Golder’s Enachescu: European investors are undervaluing German firms by up to €5 billion
Cristian Enachescu, managing director of Golder Germany argues that German companies are undervalued due to overzealous environmental accounting.
It’s not every day European investors uncover €5 billion worth of hidden value in the context of a sluggish M&A climate. But research suggests the market may be massively undervaluing German companies because of their tendency to tie up billions of euros in overzealous environmental accounting. We believe this is playing a major role in keeping the German M&A market cool as deal fever rises elsewhere in Europe.
German companies put aside around 15 billion euros a year to manage, mitigate, or moderate their environmental impact – disposing of hazardous industrial waste, preventing land contamination, and the like.
Firms hold this 15 billion in accruals to avoid being caught out by unanticipated cleanup costs fines from regulators, or environmental taxes. Broadly speaking these accruals are vital for any economy which seeks to balance business growth with respect for the environment.
But it’s very possible for companies to be too cautious and tie up too much cash with overdramatic assessments; and many German firms have fallen into this trap.
This represents a significant opportunity for investors looking to unlock value among the country’s energy, manufacturing and infrastructure firms; which might on the face of it seem less attractive targets for takeover than Western European counterparts as they appear to have less flab to cut.
The team at Golder Germany has undertaken market research into the accuracy of German firms’ environmental liability assessments and found that companies in the country are overestimating the cost of their environmental liabilities by more than 50%.
We believe this overestimation is a consequence of the difficulties they have encountered in keeping pace with regulatory, technical, and legal developments that have shifted the goalposts for those with large environmental liability portfolios.
Firstly, Germany’s environmental regulators are beginning to take a much more balanced approach to cleanup. Until recently, companies found to have contaminated sites with industrial waste products were led into undertaking, what may be considered in hindsight, unnecessarily proactive cleanup processes which took years and cost many millions.
The tide is now changing in favour of a process called Monitored Natural Attenuation (or MNA), which allows companies to oversee the natural degradation of contaminants without taking remedial measures – a lighter touch approach which is often just as effective and significantly reduces the amount of cash they must keep aside.
Secondly, major technological developments in environmental remediation also mean companies can make major savings on the cost of cleanup. By using solutions such as nanoparticles, firms can now combat groundwater contamination on a molecular level without the need for long-term, labour intensive remediation systems. Despite growing evidence from large EU-funded research projects, few German companies are effectively capitalizing on such developments; and as such are tying up too much value in overinflated accruals.
Finally, recent German High Court decisions have changed the balance of financial incentives for companies with large environmental liability portfolios. A recent decision imposed regulated discounts on the value of contaminated land (under certain conditions), which apply even if a company is not responsible for the contamination of its asset – giving all firms working in a particular location a financial incentive to proactively keep their liabilities in check and take remedial measures.
As environmental remediation becomes easier, cheaper, and offers a genuine increase in asset value, the sums German firms are holding in accruals look increasingly inflated.
What is more, in an environment of low returns and low interest rates, investors looking at increasing their possible return can see a measurable increase in the asset values by encouraging remediation. With low operational costs, new legislation and technical improvements making the process more economical by the year, remediation projects should be an appealing option.
As the European M&A market begins to heat up after six difficult post-crisis years, investors would do well to look more closely at German firms’ balance sheets. The country’s manufacturing and engineering companies may not initially look ripe for value realization; but a long hard look at their environmental liability portfolios may turn up buried treasure.