Frankfurt/Main – ESG is now an issue in the M&A market, with more and more attention being paid to potential ESG risks and value drivers when selecting suitable targets. As such, companies are increasingly engaging in ESG due diligence. Those are the findings of this year’s second M&A panel polled by international commercial law firm CMS and Finance magazine. The survey was conducted among senior employees from the M&A departments at German companies plus investment bankers and M&A consultants.
The poll shows that almost two thirds of respondents already conduct ESG due diligence on buy-side transactions. Only around 14% state that they carry out conventional due diligence. As recently as the start of the year, ESG was not a significant factor. Its new-found importance reflects the simple reality that ESG risks, such as supply chain problems or an unsustainable business model, can be deal breakers. Almost three quarters of M&A professionals agree with this proposition.
Environment and corporate governance most relevant
The M&A professionals included in the survey agree that ESG is not just a short-term concern. They rate its importance in their M&A transactions at 6.69 on a scale of 1 to 10, where 10 indicates high importance. Only seven per cent of respondents agree with the proposition that its significance will fade over time. ESG factors are not all equal, however. Most respondents rate Environment as the most important, awarding it 7.55 points on a scale of 1 to 10, followed by Governance at 7.21 and Social on 6.83. Having said that, ESG plays only a subordinate role in the everyday working life of M&A professionals. Only 17% indicated that they use M&A transactions specifically to boost their own ESG expertise or to improve their sustainability.
ESG has low impact on loans and multiples
ESG compliance is currently not a key focus for investors in M&A projects. That could also help to explain why M&A professionals still attach little importance to the issue in their actual day-to-day work. Only around 28% of all funders (banks or private equity investors) have a preference for financing ESG-compliant transactions. Some 17% state that they have no such preference, while more than half are unsure. This supports the view that M&A professionals have sufficient funds available for projects that are not ESG compliant, meaning there is no compelling reason to engage more deeply with ESG.
Similarly, the influence of ESG on M&A prices is less than expected. Only 10% regard ESG factors as having a significant impact on the purchase price, 28% believe there is no major effect on M&A valuations, and around 55% are uncertain about the influence on the purchase price. Corporate M&A bosses will likely not address the issue more vigorously until ESG criteria are reflected in the purchase price. “ESG is still a relatively new phenomenon in the transaction market,” agrees Dr Tobias Grau, a partner specialising in transactions at international commercial law firm CMS. At the same time, there is a growing awareness that good ESG credentials are a key factor in the future success of a target company, he added. “That calls for thorough due diligence, because ‘greenwashing’ isn’t enough,” said Grau.
High workloads in the market
High workloads are a prominent feature of the market at present, in addition to the growing relevance of ESG. The current workload of the M&A advisors and investment bankers included in the survey is now higher than ever before. On a scale of -5 (well below average) to +5 (well above average), M&A advisors put the current level of in-house project activity, seen in terms of deal signing in the past month or next two months, at a very high 2.18. The highest level recorded to date since the start of the survey in 2011 was 2.14 in the spring of 2018.
However, the level of project workload also depends to a significant extent on the type of deals an M&A consultancy firm generally handles. Those that predominantly advise on small-cap transactions are the least busy at present, currently assessing the volume of their work at 1.6. In contrast, the workload of mid-cap and large-cap advisors (project value more than EUR 40 million) is substantially higher. Their current project deal flow is rated at 2.87, up 0.79 compared to spring 2021. “We can confirm that there is a high level of deal activity across all segments, small, mid and large-cap,” said Dr Oliver Wolfgramm, a partner at CMS Germany. “This now includes almost all sectors, not just the less cyclically sensitive ones.”
M&A advisors also continue to assume a very high deal flow in the coming three to eight months (2.58). Mid and large-cap consultants returned a score of 3.07 for their future workload; small-cap advisors rated theirs at 2.17.
Higher activity in previously weak industries
Advisors’ ongoing projects are no longer just related to crisis-proof sectors. Even sectors that have been out of favour posted higher activity. The most active sector is still software/IT, standing at 8.88 (where 10 indicates a very high level of activity). This represents a further increase over the 8.59 reading seen in the spring 2021 survey. The score for the pharmaceutical/healthcare sector, meanwhile, has declined compared to the spring (8.07, currently 7.85). The same applies to the third most active sector, retail/e-commerce (currently 7.08, spring 2021: 7.4). In contrast, gains were made by sectors previously regarded as less attractive. Activity in the automotive sector increased to 4.97 compared to 4.71 in the spring, for example. Transport and logistics likewise saw stronger activity, rising by 0.12 to stand at 5.91.
Corporate growth as an M&A deal driver
Following the acute coronavirus crisis, a desire to accelerate growth is once again at the top of the corporate agenda. Growth is currently the main driver for M&A, at 7.76 (where 10 indicates a very important deal driver). This is followed by expansion into new markets (7.52) and extension of the product and technology portfolio (7.48). These figures indicate that priorities have shifted only slightly compared to the spring. Alongside growth (7.97), the surveyed M&A advisors and investment bankers see two other deal drivers: industry consolidation (7.28) and boosting market share (7.14).
There are also many target companies up for sale at the moment. M&A professionals largely agreed with the proposition that there are strategically attractive takeover targets on the market, producing a score of 6.93, where 10 represents high agreement. “A strong propensity to buy and a large supply of attractive targets are turbo-charging M&A activity,” said M&A expert Dr Tobias Grau. The M&A lawyer points out that rising energy prices and supply chain issues could become a spoiler, however.
Private equity gains further prominence as a source of finance
The other good news is that acquisition finance is readily available at present. With a score of 6.21 out of 10 points, M&A professionals currently see themselves in an extremely good financing environment. A similarly high level was last recorded in summer 2015 (6.47). But it remains to be seen how rising inflation will affect the availability of finance and M&A prices. In terms of sources of financing, firms’ own cash resources still rank first with a score of 7.9 (where 10 indicates very high importance). That is the lowest figure since 2017, with economic easing clearly being a factor. The second most important source of capital are bank loans at 6.59, followed by the bond market (5.69) and capital increases (5.0). Overall, however, another source of finance is becoming more prominent: at 4.59, private equity ranks well below the other sources of finance, but at the same time posted the biggest rise compared to spring 2021 (when it came in at 3.24).
The overall relationship between private equity and strategic buyers is nonetheless rather ambivalent. On the one hand, they are welcome investors, but on the other they are also rivals in the search for the next platform deal or add-on for a portfolio company. Agreement with the proposition that strategic buyers have the upper hand when it comes to competing with private equity investors is only 4.9 points (where 10 represents complete agreement). This means that for the first time since the survey was launched, companies rate private equity as having the edge over corporate players. However, lawyer Dr Oliver Wolfgramm doesn’t yet see private equity investors dominating the German M&A market: “Strategic buyers and private equity investors compete on equal terms,” he noted. “There’s a lot of money in the market, competition is fierce and financing terms are good.”
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