DealMakers AFRICA Q2 2021
ESG considerations set to increasingly influence dealmaking, investment and growth in Africa
by Duran Ribeiro
Environmental, social and governance (ESG) factors are now quintessential points of discussion, and key strategic informants, in most boardrooms around the world. Some organisations use ESG as the foundation for their vision and strategy, and some seek to leverage ESG factors in an attempt to enhance their public image. Others focus on the potential return, risk mitigation and long-term value that ESG prioritisation can deliver to the firm and, in some cases, to the broader community in which they operate.
From an investment perspective, ESG is primarily concerned with the long-term impact that a company, fund or other investment vehicle can have on the environment, society, and organisational performance. Investors that prioritise these ESG considerations typically follow a strategy of investing in companies that can demonstrate that they are working to make the world a better place or, at least, reduce the negative impact of their operations on the environment.
In recent years, there has been steadily increasing evidence that a strong ESG proposition can create significant value for all stakeholders, including investors, which is why there has been such a significant increase in investor focus on ESG factors when selecting investment opportunities. There is no doubt that ESG is becoming an increasingly important driver of deal activity. Investors no longer simply evaluate balance sheets and financial projections; they want to see evidence of far more complex, nuanced factors that influence long-term value creation. A sincere and measurable ESG commitment is often at the top of that list of non-negotiable factors.
It is not just investors who want to see evidence of this ESG commitment. Regulators and customers have the same expectations of companies, which means that organisations are under pressure from all sides to ensure that demonstrable ESG commitment is one of their most urgent priorities. Small wonder, then, that according to research done by McKinsey, 83% of C-Suite business executives say that over the next two years, ESG factors will become increasingly important to them in their assessment of potential merger and acquisition (M&A) opportunities. This feedback reinforces the fact that companies are increasingly looking beyond whether an acquisition is just a good fit from a business perspective; they are also carefully considering how the M&A transactions they enter into will positively impact their all-important ESG strategies, helping to fuel long-term value, as well as mitigate risks.
Of course, strategic fit and aligned financial profiles are likely to always be the most important factors influencing any company’s M&A strategy, but it can be argued that ESG considerations are a significant component of that strategic fit. In fact, there is likely to be an increasing trend towards selecting an M&A target company based on the potential that it offers to enhance the acquiring organisation’s ESG profile. Irrespective of the proportion that ESG considerations make up of the overall M&A assessment, though, the undeniable reality is that ESG will have a part to play in almost every such valuation. And as ESG considerations become more influential in the process of identifying M&A targets, they will also become increasingly important in the pre-deal due diligence process.
Interestingly, however, while ESG considerations have emerged as an integral part of identifying M&A targets, focus on this significant topic has still been all but absent from the vast majority of deal announcements. This will likely change as investors increasingly expect greater ESG transparency from companies in every aspect of their business. When pursuing a transformative deal or adding assets to impact strategy, investors want to understand how the move creates value and how that value is preserved and/or enhanced in the long term, through ESG initiatives.
Based on this expectation, the investment community today views ESG measurement as a core component of effective corporate strategy and, as such, the topic warrants representation in deal communications. It is, therefore, essential that transacting parties acknowledge how ESG considerations impacted the deal process, and how ESG was factored into the entire deal process, from target selection and risk identification to securing finance and preparing for integration. As money continues to pour into funds with a mandate to invest in responsible companies, overlooking communication around ESG in deal announcements could threaten shareholder value.
The COVID-19 pandemic has massively intensified the focus on ESG considerations and standards. This is especially relevant in Africa, where a key focus is obviously ensuring a sustainable recovery from the pandemic. New funding models are needed to underpin this recovery, support those impacted by the pandemic, and ensure a smooth and steady recovery that is sustainable financially, socially and environmentally.
Development financial institutions (DFIs) are key drivers of this recovery, given that they are at the forefront of sustainable developments in emerging economies. But while they have long promoted the ESG agenda, it is only recently that we have seen on-the-ground willingness of projects in Africa to ensure that they are adhering to the same ESG standards prioritised by the DFIs.
As this momentum increases, the DFIs will be in a better position to partner with other finance institutions to develop appropriate, ESG-driven models that can be structured in various ways to propel Africa’s post-pandemic recovery forward.
And it is not just in Africa that the pandemic has given rise to intensified discussions about the interconnectedness of sustainability and the financial system. It is estimated that one in every three investments in the world will be ESG-mandated by 2025. Investing evolves as the world evolves, and ESG investing has become a global phenomenon that is set to shape the way M&A materialises across Africa.
Ribeiro is an Associate: Advisory | Nedbank CIB