The trend to integration is especially noticeable in both traditional hydrocarbon players moving into low-carbon energy, and OEMs moving upstream to secure supply of key transition metals and products.
'A key driver for integrated M&A activity is a need for companies to alter their long-term trajectories, and established business models, to enable decarbonisation,' explains Philip Morgan, Freshfields Partner and head of the firm’s energy and natural resources practice in Asia. 'The European traditional oil and gas supermajors have embarked on an expansive form of horizontal integration within the energy sector in a quest to become diversified net-zero energy companies.'
Diversification on this scale would be almost impossible solely through organic investment. M&A has been, and will continue to be, a key part of these companies’ routes to net zero.
Yet M&A as a means of developing new business lines can be extremely challenging, Philip warns. 'Overpaying or acquiring a flawed asset portfolio will undermine investor confidence and damage share prices. Aside from clear financial modelling, rigorous diligence on all aspects of the target business, combined with an early review of integration challenges and possible synergies, will be critical.'
If a deal is struck, a buyer should be aware that this may be a new and emerging sector, both for the buyer’s management and objectively, Philip advises. 'The full matrix of possible buyer protections will need to be explored to insulate against downside risk, not just financial (price adjustments) and contractual protections, but also available bilateral and multi-lateral investment treaty protections.'
Understanding the current and anticipated future support for the relevant asset and sector at the governmental and regulatory level is crucial. The potential global ramifications for a buyer’s business of government subsidies and incentives granted to a target increasingly require detailed investigation: a number of jurisdictions have in recent years introduced protectionist or ‘level playing field’ measures, such as the EU’s Foreign Subsidies Regulation in a number of jurisdictions in recent years.
Established industries have made new and dramatic moves towards vertical integration.
Further integration has been a feature of the transition business landscape for several years (think automotive OEMs entering into supply contracts directly with mines). But we are now seeing companies throughout the value chain making direct acquisitions and investments into upstream and downstream businesses. For example, in early 2023, General Motors announced that it would make a $650m equity investment directly into the miner Lithium Americas to secure future access to lithium.
Similar steps have been taken, or are being taken, by OEMs such as Ford and Volkswagen to increase certainty of supply of key EV battery components.
A key driver for integrated M&A activity is a need for companies to alter their long-term trajectories, and established business models, to enable decarbonisation.
Philip Morgan
Freshfields Partner and head of the firm’s energy and natural resources practice in Asia
In the chemicals industry, we have previously seen BASF acquire a significant direct stake in the 1.5GW Hollandse Kust Zuid 1-4 offshore wind farm, one of the world’s largest. Nearly half of the electricity from this project will be used to reduce the carbon footprint of products from a number of BASF’s sites across Europe.
Similarly, creative steps towards vertical integration are being seen in the nascent hydrogen industry, as companies with various outputs, from fertiliser to aluminium, look to secure a key green input that can decarbonise their product offering and secure their future market positioning – both from a reputational and a regulatory perspective.
As with expansive horizontal integration in industries, vertical integration M&A on this level into new and developing sectors carries significant risk and complexity.
Buyers must ensure they have the right sector-specific commercial, technical and legal capabilities to carry out the transaction and mitigate exposures, and this may not be available in-house.
Validating key assumptions surrounding the vertical driver for the transaction and, as far as possible, contractually future proofing the vertical benefit, must be threshold objectives of the buyer’s deal team.
Yet the potentially huge commercial benefits of such transformational investments will still need to be carefully balanced against increased risks, both commercial and legal, says James Chapman, a Freshfields Partner advising on the energy transition, including project development and investment. 'Buyers will likely be less well-attuned to the new sectors and markets they are investing in and the potential headwinds they may face in the coming years.'
In some cases, buyers will also have little alternative but to develop and operate assets with unfamiliar JV partners with divergent agendas, business models and funding requirements, all of which need to be carefully considered.
'Owning, controlling or operating (or appearing to operate) such assets may also pose direct legal liabilities (particularly around poor ESG performance),' says James. 'These legal risks can be managed to some extent through appropriate governance, but the nature of these often-novel legal risks will first need to be clearly understood.'
In the face of this complexity, taking a holistic and multi-disciplinary approach to risk identification and mitigation may be the difference between a transformational and unsuccessful acquisition.
