Q2 | Torys QuarterlySpring 2023

Increasing ESG focus in M&A transactions

The focus on ESG considerations in M&A transactions has been steadily growing over the last several years. Corporate stakeholders, buyers, sellers, institutional investors, lenders and proxy advisory firms are according a higher priority to ESG matters, including in how they view M&A transactions. This has become particularly acute for larger public and multinational companies. Parties increasingly understand that a robust approach to ESG issues at all stages of a transaction is critical to success. They also understand that ESG factors can be employed as an important value creation lever.

The approach to ESG issues is becoming more sophisticated, with the following trends becoming apparent.

Need to articulate a clear ESG narrative

It has become increasingly important for both buyers and targets to articulate a clear ESG narrative for the transaction, alongside commercial and financial rationale. The deal should be compelling from all of these perspectives in order to build support from key stakeholders as well as proxy advisory firms. In articulating a clear ESG narrative, parties should indicate how the transaction is consistent with and advances their own ESG principles and objectives and that they have carefully considered the ESG impacts and sought to proactively address or mitigate any significant concerns. Any specific ESG benefits of the transaction should be highlighted and plans for addressing any shortcomings should be explained.

Parties increasingly understand that a robust approach to ESG issues at all stages of a transaction is critical to success and that ESG factors can play a role in value creation.

Parties have been focusing in a more sophisticated manner on laying out and advancing ESG narratives in their initial public announcements of transactions. For example, in the announcement of its recent unsolicited proposal to combine with Teck Resources, Glencore stated that:

[it] remains committed to supporting the goals of the Paris Agreement and intends to respect the net zero climate strategy Teck has announced in respect of its steelmaking coal operations” and that “[it] intends that [the resulting combined coal operation] would oversee a responsible decline of its thermal coal portfolio production in line with Glencore’s current ambition to achieve net zero by 2050.

Similarly, in the original announcement of CP Rail’s recently completed combination with KCS, the joint announcement press release highlighted that:  

We have been champions for the environment recognizing the important role rail plays in lowering overall transportation emissions. This combination advances our shared science-based pledges in-line with the Paris Agreement to improve fuel efficiency and lower emissions in support of a more sustainable North American supply chain.

Advancing the ESG narrative should continue to be a key communications focus for the parties throughout the transaction process. Failure to adequately and continuously promote a transaction’s ESG narrative and address related ESG concerns can leave a transaction more susceptible to stakeholder discontent, activist challenges and even interloper approaches.

ESG influence on target selection and assessment

ESG considerations play an increasingly important role in buyers’ selection and assessment of transaction opportunities. Beyond general factors, buyers are incorporating ESG factors into their financial modeling in determining target valuations. Targets with ESG shortcomings may not be viewed as worthy of engagement or may be accorded a valuation discount. Conversely, targets with attractive ESG credentials and that would advance a buyer’s ESG profile and strategy will generally be seen to be more desirable and may be able to extract a higher valuation from a buyer.

Buyers are also focused on evaluating how targets’ ESG performance and commitments fit with their own ESG principles and strategies. This extends to considering issues such as how the target will impact the buyer’s post-closing greenhouse gas/carbon reduction targets and compliance with growing mandatory and voluntary ESG disclosure and transparency obligations. Buyers will need to focus not only on the ability to comply with those obligations, but also on the expected results of the disclosure and how they will reflect on the buyer post-transaction. For example, a buyer who acquires an industrial business in a jurisdiction where the power supply is predominantly generated from fossil fuels may recognize a significant impact from the acquisition when reporting on its carbon impact on a combined basis post-transaction. Other areas of key focus include supply chain matters and employee working standards, particularly in emerging markets jurisdictions.

Analysis of ESG opportunities

Through the target selection and assessment process, it is important to identify and understand both the target’s ESG weaknesses and its strengths. A buyer will need to be confident that it can address and improve any weaknesses—whereby value creation can be delivered by enhancing the target’s ESG performance. Conversely, a target’s ESG strengths and successful implementation of ESG strategies can be levered by the buyer on an organization-wide basis.

Buyers ought to articulate and promote a strong narrative of the net ESG benefits of the transaction and how the transaction will lead to significant ESG improvements in the long term.

Opportunities may arise for a buyer to make key ESG commitments in connection with an acquisition. For example, in the recently completed Rogers Communications acquisition of Shaw Communications, Rogers committed in the transaction announcement to establish a new $1 billion fund dedicated to connecting rural, remote and Indigenous communities across Western Canada to high-speed internet and closing critical connectivity gaps for underserved areas. In the resources sector, acquisitions often provide buyers with important opportunities to make new ESG-related commitments. Likewise, in announcing its agreement to acquire Sabina Gold and its project in the Black River Gold District in Nunavut, B2 Gold noted its commitment to respect and collaborate with the local Indigenous community and to develop the project in a manner that recognizes Indigenous input and concerns and brings long-term socio-economic benefits to the area (see our article “Indigenous involvement in major projects: 3 best practices to thrive in the evolving projects ecosystem” for more). B2 Gold also announced its intention to explore the development of a renewable wind power facility for the project (including to support B2 Gold’s existing greenhouse gas emissions reduction targets) and to assess the possibility of introducing a green hydrogen powered mining fleet.

Complexity of ESG considerations in certain transactions

In the case of some transactions, the ESG considerations can present additional complexity as different buyers may look at ESG matters from different perspectives and have different objectives. Some buyers may view a target with ESG shortcomings as an opportunity to enhance the target’s ESG performance and hence create a net ESG gain once buyer and target are combined. For example, target companies that are heavily fossil fuel dependent may be attractive to buyers seeking to invest in an energy transition opportunity. They may also be attractive to buyers who could serve as responsible owners of those assets while in the medium to long term reducing their carbon intensity—even though the acquisition would increase the immediate overall carbon intensity of the combined company. In these types of cases, it is important for buyers to articulate and promote a strong narrative of the net ESG benefits of the transaction and how the transaction will lead to significant ESG improvements in the long term. As part of this, buyers may consider making specific ESG commitments to support the strategy and messaging. Buyers need to consider the ESG priorities of their shareholders and broader stakeholder base and whether (and how to ensure that) the transaction will receive sufficient support from the various corporate constituencies and the market in general.

ESG activism

Once a transaction is announced, it may be subject to shareholder criticism or activist challenges on ESG grounds. Also, parties may be confronted with newly occurring ESG problems that cast doubt on their ESG credentials. As seen in other contexts, activists and NGOs are increasingly likely to focus on ESG issues to criticize or challenge transactions (in the case of other contexts, see for example our article “Shareholder litigation and corporate ESG policy: ClientEarth v. the directors of Shell plc”). In the event of such challenges or occurrences, transaction parties should promptly reiterate their commitment to ESG principles, show that extensive investigatory work was indeed done during the diligence process and lay out a credible and proactive plan to address the issues as soon as possible.

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