[Ed. note: This blog was originally written for us by our research intern Tristin Young.]
Climate commitments and emissions reductions targets are now important enough that they are impacting M&A. Companies take on the GHG emissions of the acquired businesses at at time when GHG reduction commitments and goals are common. Almost 35% of the world’s largest companies have Net Zero commitments. However, a study from Accenture predicts that 93% of companies with these commitments will fail to achieve Net Zero if they don’t at least double their rate of emissions reduction by 2030. As 2030 looms closer and public demand increases, more companies are feeling pressure to make commitments addressing their carbon footprint.
Yet M&A has skyrocketed from a historical perspective. Rising from 2,676 global transactions worth $347 billion in 1985 to 57,947 transactions worth over $5.2 trillion in 2021. According to surveys, 58% of M&A advisors predict an increase in middle-market deal volume in this year.
So how is this seeming contradiction between M&A growth and decarbonization playing out in the market? How companies calculate the value of merging with or acquiring companies with/without carbon emission commitments depends on a few key considerations:
- Opportunity costs: When a company with carbon emission reduction commitments is acquired by a company without them, the acquirer must factor in the additional costs of meeting unmet commitments. This could include investments in new technology, changes to business practices, or even the divestment of certain assets or operations that are particularly carbon-intensive. Accounting for additional costs tied to carbon emission reduction commitments will likely impact the bargaining process or even the perceived sale price of the acquired firm. Acquiring a firm that has made progress on its commitments could increase its perceived value because successful climate reduction initiatives can be viewed as a value creator rather than added costs or liabilities.
- Reputational impacts: If one or both of the companies involved have already made significant progress on their commitments, then a deal may be viewed positively by investors, customers, and other stakeholders. The combined entity may be seen as able to accelerate climate-related risks and opportunities. Additionally, increasing shareholder activism is likely to affect board decision making and priority setting in the M&A space. On the other hand, negative impacts may also be felt from missing or changing initial Net Zero goals as a result of taking on increased emissions of the acquired company. Some investors and other stakeholders are likely to consider the transaction a signal that the company has abandoned climate commitments altogether.
- Higher carbon costs: Companies may hesitate to pursue a merger or acquisition if doing so would result in a significant increase in carbon emissions. This hesitancy could come from a variety of concerns, such as fear of reputational damage; potential impact on shareholder value/activism; board shakeups; increased regulatory burden/cost; changes in ESG ratings of reputational damage; and increased operating costs due to the higher emissions.
A wide variety of factors weighs into the decision making. Risks and rewards are viewed differently by companies and the impacts of emissions reduction targets on M&A are highly contextual. Some of these factors include:
- Industry: Each industry has unique settings of public visibility/accountability, carbon dependency, or supply chain visibility that will influence their perspective. For example, in the oil and gas industry, research from the Environmental Defense Fund suggests that oil and gas assets are viewed as being liabilities to companies with climate commitments. They state that: “in aggregate, upstream oil and gas assets are being transferred from companies with climate commitments and public disclosure requirements to companies without those safeguards. This means that while such transactions may help companies reach their own corporate emissions reduction targets, they do not contribute to global greenhouse gas emissions reduction—and may even result in global emissions increasing.” At the same time, private equity are more willing to take on these risks and had been actively acquiring oil and gas operations.
- Geography: Cross border M&A may be particularly impacted by ESG considerations such as carbon emission reduction commitments. Foreign companies with weak ESG track records are viewed as being less attractive to western companies. This is particularly illustrated by companies in Latin America. Despite this trend, research indicates that some high emitting companies have an interest in acquiring foreign assets subject to more relaxed ESG standards. They state that “Acquirers with high carbon emissions are more likely to choose foreign targets in poorer countries with fewer regulations protecting shareholders and weaker environmental controls. This is particularly true when the acquirer’s home country is wealthy and has strong shareholder protection.” This could be perceived as outsourcing own carbon risks to other areas of the world in an effort to circumvent high levels of domestic regulation and cost.
- Corporate Transparency: Availability and accuracy of data regarding the target company’s progress on their emissions reductions is important in general, but certainly in M&A. Greenwashing presents a risk that target companies are using reduction commitments as a means to generate goodwill – or just marketing – without follow through. Transparency and accurate data determine if carbon emission reduction commitments are an asset rather a potential liability. Unfortunately, these data characteristics are generally lacking at the moment. Therefore, extra due diligence by the buyer into target company climate claims and actions may be necessary.
What This Means
There is no clear answer as to how emissions reductions targets affect M&A activity at the moment – the highly contextual nature of M&A leaves us at “it depends.” However, emissions reduction targets are an issue that stakeholders care more about by the day. Companies need to consider their own individual and sectorial factors. Neither climate commitments nor mergers and acquisitions are going away soon. Not long ago, Meredith blogged over on DealLawyers.com, “Whether your client or company is addressing ESG from the perspective of strategy or risk avoidance, clearly there are some ‘pain points’ associated with considering ESG factors in M&A strategy and execution.”