Social concerns increasingly important in European consumer M&A

Divya Grover and Barbara Pianese
12 October 2021

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As ESG increasingly factors into European consumer firms' M&A decisions, social concerns are gaining prominence, according to a number of sector advisers. Divya Grover and Barbara Pianese report

In the burgeoning field of environmental, social and corporate governance (ESG), "the S is on an upswing," says James Potts, head of EMEA Activism Defence at Barclays. "We have just started to see the tip of the iceberg [for its impact on M&A]."

The social side of ESG includes ethical supply chains, modern slavery, diversity and inclusion, wage gaps, and health and safety, with each "having the potential to become a liability" for sponsors, says Domenic Brancati, CEO for the UK and Europe at Georgeson.

Though the consumer sector lags behind other business areas in addressing social concerns, its leaders are embedding ESG into working practices, with their due-diligence teams attuned to M&A targets' red flags, says Dhruv Sarda of Alvarez & Marsal. In addition, consumer-focused PE firms are hiring advisers to weigh up ESG factors alongside financial, technological and operational due diligence.

Unilever has taken up the mantle for the sector, according to two advisers. For a start, the company has said on the record that it will only buy assets that align with its ESG criteria. "Deep consideration of ESG values and behaviour is front of mind in all of Unilever's acquisition activity," says David Scott, co-head of consumer goods & retail at Baker McKenzie. He also notes similar public statements by Nestlé, Danone and others in the sector.

Social issues are also not only a factor in Unilever's acquisitions but also in its disposals, says a source familiar with the company's sale of its black-tea business. With a significant part of the black-tea business's supply chain running through Pakistan, PE funds bidding for the asset are working on behalf of their concerned LPs to ensure that its goods are ethically sourced. Unilever declined to comment.

Elsewhere in the market, some transactions have been called off before signing specifically due to ethical concerns, says Jacqueline Windsor of PwC, citing firsthand experience.

Still, even as many sponsors and strategic buyers are less willing to shell out for assets in which they have identified ESG risks, these concerns are not a deal-breaker for everyone. This is assuaged further by the fact that some regulatory and litigation risks can be addressed by seller indemnities, says Vanessa Jakovich, a partner at Freshfields Bruckhaus Deringer.

Diverging valuations
Compared to environmental and governance concerns, social issues are "softer" and therefore harder to account for, even as their effect grows on investor sentiment, Potts says. But with an eye to downside risk, these issues may get more prevalent in the future, hurting valuations. Worker rights in apparel production is a particular issue on the watch-list, with Windsor summing up that a reputational risk today might become a compliance risk tomorrow.

As for the upside, consumer firms are starting to seek targets with a "socially conscious aspect" to improve the overall group's brand value, Jakovich says. Even as consumers punish businesses that fall short of ethical standards, they reward those that meet them, Windsor adds.

Furthermore, competition for ESG-compliant assets is driving multiples up. ESG is expected to have a "higher weighting on valuations in the next three years than it does today", says Alvarez & Marsal's Sarda, noting the growing regulatory and competitive pressures on companies to set and report progress to meet ESG goals. Firms that are perceived as "value-accretive" from an ESG perspective are likelier to draw investment and demand higher valuation multiples.

Freshfields partner Andrew Hutchings argues it is hard to separate a deal's ESG motivations from its overall business case, but he also agrees that ESG is a key driver for M&A in the sector.

E and G
This is not to say that the environmental and governance topics are less impactful. But environmental risks in particular carry a more easily quantifiable downside than social ones: businesses that perform poorly on the E in ESG will likely face increased credit risk and reduced access to, or higher costs of, insurance products, says Philip Bloomfield of PwC. A further upside to good environmental behaviour is that lower energy consumption and reduced water usage can deliver cost savings.

With that in mind, acquirers are already on alert. "Companies are moving away from business models that are based on non-sustainable supply chains," Freshfields' Jakovich says. To do this, brand portfolios, particularly in the fashion space, want targets that have embraced sustainability. Categories that have benefited from Covid-19 – such as skincare and 'enthusiast' activities from cycling to gaming – are also assets to watch, Windsor says. Food and drink – with attendant concerns about products' disposability – is another relevant segment, says Scott.

Meanwhile, good governance has long been important. In turn, stakeholders are now well positioned to hold companies to account on ESG compliance across the board, Jakovich notes.

Overall, the future is bright for businesses that perform well on ESG metrics. "There is a significant interest in climate-friendly, healthy, sustainable brands that can articulate purpose beyond profit," says Sarda. "Attractive acquisition targets are likely to be both innovative and purpose-led."

Deals in the sector this year that highlight this trend include US-based snack company Hershey's acquisition of US-based low-sugar confectioner Lily Sweets for USD 425m; PE firm Astorg's purchase of France-based Solina Group, which produces healthy and sustainable food; and Unilever's acquisition of US-based skincare brand Paula's Choice.