Strong ESG Credentials Paramount in Value Creation and M&A
As part of IMAP’s special focus on environmental, social and governance (ESG), Creating Value hears from Christopher Kiermayr, Partner at ERM GmbH, the largest global pure play sustainability consultancy and market leaders in ESG due diligence. A regular collaborator on deals with IMAP Germany, Christopher explains the role of ESG in value creation and provides practical advice for investors looking to capitalize on the biggest investment opportunity of the decade and beyond.
Investors and buyers are willing to pay a premium for companies that can demonstrate strong ESG credentials. Stakeholder activism on ESG aspects is adversely impacting the availability of capital.
The last year has shown how robust ESG management provides companies with resilience to external shocks.
Stocks of companies with strong ESG credentials and robust climate strategies have outperformed those of peers this year. Corporate goals around carbon neutrality and energy transition strategies have accelerated activity to manage corporate portfolios by decarbonizing the asset base while increasing investment in and acquisition of sustainable products and technologies. ESG and sustainable investing has become the new standard to access finance. There has been a significant increase in the size of ESG funds, green bonds, capital flows to ESG funds and sustainability-linked financing, with ESG viewed as integral to strong corporate governance and business performance.
Integrating ESG is no longer a “nice to have”; it is integral to strong corporate governance and business performance. Stocks, multiples, and valuations in general of companies with strong ESG credentials and robust climate strategies have outperformed those of peers this year. Investors and buyers are willing to pay a premium for companies that can demonstrate strong ESG credentials.
The amount of assets under management among ESG funds as of March 2020 was more than $1 trillion, having grown by more than 35% over 3 years. The world’s largest asset owners are committed to mobilizing significant sums of private capital towards the 17 Strategic Development Goals (SDGs) and an increasing number of the world’s most influential LPs are focusing on ESG.
Significant Investment and Value Creation Opportunities for Astute Investors.
According to ERM’s 2020 survey of over 50 Private Equity (PE) investment professionals, ‘Eyes on the Prize: Unlocking the Value of ESG Premium in Private Markets’, 86% of those polled now have access to dedicated ESG teams when making investment decisions.
Furthermore, the results reveal that ESG issues offer significant value creation and investment opportunities in the coming 3-5 years and that there are specific actions that PE firms can take to help them make their way to the top of the ESG summit.
Based on this survey, firms should feel galvanized to take bold steps toward the significant opportunities presented by the transition to a sustainable, low carbon and equitable economy. While value protection is important, future-facing firms will generate higher returns by incorporating an ESG approach that systematically targets ESG based value creation and proactively invests behind the sustainability megatrends.
To truly realize the full potential of ESG we believe that PE firms should consider the following:
• Setting a strategic vision, and fostering a culture that sees ESG as a significant value creation opportunity
• Establishing the firm’s ESG investment strategy and process for identifying ESG market trends
• Moving due diligence from compliance to ESG best practice, to generate superior returns
• Ensuring companies become “ESG strong” during ownership to benefit from a higher exit multiple
Stocks, multiples, and valuations in general of companies with strong ESG credentials and robust climate strategies have outperformed those of peers this year
The world is changing. Forces from all directions are pushing governments, regulators, businesses, NGOs, and investors to build a more sustainable future – and fast. This sustainability shift and resulting disruption is creating significant investment and value creation opportunities for the astute investor.
Integrating ESG into Investment Decisions
ESG factors and aspects play a pivotal role in the valuation of an asset in terms of both ascertaining its current value and protecting the initial investment, as well as gauging the potential for value creation and defining an asset’s ESG trajectory and shaping the exit strategy.
Capitalizing on the Biggest Investment Opportunity of the Decade
The megatrends underpinning the transition to sustainable economies create genuine opportunities to outperform while also creating a positive legacy for society and the environment. Addressing this opportunity does not need to be resource intensive; in fact, there is evidence that structured approaches are more, not less, efficient than reactive ones. The scale and pace of change means that ESG can no longer be considered a small corner of the specialist investment world, a tickbox exercise or simply a risk management framework.
ESG and sustainability themes need to be at the core of investment strategies, decisions, and processes if PE firms are to continue raising capital from increasingly ESG- focused LPs and to capitalize on the biggest investment opportunity of the decade and beyond. There is a need for significant investment to address pressing sustainability challenges and a clear role for investors to play in the transition to a sustainable, low carbon and equitable economy.
The growing ecosystem of ESG regulations, voluntary disclosure frameworks, incentives and targets are driving corporate leaders and financial players to make sustainability commitments and disclosures. Financial organizations – and their clients – must respond to quickly changing sustainability policies and increasing stakeholder scrutiny.
ERM is an advisor to more than 500 corporate and financial sector organizations, building on our technical, strategy, legal and in-house private market, and banking experience.
ESG risks and opportunities have entered the mainstream and become inextricably linked to corporate strategy and business outcomes. Faced with this, companies have an opportunity to position themselves to act on the challenges and opportunities presented and to turn them into a competitive advantage.
A proactive business response to ESG risks and opportunities has the potential to protect and maximize the top-line by being more aligned with customer expectations, increasing innovation, reducing operating costs, and lowering cost of capital via participation in sustainable finance products. Facing up to these challenges will also better position companies to tell their ESG stories more authentically – creating narratives which can be directly increase enterprise value (EV).