The growing role, and appeal, of ESG

ESG factors have become increasingly important to investors since their introduction as part of the 2006 United Nation’s Principles for Responsible Investment (PRI). It is safe to say that ESG has become one of the most commonly used terms in many boardrooms across the world. For many organisations, though, ESG has still been more of a reporting concept than an actionable investment direction. This has meant that, from an ESG perspective, there has been a general lack of investable businesses and projects. COVID-19 changed this situation and, today, financiers and debt providers are tailoring their financial products to align with ESG requirements. In South Africa, this evolution has been further fuelled by the shift in government policy regarding self-generated electricity and the publication of the updated technical paper on Financing a Sustainable Economy. It is anticipated that demand for deals that enhance the ESG position of businesses and investors is set to increase exponentially in the coming year as corporates and financiers actively search for investable projects.

 

Continuing supply chain challenges

Supply chain challenges experienced in most countries due to the COVID-19 pandemic are unlikely to abate in the next year. While infection statistics point to the possibility that the virus is largely becoming more manageable, recent history tells us that even outbreaks in remote corners of the globe can impact negatively on lives, businesses and economies around the world. The semiconductor shortage in South East Asia in the third quarter of 2021 is a good example of this supply chain knock-on effect; in that instance, on global vehicle production levels and, inadvertently, inflationary increases.

 

The challenges to the South African supply chain environment are further exacerbated by a litany of rail and port problems. While some might argue that this type of risk is inherent to the South African operating environment, the impact of the structural challenges on supply chains is highly relevant for any company considering M&A deals in this country. Not only do supply chain-level disruptions severely impact actual cash flow performance, they can also have a large impact on net working capital cycle (NWC) assumptions for valuation purposes and pricing expectations between interested parties.

 

There is likely to be significant debate between buyers and sellers in the coming year regarding what the real NWC levels are, as well as what to anticipate in terms of normalised NWC levels. The result will almost certainly be an increase in M&A transactions that include a deferred or earn-out component in the short- to medium term.

 

Continued activity in the equity capital market (ECM)

For many companies, the driving force for listing on an exchange is the ease with which they can raise capital through equity issuances, and from a greater pool of investors. The challenges, however, include the timing of a potential listing (macro-economic conditions), the availability of capital amongst institutions and individuals, and market perceptions as to what could be in-demand or high-growth sectors. COVID-19 has had a significant impact on various sectors, with some of the hardest hit being the travel, tourism and food services industries, and the winners being technology, software, logistics and healthcare.

EY reports that 2021 saw an increase of around 64% in global initial public offerings (IPOs), with technology (c.26%), healthcare (c.16%), industrials (c.13%) and materials (c.13%) being the dominant sectors for this activity. If the views of US investment banks are to be believed, the outlook for global economic growth will remain robust for the next two years, which will provide a fertile environment for well-placed companies to look towards IPOs as the next natural evolution in their business life cycle.

 

On the other side of the ECM coin, with increasing inflation being one of the hottest topics at the start of 2022, reports from the likes of CNBC and the Financial Times point to an imminent move by the US Federal Reserve to raise interest rates. This same sentiment is echoed by the South African Reserve Bank, as the country, and the global environment, experience increasing inflationary pressures.

 

From a funding perspective, this rising inflation environment will make debt funding marginally more expensive in the near term, but that should in no way impede the desire by private equity firms to deploy their large capital reserves into value-accretive investments. We are already seeing evidence of this trend with KKR’s $40bn proposed offer for Telecom Italia, Bain Capital and H&F’s $17bn acquisition of Athenahealth, and McAfee’s $14bn sale to an Advent-led investor consortium.

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Depending on your point of view and your investment mandate, the year ahead looks to contain increased activity, both onto and off exchanges the world over.

 

Smith is a Corporate Finance Senior Associate | Nedbank CIB.