Companies around the world have come to recognise the growing significance of environmental, social, and governance (ESG) factors. ESG has emerged as a widely accepted framework for evaluating companies’ sustainability, social responsibility, and corporate governance practices. In addition, this growing recognition of ESG is now significantly influencing mergers and acquisitions. According to a global survey conducted by Deloitte, 60% of dealmakers worldwide have identified ESG as a crucial criterion in their decision-making for deals and investments.
India, like many other countries, is witnessing a similar trend. The organisations in the country are embracing ESG-driven M&A strategies to achieve their objectives of reducing carbon emissions and meeting the evolving expectations of policymakers, investors, and consumers. With the Indian government’s ambitious target of reducing carbon emissions by 1 billion tons (by 2030), companies in India are already shifting their focus from fossil fuel-intensive sectors towards investments in renewable energy.
ESG is increasingly emerging as a crucial component throughout the M&A journey, from target selection and screening to post-merger integration. There are ways in which ESG is influencing M&A deals and becoming a critical component of the deal lifecycle.
First, ESG evaluation during target selection and screening is becoming a critical component of the deal lifecycle. Today, companies are not only choosing targets that provide them with revenue and cost synergies but also looking at targets as an opportunity to fulfil their sustainability objectives. According to a recent survey by Deloitte India, 75% of CXOs revealed that they were assessed on ESG performance before finalising of the deal. By incorporating ESG as a Key Performance Indicator (KPI) in target screening, acquirers are mitigating financial and reputational risks. Further, conducting ESG assessments presents a valuable opportunity for acquirers to enhance the target company’s sustainability performance even before the completion of the integration process.
For example, a major organisation in the oil and gas industry conducted detailed due diligence on the potential targets in the renewable energy sector for an acquisition. ESG metrics played a significant role in selecting the most suitable target. The selected target was able to demonstrate a superior ESG standing compared with other targets, underscoring the importance of screening targets through an ESG lens. In this case, the company was able to strengthen its ESG posture following the acquisition.
Second, acquiring companies that rank high on the ESG scale can improve returns and enhance brand equity. Businesses that prioritise value-driven practices, give back to society, and maintain strong codes of conduct tend to enjoy heightened consumer support. This support translates into improved shareholder returns, as consumers are more likely to favour and invest in companies that align with their values. Further, acquirers can use the positive sentiment associated with ESG-focussed companies to enhance their brand equity and build long-term success and profitability. In a recent 2023 survey by Deloitte India, nearly 90% of organisations expressed that ESG reporting would benefit their company by enhancing brand reputation.
For instance, a financial investment firm expanding into the responsible investing space developed a comprehensive target assessment strategy. This strategy incorporated an evaluation of the target company’s sustainability positioning, utilising frameworks, such as ESG and the United Nations Sustainable Development Goals (SDGs). The assessment strategy encompassed various criteria, including emissions, workforce policies, and Corporate Social Responsibilities (CSR) strategies. Using this comprehensive approach, the investment firm achieved approximately 2% higher return on investment compared with its competitors.
Third, ESG can also be used as a catalyst to attain higher valuations. Investors are increasingly prioritising positive environmental and social change through their capital allocation decisions. This shift has prompted more organisations to integrate ESG considerations into their operational plans to attain higher valuations. Per Deloitte analysis, companies that can increase their ESG scores by 10 points have witnessed a substantial boost in their enterprise multiple, with an approximate increase of 1.8 times. This demonstrates the financial benefits of prioritising ESG factors, as investors perceive value in businesses that align with environmental protection, societal well-being, and strong corporate governance.
For instance, a traditional power generation company undergoing a transition from coal to renewable resources re-aligned its disparate operating models. The advisor assessed the existing operating model and worked towards aligning it with the requirements of the renewable energy business. By opting for less carbon-intensive operations, the company commanded a valuation premium. Within one year, its price-to-earnings multiple increased significantly, outperforming the industry indexes.
ESG considerations have become a pivotal factor in the M&A lifecycle. Companies are proactively seeking targets that align with their sustainability objectives, resulting in increased sustainability, brand equity, valuations, and returns. By incorporating the ESG principles into M&A decision making, companies can achieve additional benefits beyond financial synergies, such as improved brand reputation, long-term profitability, and resilience in the face of changing societal expectations.
Mayank Jaswal and Anuj Suneja are partners, consulting, Deloitte India. Views are personal.