Sustainability and other environmental, social and governance (ESG) factors are “now more than ever driving strategic acquisitions by food and drinks companies”, lawyers at Pinsent Masons said earlier this year. Theirs is not the lone voice, with others including Bain Consulting Group, Deloitte, KPMG echoing the sentiment. Some surveys even suggest a fair chunk of deals have been binned over ESG concerns.

“ESG has grown from the occasional area of focus to a more influential and consistent M&A consideration over the past two years,” Sarah Corrigan, MD for mergers, acquisitions and restructuring services at Deloitte, noted recently. “This is only the beginning”.

A Deloitte survey of 500 global M&A leaders from various sectors this year showed 72% of corporates in the consumer industries sector said they’ve abandoned a deal due to concerns over the target’s ESG performance. That is significant (in the consumer industries sector it was 72%, while in private equity it hits 80%).

What’s more, the number of those actively preparing to divest or acquire assets to improve their ESG profile has jumped in the past two years from around of third of those surveyed to a shade under half. ESG “red flags” are increasingly considered with the same level of seriousness as commercial or operational concerns, said Deloitte Canada partner Brooke Thiessen.

There are many drivers making ESG a more important factor in the acquisitions done in the food industry, including consumers, investors and retailers. The mix of these will depend on the brands, the companies, the products, the leadership teams and the location. In Europe, for example, net-zero is the topic on ESG. In the US and Asia, this is not necessarily the case. As, Isabelle Allen, KPMG International’s global head of consumer and retail explains: “Attitudes towards ESG vary highly across the world and have been increasingly politicised and polarised.”

You could say that again. For Allen, the most influential aspects of ESG will also vary from deal to deal and place to place. Industry segment and the size of a company or a brand's attributes will play a part but so too will reputation, sourcing and quality set-up, and the compliance culture. “Ultimately, ESG brings about a discussion on compatibility of ambition and commitments, and how both parties will evaluate the gap that might exist between them (if any),” she adds.

Cereal committer

Consider one of the big deals of 2024: that of Mars gobbling up PopTarts and Pringles owner Kellanova. In the press statement much of the focus was on the future of snacking, and the two giants’ “beloved brands” and “complementary footprints”. However, right at the bottom – almost a footnote – was a reference to another type of footprint: Kellanova will become part of Mars’ net-zero commitment (a 50% reduction in greenhouse gas emissions by 2030 and net-zero by 2050) on carbon emissions.

For Kellanova, this may well be a shock to the system. Mars is now considered one of the pacesetters on net-zero as one of the few big food firms showing how to decouple carbon emissions from business growth (the owner of Dolmio and Snickers managed to reduce its emissions by 5.7MtCO2e since 2015, while growing the business by 60% to over $50bn). The company’s Scope 3 emissions reduction target is 50% by 2030 and 90% by 2050.

Kellanova meanwhile has historically committed to science-based targets but is yet to set any – a bit of a problem for a company that at the last count (31 December 2023) was responsible for around 5MtCO2e and recently only managed a 3.5% reduction in its Scope 3 emissions (the target is 20% by 2030). Some firms in the food sector have recently adjusted, reduced, or scrapped their sustainability goals, but the new Mars-Kellanova entity will “buck that trend”, wrote Rabobank analysts in a recent paper. Kellanova will see the ambition in its targets accelerate, it suggests but will be able to take advantage of Mars’ long-term view on sustainability to achieve “steeper reductions” over a longer period of time. In other words, Mars will pull Kellanova up by the bootstraps – and not just on climate.

Hot chocolate

Analysts have been busy unpicking the ambitions and performance of the two entities to identify where the biggest ESG gaps might be. Investors will certainly want to as well. But this takes time, so why not let AI do it?

Using materiality frameworks, news data, financial disclosures and specific disclosure frameworks such as CDP Forests, consultancy Neural Alpha was able to able to uncover “salient differences” between Mars and Kellanova and identify potential sustainability risks and opportunities. Mars, despite being a private company, came out on top in many areas of monitoring and sourcing practices. There was one “blind spot” the AI tool picked up, however.

“Kellanova’s poor performance on cocoa, for which no traceability or certification processes are in place, is perhaps the most significant blind spot in the deal,” explained Neural Alpha CEO James Phare in his accompanying blog. “Given the historical press coverage and controversies around Mars’ cocoa supply chain exposure this will undoubtedly be an area of focus for investors and others,” he added. Mars, it should be noted, is aiming for 100% “responsibly sourced and traceable cocoa” by 2025.

While the additional exposure to such reputational and supply chain risks may induce anxiety among some investors, there are ways in which the deal will spread risks too. The deal is “especially good for the bottom line” for Mars, explains Charlotte Bande, global food and beverage sector lead at Quantis, a consultancy, because no longer will the company rely so heavily on cocoa – a commodity that is extremely volatile in terms of price and “so much at risk from climate change”.

Mars’ efforts around deforestation-free ingredients will also “need to be adjusted for an influx of ingredients”, noted Rabobank. Indeed, Mars has initiatives relating to cocoa, rice, mint, palm oil, beef, pulp and paper, soy, dairy and fish; Kellanova focuses on sugar, palm oil, cocoa, rice, corn, fruits, potatoes, nuts and wheat. It’s a heady mix, so there is work to do as Mars works to integrate the Kellanova business without losing ground on its various ESG commitments (some of which provide medium and longer-term financial benefits too). It will be a “balancing act between returns and sustainability”, explains Cyrille Filott, global strategist for consumer foods at Rabobank and one of the authors of the bank’s paper on the deal.

