ESG considerations driving food and drink industry acquisitions

The shift is driven by changes in consumer behaviour. Consumers are increasingly looking for products that are sustainable and taste good while still being nutritious, convenient, and affordable – with healthy and plant-based alternatives becoming more popular.

Businesses are increasingly conscious of the importance of ESG in M&A. For example, Diageo’s acquisition of Seedlip, a non-alcohol spirit brand, shows a response to consumers opting for low/no alcohol brands.

As food and drink companies seek to provide long-term value to their shareholders and stakeholders, as well as boost their own ESG credentials, merger and acquisition (M&A) activity in the sector is now predominantly driven by strategic buyers. M&A deals in the food and drink sector as a whole increased in the second half of 2023, with strategic transactions representing 78% of total deal volume, according to KROLL industry insights.

However, this sustainability trend poses additional challenges for food and drink businesses which must bear in mind M&A activity issues – including brand reputation, economics, and regulatory restrictions.

An increased ESG focus

Investors should carefully consider social and environmental factors before investing in a business. For instance, it is important to look at what a company is doing to reduce its carbon emissions, as well as wider ESG-related targets such as using recycled products for packaging.

The focus is not only good for business, but also increases staff engagement and graduate talent and client acquisitions. A recent PwC survey (16 pages / 4 MB) showed that 37% of private equity respondents have turned down potential transactions due to ESG issues, and a report by Bain & Company indicated that 93% of limited partners would walk away from an investment if it posed an ESG concern.

An example of ESG driven investment was the £20 million investment led by Highland Europe and including A-list celebrities in Huel. Huel is a meal replacement retailer focused on supporting healthy, low-carbon footprint diets, as well as agricultural development in Sierra Leone.

Global consumer goods companies are looking for high growth, high margin challenger brands that they can plug in to their global distribution network. However, more than ever, they are looking for sustainable products that taste good but are nutritious, convenient and affordable all at the same time. Essentially, the products that we are all wanting to eat and drink in the context of the world in which we live. Huel is a classic example.

Businesses should undertake ESG-related due diligence on potential targets in the food and beverage industry. This could include assessing the degree of alignment between the target and the bidder's ESG objectives, and considering what additional value the target might bring to the bidder in terms of established ESG credentials.

Consumer trends and regulation

Consumer preferences have a significant impact on the food and drink industry. Increased production costs and changes in consumer behaviour play an important role. Changing consumer attitudes towards health, wellness and sustainability mean that companies are having to adapt and innovate to remain competitive.

These changes in consumer behaviour have created and continue to create more interest in products such as plant-based foods, low/no sugar food, and low/no alcohol beverages – with these types of acquisitions becoming increasingly common. For example, 0% beer, mocktails or even specific zero alcohol alternatives such as “no-secco”. In terms of food, consumers are now often reaching for meat free alternatives such as Quorn or tofu-based dishes.

It is important that food and beverage companies, as well as those investing in these companies, keep a long-term view on how ESG may be shifting in terms of regulation. There is already an indication of a growing regulatory framework around sustainability on the international stage, such as the EU’s ‘food and fork’ strategy aimed at creating a fair and sustainable food system. Investors may therefore be keen to identify the way in which food and drink firms have complied with any applicable regulations, for example determining whether the business holds all the relevant licences.

Other challenges in the food and beverage sector

The food and beverage sector faces a number of other challenges in terms of sustainability. It is important not only to ensure a business operates sustainably, with a focus on improving environmental impact, but that the brand is also sustainable in terms of being acquired and protected. Focusing on ESG can help boost the value of a business, but a lack of this can create challenges and in turn decrease growth or even have a negative impact on the brand overall.

Businesses can counter this by taking more control of brand management. This may include monitoring comments about brand reputation on platforms such as social media and websites to ensure that this commentary is correct and in line with any ESG activity and aims.

A range of economic factors are currently impacting businesses within the food and beverage sector and beyond. High interest rates and global inflation have created huge financial challenges, influencing M&A activity in the sector. High interest rates have also resulted in a decrease in buyer leverage, leading to lower valuations. Some companies have had to implement measures and introduce strategies to manage pricing on the supply of raw materials.

The UK is heavily reliant on food imports, and the price of imported food materials has been rising at twice the rate of domestic food materials. It means that some pricing strategies have involved an increase in “home grown” demand and there is an impetus to scale operations nationally. For example, Diageo’s ‘branded’ shopping spree of 21Seeds, Balcones Whisky, Mr Black Spirits, East African Breweries and Don Papa Rum, all in line with their “strategy to acquire high growth brands with attractive margins” as reported by their European President, also demonstrates the drive to increase operations while maintaining margins.

However, interest hikes are beginning to decelerate with inflation levels dropping. It means investors are becoming less cautious and are looking to invest their capital, despite debt being more expensive and less readily available compared to a year ago. Although deal flow experienced a quick ramp up in the second quarter of 2023, increases in input costs remain relevant for businesses within the food and beverage industry as consumers are beginning to push back against prices increases and global conflicts continue to impact the supply of raw materials.

There has also been a shift in investment focus, with both companies and investors shifting their focus from expansion prospects to optimise efficiency in core operations, for example improving processes to implement more sustainable practices.

Companies may also be able to gain significant financial benefits from these transactions by expanding the acquired businesses into existing channels or internationally. In addition, cost synergies can be achieved by realigning operations or through increased bargaining power with retailers.

Co-written by Katie Whiteman of Pinsent Masons.