With the investment community increasingly taking environmental, social and governance (ESG) factors into account in their appraisal of companies, the green agenda is playing a much more significant role in decision-making on mergers and acquisitions (M&A). After all, the last thing a company wants to do is buy a bad reputation for itself when making an acquisition.
Companies can also use strategic M&A to earn ESG kudos by acquiring firms with innovative environmental technologies or superior labour practices, but this has yet to become a feature of the Irish market.
Barry Dixon, who leads Davy’s newly established renewables team, says there haven’t been many climate-driven M&A yet, but that may change in years to come.
“What we are trying to do is see if we can support businesses in their decarbonisation efforts,” he says. “Most businesses are being impacted in some way. Over the last 20 years we have been making some gains in relation to our decarbonisation targets but we have to do a lot more. The target for Europe is a 55 per cent reduction by 2030.”
That will require businesses to develop new technologies and ways to reduce emissions. “That’s going to require funding,” Dixon says. “Capital expenditure budgets will have to align with decarbonisation targets and strategies. The question is if they develop the technology themselves or acquire it. We are not seeing much M&A to acquire decarbonisation technologies at the moment. The technologies are not there to acquire. Most are at very early stages of development and will have to become more mature before we see a lot of M&A.”
Deloitte M&A advisory partner Jan Fitzell agrees: “It might be early days from an Irish perspective, but we are seeing some large corporations who are maybe a little less flexible and innovative doing some of it. It makes sense for them to acquire technology and capability that they don’t have internally, but it doesn’t always work out. We have also seen some companies set up their own corporate venture capital funds to invest in future prospects in this area.”
BDO corporate finance partner Katharine Byrne foresees increased activity in the renewables sector in the near term. “Since the results of the first Renewable Electricity Support Scheme auction were awarded in September 2020, we are seeing the development of renewable energy projects that have been stuck in planning for a number of years and this in turn will drive more M&A activity, with international buyers seeking to buy up majority stakes in Ireland’s green market. Similarly, there is a lot of investment and cross-border activity in the cleantech sector with global tech companies and tech-focused funds looking to back the next disruptor.”
Deal structure could be a challenge, however. “As ESG continues to dominate the headlines from both a global-corporate and private-equity perspective, the challenge for many deal makers is to formulate an M&A strategy that can adapt to meet the needs of the buyers,” Byrne says. “Innovation underpins the growth of renewable energy and investors need to recognise the balance between the long-term nature of infrastructure and the disruption of new technologies. And while sustainability goals and targets are set at global and local levels, regulators and government support schemes are only catching up, which makes it harder for valuations and funding structures to be agreed.”
These challenges are not having a negative effect on valuations, however. “We are seeing premium valuations for companies involved in renewables and the broad green agenda,” says Deloitte corporate finance partner Anya Cummins.
Sustainability is also being taken into account for deals across the M&A spectrum. “Sustainability is part of due diligence no matter what you are buying and ESG will affect valuations,” she says.
In effect, all companies regardless of sector now have an ESG score, and a low score will depress their value. “All businesses now need to have clear sustainability programmes and policies. The sustainability of their products and processes, how they engage with employees and contractors, and governance issues like cybersecurity, bribery and corruption, and diversity policies all matter. Buyers want to know if a company represents a business risk to them when it comes to ESG.”
M&A activity will ramp up as technologies mature, according to Dixon. “One of the only hard targets for 2030 is 70 per cent of electricity to be generated from renewable sources,” he says. “When it comes to energy-storage solutions, hydrogen is the big one. Technologies are being developed to use wind energy to crack water molecules to manufacture hydrogen. You can inject the hydrogen into the gas grid, use it for electricity generation or for transport fuel.”
It might be early days yet, but the technology could have a profound impact on the energy sector. “How will that work in supply chain?” Dixon says. “There will probably be a requirement for a hydrogen refuelling infrastructure for transport. Filling station operators will have to decide whether they want to invest in hydrogen capacity or EV [electric vehicle] charging points. It could get to a point with the technology where you pull into the station in your car and connect a water point and an electrolysis device to your car and manufacture the hydrogen on the spot. That’s a fantastic concept but it’s a while off yet.”
But when the concept does materialise, its effects could be profound. “We might see M&A along the chain,” says Dixon. “We might see the formation of renewable majors in the same way as the oil majors were formed. At the moment the supply chain is very fragmented. Perhaps it needs to be more integrated. We will also see electricity generation companies moving more into the renewable generation technology space. Capital allocation strategies will have to be rethought. These companies may invest in renewables firms rather than return the money to shareholders in the form of high dividends. We will also see private equity and other funds going into these areas to look for growth and to improve green credentials.”
This activity is set to increase in the coming years. “It’s an exciting space,” says Dixon. “It is being driven by consumer demand, the European Green Deal and our own Climate Action Plan. We are seeing the evolution of an industry, but it will need to be subsidised initially. It is not viable on a standalone basis yet.”