Investing Responsibly: ESG Assessment Case Studies

In this installment of our “Investing Responsibly” series, Anthesis Group’s Phil Harrison discusses the role of ESG factors in three case studies.

The following three case studies demonstrate how ESG factors can influence investment decision-making, and potentially the overall return of an investment. In two of these cases, ESG factors were considered during the investment due diligence process, which enabled the investment team to better anticipate and manage risks beyond “traditional” environmental liability. In our third example, we present a case where broader ESG issues were not part of the due diligence scope.

North American Jewelry Retailer

A large cap Private Equity investor was pursuing an investment opportunity with a North American jewellery retailer. The company had grown and expanded rapidly since its humble beginnings from a single US location. The target now had substantial retail operations across the United States and Canada and an extensive network of suppliers/manufacturers in the Asia-Pacific region.

It is standard practice for this PE firm to conduct a high-level ESG screen for all new investments. For this type of business where manufacturing was outsourced and retail locations were leased, it did not make sense to conduct “traditional” environmental due diligence focused on soil and groundwater contamination and associated liability. However, the ESG screen did result in a potentially critical finding that needed to be addressed by the seller before the deal could move forward:

• Supply Chain (Environmental & Social): During the due diligence investigation, it became clear that the target knew very little about the companies it was buying precious metals and finished goods from in the Asia-Pacific region. No information or documentation could be provided concerning conflict minerals, the origin of raw materials, or the profiles and compliance status of its suppliers. Further, by also reviewing the ESG/Sustainability performance of key market competitors, it was revealed that a key competitor had all of its suppliers (also located in the same geographic region) certified by the Responsible Jewellery Council while none of the target’s suppliers carried this certification. In this case, the ESG workstream revealed the potential for supply chain issues (due to lack of visibility and sector certification), in addition to a competitive disadvantage from a brand positioning standpoint.

On a more positive note, the ESG screen also identified a strong corporate philanthropy program that was embedded within the company’s culture. A core pillar of the target’s operating philosophy was “giving back” and the maturity of this program placed the company amongst the leading retailers in the sector.

Global Manufacturer of Artificial Turf

The target company is in the business of manufacturing, installing and maintaining synthetic outdoor sports and recreational surfaces. These products include artificial turfs (AT) for sports fields, and polyurethane based running track surfaces, as well as surfaces for other outdoor spaces such as playgrounds.

The investment due diligence process included “traditional” environmental legal and technical scope due to the target’s manufacturing operations. However, broader ESG factors were also investigated for the buyer, revealing the following risks and opportunities:

• Environmental: A potential threat to the business was identified as certain raw materials may be phased out in the future (e.g., phthalates). The company did not have a robust management system in place to monitor this development on a global basis and, as a result, had not discussed or documented any steps to plan for the future replacement of these materials.
• Environmental: From a marketing perspective, one of the company’s selling points was the fact that artificial turf does not require water, which is a positive sustainability statement in drought prone and water stressed areas. However, the company had not conducted any life cycle analysis (LCA), or similar scientific studies, to back up statements that artificial turf is more sustainable than natural turf alternatives.
• Social: The biggest potential risk to the business identified during due diligence was a potential link between long-term exposure to artificial turf and cancer (Daily Telegraph article). The study, and related reporting, suggested higher instances of cancer amongst athletes who spent significant time on artificial turf whose core production processes, and the product itself, included reclaimed automotive tires. These studies indicated more research was required and the recommendation to the buyer was to carefully monitor these developments.

US-based Natural Gas Fired Generating Station

A global infrastructure investor owned a natural gas fired generating station in its investment portfolio. This asset had undergone “traditional” environmental due diligence during the investment process, but a broader ESG screen had not been conducted. During the ownership period, the following ESG issue arose and needed to be dealt with, which eventually impacted the expected ROI at exit:

• Environmental: The plant sourced its process cooling water from an adjacent river. The region of operation historically had experienced periods of extreme drought. During the investor’s hold period, the water levels in the river were lowered by a drought event that began impacting a local salmon population. As a result, the plant was ordered by the local authorities to cease intake of water from the river. This unplanned event resulted in a brief outage, in addition to additional capital expenditures to establish an alternative water supply to the facility.

As a result, when the firm sold this asset, they did not achieve the full return that was anticipated in the original investment case and business plan. Had a broader ESG screen been conducted during the investment due diligence phase, it is reasonable to assume that an event such as this might have been identified, which would have enabled the investor to proactively plan for this type of future situation. 

In this installment of our “Investing Responsibly” series, Anthesis Group’s Phil Harrison discusses the role of ESG factors in three case studies.