Dealmakers Climate Allocators

Climate investing will require a different PE playbook

0

Climate investing and the implications it could have on private market portfolios has become an important part of the discussion between GPs and LPs, as the industry looks to navigate a path towards long-term, sustainable growth.

In the coming years, the scope of companies that private equity firms will be allowed to invest in is likely to shrink. This will mean higher entry valuations, and it will also require buyout firms to build new equity stories; those based not purely on global consumerism but on long-term sustainable value that can thrive in what will literally be a new climate. It will, in short, require GPs to re-think the playbook and how to share value from owner to owner when transforming companies.

IPEM has increasingly acknowledged the need to provide a dynamic forum to debate many of the key issues that climate change could have on portfolio assets over the coming decades.

In the last two editions of IPEM, delegates were given the opportunity to focus exclusively on the task at hand, during the Climate Investing Summit at IPEM Paris 2023 and the Portfolio Transformation Summit at IPEM Cannes 2024. An array of sponsors provided the stage setting for industry experts to debate, share ideas and transfer knowledge via tailored presentations, including Indefi, Argos Wityu and Sweep.

Delegates attending IPEM Paris 2024 will have the opportunity to continue to shape the debate on this key topic. The Climate Summit on 11th September, 2024 will analyse the climate versus returns equation, how to deliver on both returns and results, and discuss how GPs will need to adjust business valuations and portfolios to account for climate risks. AXA Climate, Lombard Odier, Marsh and Tikehau will be the summit hosts.

Some of the key takeaways from the past two IPEM summits include:

  • Vulnerable assets (i.e. those unlikely to thrive in response to climate change) are mushrooming as social, environmental and regulatory expectations grow by the day. This is shrinking the investable universe for PE firms
  • Climate investing is the art of investment within a new climate era. As such, it raises fundamental questions on deal making, portfolio support and how value perception could evolve
  • The need for upskilling tradespeople (i.e. plumbers learning to install heat pumps) has led to transformation of the construction supply market in Europe, with the creation of training academies to help unlock potential growth in manufacturing. As INDEFI Sustainable Finance noted, some may see this as unnecessary costs, while others regard it as necessary ‘expansion costs’ to support tech transition
  • What value creation levers are needed to build successful companies in a new climate era?
  • Long-term thinking on portfolio construction and portfolio business models, articulated on short-term actions, becomes a must-have and not a nice-to-have to navigate climate-related complexities
  • Transforming portfolio companies means acting on several building blocks of their business models; GPs should anticipate transformation strategies before the start of the deal process

PE firms might also require greater operational team resources and AI capabilities to facilitate and enhance their transformation skills. It will also require a shift in the industry’s collective mind set to design a new playbook of value protection and value expansion.

GPs, even those who are non-impact managers, are raising Article 8 and Article 9 funds as they focus their attention on building sustainable businesses across the value chain that are best equipped for climate change.

Here’s a short clip featuring Alessandro Tappi, CIO, European Investment Fund, speaking on an LP panel during the Climate Investing Summit at IPEM Paris 2023:

 

 
 

“The discussion at IPEM last September and January was the call for the private equity industry to think ahead: to not look down at the numbers, which are only the results of choices of the past, but to look up and see where the investable territories will be moving forward,” comments Imène Maharzi, Senior Advisor at INDEFI Sustainable Finance.

 
In one of the discussions during the Portfolio Transformation Summit at IPEM Cannes 2024, the question of duration was discussed. Part of the decarbonization plan for an industrial company, for example, might involve greater integration of solar energy for its ongoing production capabilities – or perhaps as an energy source for its fleet. A private equity sponsor might think, ‘I don’t see the ROI for this capex. I don’t want this to impact current cash flow so let’s leave it for the next owner to handle.’

Ten or twenty years ago, when climate risk was barely mentioned, buyout firms could afford to take a shorter-duration approach to company ownership using the LBO playbook.

That is not quite so relevant today when thinking about future value creation. Owners will need to expand their investment horizons. If heavy investment is needed to secure a company’s long-term prospects, one approach could be for buyers and sellers to agree to a revenue sharing mode; i.e. adopting a value share mechanism based on the amount of capex needed to help transform a company and reposition it as a sustainable business that can operate effectively as megatrends such as decarbonisation and deglobalisation take hold.

“We’re talking about ‘What are the fundamentals of value creation that will justify LPs’ allocating their capital to your firm?’” says Maharzi. “How can PE owners extend the way they look at investing so that value is shared between different generations of owners? I think we need to be more creative about this.”

Earth’s climate rose by one degree Celsius between 1850 and 2021. By 2050, it is expected to rise by a further two degrees. Regionally, this will vary. Average temperatures in Europe are forecast to rise by three degrees Celsius.

Everything will be disrupted, from energy demand to food supply. Hoping that European companies will keep on operating the way they always used to will soon appear a utopian dream. Rather, it will require GPs to invest in, and build, bigger operating teams. The blue chip names are already doing this.

Looking ahead, as climate investing alters the PE playbook it will provide myriad opportunities for managers to demonstrate their prowess as value creation engines. Even if firms don’t fully complete their transformation plans, they should be better placed to sell the promise of future value, provided a portfolio company’s equity story fits the narrative of prevailing megatrends.

Shape the debate at our upcoming events 🔥

 Climate change is the most important challenge faced by our times. We at IPEM believe that we must do our part – and that the private capital industry is part of the solution.

LEARN MORE ABOUT 👉 IPEM Going Green.

At IPEM we bring together the leading names in climate investments, to ensure delegates are getting to the very heart of the issues and look towards what’s to come.

If you weren’t able to attend the last two editions of IPEM, don’t worry. We will be continuing to forge ahead and debate the key issues of climate investing at our upcoming IPEM Events.

Discover our further reading 📰

 
 
 
 
Ashling Barry
Ash coordinates IPEM's speakers, conferences, summits, webinars and thought leadership projects. She is based in Dubai.
Previous
Next

RELATED NEWS