The connection between ESG and value creation

Ruari Sinclair, Director, BDA Partners, shares his insights with Morrison Foerster and AVCJ in the Asia Funds ESG Report 2023.

To what extent do investors regard ESG as a driver of value creation?

Value creation and superior returns on exits are widely considered globally, and now in Asia, as the critical driver for ESG initiatives with financial sponsors. We see ESG being integrated more and more into the post-acquisition value creation plans. However, we also see differences in ESG approach and maturity across the region by different financial sponsors, industries and portfolio companies. There is still a lot of work to do in Asia for ESG, but it is certainly gaining momentum.

How do you demonstrate the ESG value?

This is a key question that we get asked regularly. The reality is the ESG valuation premium is specific to each company and exit process. It remains challenging to give even a ballpark estimate for the IRR or multiple uplift from successful ESG initiatives, let alone a precise one. However, through various factors such as measurable ESG data, financial analysis, benchmarking and good leadership, we believe a premium valuation can be achieved on exit. Finally, ESG is now a recurring cost (or investment) of operating and owning a business. You can’t ignore ESG because if you do, you may lose your competitive advantage, fall on the wrong side of the increasing regulatory requirements and greenwashing risk. ESG improvements and value creation takes time and requires significant expertise and resources to create value.

Where is value most likely to come from?

There is a range of ESG factors now responsible for creating value on an exit, but we need to identify these on a case-by-case basis. As companies strive to have more sustainable business models, they focus on new product development, entering new markets, developing cleaner manufacturing processes, supply chain improvements, etc. Focusing on the ESG value factors, which are most material to the company and the industry, will yield the highest returns on an exit. We are currently working on a sale process for an Asian sponsor for its European consumer portfolio company. The company is facing increased product sustainability regulation changes in the coming years. They have invested significant resources and leadership to create a more sustainable product which will create significant environmental benefits for customers and employees, along with improving profitability from the new products and a cleaner manufacturing process. We believe communicating the ESG equity story will support the investment thesis for the company being a market leader, commanding a premium valuation on exit. Finally, further value from ESG initiatives will start becoming more prominent with wider use of sustainability-linked financing where the interest rate of the credit facility will be linked to agreed targets, such as reduction in greenhouse gas emissions (GHG) and gender diversity.

How does BDA approach ESG in an M&A sales process?

BDA has established an ESG Transaction Advisory team where we work with clients to better understand the material ESG initiatives, opportunities and risks relevant to their portfolio company.

ESG is now more integrated into both selland buy-side due diligence, especially for financial sponsors and how they look at acquisitions at various stages through the acquisition process with their investment committees. Consequently, this needs to be communicated early in a sales process to avoid sponsors rejecting an opportunity for not being able to address key ESG questions.

The BDA ESG Transaction Advisory team follows three steps during the M&A sales process.

First, we communicate in our sell-side marketing materials the company’s successful ESG initiatives to date, the stage of the company’s ESG journey and future ESG strategy.

Secondly, we are recommending to our clients to include ESG vendor due diligence (VDD) along with other VDD reports. ESG VDD can also be connected with the commercial and financial VDD reports to help evidence the financial and commercial drivers. To the extent material—and where the data allows—any ESG driven margin improvements, new product launches and capex should be separately identifiable in the financial model to evidence the value creation.

Thirdly, being aware and on the front foot regarding key risk ESG due diligence topics such as GHG and supply chain reporting (especially in Asia) will help preserve value. Supply chain is a particularly important topic for companies in Asia serving customers in the West, where modern slavery, health and safety, and labor rights are gaining increased focus. This became a key diligence topic when we advised on the recent sale of Hop Lun to Platinum Equity. Communicating the ESG value creation story and addressing any risks early in a sales process will help increase buyer interest globally, avoid sale process disruption and maximize returns on exit.

About BDA Partners

BDA Partners is the global investment banking advisor for Asia. We are a premium provider of Asia-related advice to sophisticated clients globally, with over 25 years’ experience advising on cross-border M&A, capital raising, and financial restructuring. We provide global reach with our teams in New York and London, and true regional depth through our seven Asian offices in Mumbai, Singapore, Ho Chi Minh City, Hong Kong, Shanghai, Seoul, and Tokyo. BDA has deep expertise in the Chemicals, Consumer & Retail, Health, Industrials, Services, Sustainability and Technology sectors. We work relentlessly to earn our clients’ trust by delivering insightful advice and outstanding outcomes.

BDA Partners has strategic partnerships with William Blair, a premier global investment banking business, and with DBJ (Development Bank of Japan), a Japanese Government-owned bank with US$150bn of assets.