The impact of ESG activism in M&A and demergers

In 2023, we expect environmental, social and governance (ESG) concerns to be a driving force in M&A and divestment activity, particularly as pressure mounts for carbon-intensive oil companies to rationalise their portfolios. This should, in turn, unlock deal opportunities – although buyers will need a convincing ESG and decarbonisation narrative in order to find support from the regular stable of onshore funders.

The market is seeing high levels of interest in these assets from smaller regional exploration and production businesses as well as large-scale offers such as the recently announced bid for Origin Energy from Brookfield Asset Management and EIG. Once the large-scale mergers (such as the Woodside and BHP Petroleum transaction) settle down, non-core assets are likely to be next on the auction block.

We have already seen companies divesting assets with high carbon footprints with varying levels of success. There are several impediments to these transactions, including uncertainties around the accuracy of current models for assessing decommissioning costs.

There are recent examples of investors and shareholders applying an ESG lens and taking a proactive role to influence the outcome of an M&A transaction which they consider inconsistent with their perception of good governance or accepted ESG standards.

The AGL Energy Limited (AGL) demerger proposal is one example, where AGL abandoned a plan to split its business into separate generator and retailer arms in response to shareholder pressure, including from Mike Cannon-Brookes’ private investment firm Grok Ventures and institutional investors like HESTA.

The AGL experience illustrates how transactions which require shareholder approval can be vulnerable to external pressure especially where activist investors are prepared to acquire stakes in the business.

We anticipate that ESG-conscious stakeholders, including key investors, will not be shy in looking for ways to adversely impact structural decision-making, which may include a range of techniques such as ‘buying’ votes as a means to vote down proposals. Under Australian law, shareholders can separately deal with their rights to vote and their economic interests.

As a result, voting rights can be transferred in a variety of ways (such as stock lending, equity swaps and voting agreements) to enable a motivated ESG-focused shareholder to thwart a proposed transaction.

These sorts of strategies will be particularly effective if the transaction requires a special majority, where the go/no-go threshold is 25% of shareholders present and voting. The evolution of derivative structures to facilitate stake-building has also enabled shareholder activism in these types of transactions. In particular, this will be the case for companies where the acquirer either needs regulatory approvals to build the stake (for example, Foreign Investment Review Board (FIRB) approval) or where there is insufficient liquidity in the existing stock to acquire a stake directly.

In the case of AGL, an entity associated with Mr Cannon-Brookes amassed an 11.28% interest in AGL shares through complex arrangements involving a loan and equity collar transaction and a cash-settled total return swap with an investment bank.

While transactions that reflect ESG best practice are clearly the preferred outcome from a board’s perspective, preparation is required for potential activist approaches on future M&A transactions. Detailed forward-planning and consideration of alternate strategies and restructure options are likely to be of critical focus. This includes an emphasis on target boards staying proactively and meaningfully engaged with the company’s shareholder base.

This article first appeared in Corrs’ M&A 2023 Outlook.