Cutting (carbon) corners

Filott says there is undoubtedly more consideration of ESG performance within M&A these days compared to, say, ten years ago. However, there is nuance within that and he is not so sure it is consumers driving things (as some believe). Consumers want to buy into sustainable brands but few are willing to pay the premium required to do so currently. Filott suggests the more forceful driver of this trend is one step back in the supply chain: “It’s the retailers,” he says.

Many supermarkets have ambitious carbon reduction targets to meet by 2030 and these include scope 3 for which they will be looking to their supply chain to do the grafting. Supermarkets are applying pressure in a fairly friendly way, says Filott, but this could quickly change as the 2030 targets come into focus. Rather than simply commit to science-based targets, supermarkets will want to see emissions falling – and fast.

This pressure also explains why food manufacturers are not just investing in new products and brands but also new capabilities. This can take the form of looking to acquire a packaging facility, renewable energy, a recycling facility, expanding upstream and acquiring suppliers to control the supply chain, says Allen at KPMG. There is also more collaboration happening when it comes to such investments – consider for example the various food and drink-backed start-ups innovating in the paper packaging space, or the projects seeking to reduce methane emissions from livestock (like the one Arla, Morrisons, Tesco and Aldi have just announced in the UK). And who can forget the investments going on around regenerative agriculture and the tech and innovation being eaten up by big brands in that space as they seek people with the right skills to bring results at scale.

Historically, companies have also invested to cut corners on carbon. And no, not by offsetting: they manage carbon risks by operating in countries with less strict environmental protections, explains Kristina Minnick, Stanton professor of finance at Bentley University, US. “For example, a manufacturing firm might acquire a factory in a developing country with lax environmental regulations, reducing costs and facing fewer restrictions on carbon emissions,” she says.

Minnick, together with Sudipta Bose and Syed Shams of the University of Newcastle, Australia and the University of Southern Queensland, Australia, respectively, looked at this in detail as they assessed whether carbon risk matters when possible deals are weighed up. Companies could reduce the costs associated with carbon risk by making environmentally sustainable investments, they explained in their paper for the Journal of Corporate Finance, or they could use an acquisition to “offload” this risk.

The academics found companies used to lower their carbon costs by doing business in countries with loose environmental laws. Some food and drink firms have chosen supply chain partners in countries with more lax protections, Minnick explains, “outsourcing” their carbon risk through Scope 3 emissions in their supply chains rather than through Scope 1 or 2 emissions. The opportunities to game the carbon system in this way are shrinking, however: there is a growing trend to be held accountable for all emissions in their supply chains, says Minnick, “so they can't avoid strict environmental rules just by operating overseas”.

A plethora of reporting rules around sustainability loom large on the horizon for the world’s biggest food and drink companies. In Europe, there is the Corporate Sustainability Reporting Directive (CSRD), for example, as well as the Corporate Sustainability Due Diligence Directive (CSDDD) and the EU Deforestation Regulation (EUDR). These will start to bite the big firms first but ESG due diligence reports and warranties will gradually become a fixture for the mid-market M&A deals of £10m to £250m too, says Keith Davidson, partner at Irwin Mitchell, a law firm.

Who cares wins?

The impact of Scope 3 emissions, climate risk searches and the EU directives are already filtering through to deal-making – especially in Europe and the Middle East where 68% weigh up the potential impact of a deal against their own ESG profile, compared to 49% in the US, according to Deloitte’s survey this year. Some 78% of those from companies with clearly-defined measurement metrics have ‘very high confidence’ in their ability to evaluable a target’s ESG profile (which will soon be part of their profile). Better data and (slowly but surely) a more standardised approach to sustainability reporting are helping companies better assess where potential targets are on their net-zero journey. High or very high confidence in accurately evaluating a potential acquisition target’s ESG profile has jumped from 74% to 91%.

Poor ESG scores or lack of carbon emissions data can negatively impact a company’s valuation.

Richard Singleton, Menzies

There is still an opportunity to gather more tax-related ESG data, potential tax savings and metrics in the due diligence phase of an M&A transaction so companies can “more proactively plan for value creation”, said the accountants at Deloitte. They would say that. But there is a question here about the impact of ESG performance on the price of any deal. “Poor ESG scores or lack of carbon emissions data can negatively impact a company’s valuation, and with increasing effect as reporting emissions become tighter,” explains Richard Singleton, finance and sustainability director, an ESG specialist at accounting and advisory firm Menzies. “It is likely that better ESG credentials will push the value higher,” he adds.

Others are not so sure we are quite there with an ESG premium in deals but there is potential for a “value differential” based on ESG, says Rabobank’s Filott – those not in compliance with new rules (and requiring additional investment) could possibly be captured at a discount. It could also become a “hygiene factor”, he adds (and perhaps already is with those high numbers who say they’ve abandoned deals).

ESG can break big, big deals (consider Kraft Heinz’s failed takeover bid for Unilever). Major brands will also continue looking for companies that are keeping pace with consumer trends on sustainability, like plant-based options or cultured meats for example. These purchases can help balance their portfolios as the net on everything from their carbon emissions to their junk food – healthy food mix tightens. Think, too, of the drinks giants that are making moves into the low- and no-alcohol category.

All this must be tempered with a difficult period, where price elasticity reached its limit, CEOs were moved and companies have knuckled down on their hero brands. There is safety in numbers and while some might see a $60bn snacking company as a villain, there is an argument made by some that this could drive real change in regenerative agriculture, for example. Mars could also guide Kellanova through the tricky terrain of setting science-based targets and then meeting them.

Now, more than ever, it is easier to assess how a company is doing and whether it is prepared for both new regulations and consumer trends related to many areas of ESG. Those falling behind are easier to spot than ever. Let’s not get too carried away though, suggests Bande at Quantis, because while ESG is a more important factor in food-industry acquisitions, she adds: “I am not convinced it’s that important.”