Sustainable value creation for private equity through the ESG lens
09/07/21
Focus on ESG shifts from compliance to value creation
Private equity (PE) is increasingly paying attention to the ESG factors (environmental, social and governance) in transactions and portfolio management. The focus is on value creation, where compliance was historically the main driver, as recent PwC research and the practical experience of Viviana Voorwald and Remco van Daal show. They talk about how PwC supports PE houses to identify value creation opportunities through the ESG lens.
PE wants to contribute to society and create value
'ESG has been in the spotlight of private equity for many years,' says Remco van Daal, PE Industry Leader at PwC Europe. Almost all PE houses have a responsible investment strategy, an ESG policy and the necessary monitoring tools. The focus on ESG was initially on compliance: making sure you don't do anything stupid. We have noticed that our large PE clients also look at ESG to do good and to create value. These are not mutually exclusive and we are increasingly noticing that they reinforce each other in the rapidly changing environment.'
The shift from compliance to value creation is also the conclusion of the Global Private Equity Responsible Investment Survey 2021, for which PwC spoke with 209 PE houses in 35 countries. Whereas in the 2019 survey risk management was still the main driver of ESG activities, respondents now cite value creation as one of the key drivers.
Our analysis naturally leads to conclusions about compliance, but we also investigate what the opportunities are if points on these ESG axes are improved. The central question is how the client can achieve the same or a higher financial return with a higher ESG return'.
ESG policies lead to increased shareholder value
‘We see this development in other sectors as well,' explains Viviana Voorwald. The integration of ESG in business activities has developed from intrinsic motivation as well as driven by financial institutions and investors. And in Europe, the increasing pressure of EU regulation certainly plays a role.'
Voorwald also refers to research by Harvard, among others, which substantiated already years ago that companies that focus on non-financial (ESG) indicators have a better financial performance and therefore create more shareholder value than companies that don’t. 'Research also shows that companies can implement higher price increases on sustainable products than on non-sustainable products. The fact that good performance on ESG KPIs creates value is increasingly clearly demonstrable.'
Applying ESG to all aspects of the transaction
Van Daal indicates that PwC supports many large PE firms worldwide in embedding the ESG strategy based on a vision of value creation. He is not surprised by the growing interest in ESG: 'External stakeholders are asking for it, and interest in ESG is also growing within PE firms because they see that it adds value. I see it as an evolution. Twenty years ago due diligence was also strongly risk-based. That evolved into looking for opportunities to create value. We are now seeing the same development with ESG. Van Daal explains that PwC looks at the commercial, financial, tax and HR aspects through an ESG lens. We differentiate ourselves from others because we can apply ESG to all these aspects of a transaction.'
Higher financial and ESG returns
Van Daal continues: 'Prior to a transaction, or during the life cycle of portfolio companies, we can map out how the company is positioned along the ESG axes. This analysis naturally leads to conclusions about compliance, but we also investigate what the opportunities are if points on these ESG axes are improved. What, for example, are the commercial opportunities of a more sustainable product? What financial impact does lower water consumption have? What are the tax benefits of reducing CO2 emissions? And what are the consequences for HR if working conditions improve? The central question is how the client can achieve the same or a higher financial return with a higher ESG return'.
Contribution of ESG to valuation in deals
The analysis of opportunities through ESG is an opportunity for sellers, but also upon acquisition it is important to work on a good ESG assessment, says Voorwald. PwC also conducts research into the contribution of ESG factors to the valuation of companies, as Manoël de Goeij recently explained, and weighs ESG in valuation models on the basis of that knowledge. Voorwald: 'The most obvious influence is seen in companies that contribute strongly to sustainability, such as companies operating in the field of renewable energy. The EBITDA multiple there has visibly risen in the past three years. But we also see a clear impact on value in other industries.'
Sector-specific opportunities for private equity
Sustainability partner Joukje Janssen said about the PE sector earlier that there are more opportunities than just CO2 measures, diversity and governance issues such as combating bribery and corruption. Voorwald also sees opportunities for private equity to take it further: 'Although this goes hand in hand with a strategic choice: do you want to comply with minimum regulations, do you want to be best in class or something in between? But in practice we see that sometimes unsuspected opportunities for value creation emerge by making an analysis through the ESG lens even before an investment is made’.
According to Voorwald, those opportunities also depend on the sector in which the company operates: 'That's why we base ourselves on an extensive analysis of the value drivers per industry done by Strategy&, PwC's strategy consultants. We are constantly updating our knowledge on ESG for PE and in transactions'.
One hundred thousand extra colleagues for ESG
PwC's own strong commitment to ESG is evident from the recent presentation of the global strategy in which the firm is investing twelve billion dollars to recruit one hundred thousand people to work primarily on ESG themes. Van Daal: 'PwC is the number one in mergers and acquisitions worldwide and we also have had a large, flourishing sustainability practice for years. We successfully bring the two together. We've been doing that in the Netherlands for some time, and with this strategic investment in people we'll be supporting companies even better in the process of value creation.'
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