ESG: Selling sustainability

More ambitious and wide-ranging environment, social and governance (ESG) programs among private equity firms in Asia are not merely the result of LP prodding. There is greater recognition – at the GP level and at the portfolio company level – that issues like environmental protection and social welfare have become hot-button topics for all stakeholders. Failing to address them could be damaging, reputationally and financially.

Nevertheless, convincing founder-entrepreneurs to embark on initiatives that may inhibit commercial performance in the near term for the sake of a theoretical longer-term payoff remains a significant challenge. Those operating in high-growth markets might have very different priorities.

This was the situation that confronted CVC Capital Partners when it took a minority stake in Softex Indonesia in 2015. The GP’s pitch to the family-owned diaper and sanitary napkin manufacturer involved a push into the large-scale hypermarket segment, which required significant advertising and marketing expenditure. They would find the extra money by identifying efficiencies elsewhere.

CVC therefore broached the topic of ESG amidst a 12-month push to deliver six percentage points in gross margin improvement. The CEO’s response was predictable: That sounds great, but we are working on so many other things right now. Let’s wait.

The contribution that diapers make to Indonesia’s pollution problems is clear to anyone who has seen the country’s rivers. Half a ton of disposable diapers are dumped into the Brantas River – which serves six million people in East Java – every year, according to a 2018 study. Researchers found plastic fibers in 80% of fish. Even when diapers end up in landfill, they take 500 years to biodegrade.

CVC’s investment was in part predicated on rising demand as Indonesia’s relatively young population produces more children. Barring a substantial turnaround in consumer behavior, more sales would mean more pollution. The private equity firm suggested counteracting the negative environmental impact by deliver ESG gains in other areas. It put up $50,000 to fund a third-party energy audit.

The audit found $250,000 in potential savings. “That was the trigger to convince the CEO that someone could come in from outside, tell him about opportunities, and they were credible,” Atiff Gill, a principal in CVC’s Asia operations team, told AVCJ last month.

Softex went from doing nothing to providing ESG training for staff, conducting materiality assessments, and setting up real-time reporting on metrics ranging from energy bills to societal trends. Planet Mark was brought in to assist with carbon footprint measurement and establishing targets for emissions reduction. Softex is now spending $120,000 itself on sustainability consulting services and it has also launched diaper recycling trials and river clean-up initiatives.

CVC has now exited Softex following Kimberly-Clark’s $1.2 billion acquisition of the business. But the Softex experience lives on as a reference point when encouraging other portfolio companies to embark on similar journeys. The GP did a proof of concept study for Indonesia’s Siloam International Hospitals and identified a higher level of potential savings than at Softex. It has also hired EcoVadis to work on sustainability benchmarking for every company in the latest Asia fund.

An ESG agenda pursued through a cost-saving initiative can be a useful tool in creating an alignment of interest with the founder-entrepreneurs, as numerous private equity firms have discovered. The next challenge is expanding coverage across the portfolio – including minority and majority deals – to give LPs a clearer picture of fund-level performance. Never underestimate the power of a strong case study in these endeavors.

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• Topics
• Southeast Asia
• Consumer
• ESG
• CVC Capital Partners