at an acquisition target in a three-step framework.
Dealmakers need to evaluate their ESG capabilities and should proactively deploy those capabilities to address increased stakeholder and government scrutiny. Whether as a buyer or a seller, the ability to report key ESG metrics and compare them to peers is going to be a threshold capability. The key elements of such a capability-driven strategy include:
Dealmakers need to understand how ESG can act as a trust barometer for acquisition targets. Given the charges of greenwashing, companies should follow through on commitments to demonstrate their authenticity. That ESG authenticity often serves as a litmus test for a broader set of capabilities when it comes to trust in management and brand equity in the marketplace and with stakeholders, which should factor into valuation calculations.
An ESG-dedicated capability on the deals team can be a valuable way to attract capital. Both traditional and new funding sources are placing greater priority on ESG projects and investments, especially on climate issues. The shift from a shareholder-value model to what we have called an enterprise-value model means that the deals marketplace may have little choice but to respond and adopt a proactive stance.