Evaluating Through a Finance Lens
As companies strive to remain competitive and profitable in today’s uncertain economy, asset transactions continue to play a leading role in their efforts to transform, adapt and re-invent themselves. A well-thought out and well-executed acquisition can bask even the most gloomy of balance sheets in sunshine by bringing rapid revenue growth, added geographic coverage, a complimentary value offering to customers or even entry to a more favorable space in a competitive market.
Unfortunately, many of these acquisitions also harbor a “shady” spot or two that comes in the shape of legacy environmental liabilities. Acquiring liabilities is not entirely negative – typically this is an unavoidable part of getting the deal done, and many times it devalues the total asset asking price favorably for a buyer. However, what may be accepted as a little shade in an otherwise sunny deal can quickly become an unresolvable damp basement of doom, gloom and horror for a company through the mismanagement of the acquired environmental liabilities.
It is important to define and stick with a long-term strategy for effective environmental liability management and to understand the implications and true costs of the strategy selected. With that in mind, here are three strategic options usually considered when managing a portfolio of environmental liabilities:
1. Cash Flow Minimization
This strategy is the equivalent of paying only the minimum payment on your credit card….you are making interest payments, and maybe making some progress, but you will typically pay 3-10X more than you originally charged over a very long duration. In practice, this strategy manifests as a focus on regulatory compliance only, and nothing more. The scope of work usually equates to regulatory-required periodic monitoring of conditions to ensure no further adverse impact to human health and environment is incurred. Although this approach minimizes cash outflow in the short term, it results in a prolonged project duration.
During this extended period of exposure, the organization continues to face elevated risk (due to an open spill case, a new release causing compounded environmental impact, regulatory or public scrutiny, etc.) and the company must also bear ongoing management and compliance costs for the environmental liability. This strategy is obviously most appealing for companies operating in a cash flow-constrained environment, or where cash is viewed as having a considerably higher investment return deployed for some other benefit to the organization. This strategy might also be viable/desirable if there is uncertainty about whether the environmental liabilities are finite in nature and will not be compounded by future operations of the asset.
2. Lifecycle Cost Optimization
This strategy equates to a “market timing” tactic, where the organization attempts to spend when the environment is favorable to reducing liability, and shifts to compliance-only when it is not.
This approach can be effective in difficult or uncertain regulatory environments or where stakeholder politics unduly influence technical decision-making. However, just as with the financial markets, getting the timing down perfect is difficult, if not impossible, and more than likely this strategy is not optimally efficient due to lost opportunities and project start up and shut down costs, as the organization tries to time driving work scopes.
3. Liability Reduction
This strategy is defined by a concerted effort to reduce and eliminate a liability as quickly as possible. In many cases, the upfront cost of executing this strategy may be greater than the cost of merely monitoring the property conditions for years and the cash flow demands are typically heavily front-end-loaded. However, the aggressive pursuit of site closure is generally viewed favorably by regulators, allowing a company to potentially bank some regulatory goodwill. Out-year uncertainties are also significantly diminished, and total site and project management costs significantly reduced due to the compressed duration of the project.
This strategy requires a company to have the cash on hand to spend on aggressively pursuing liability reduction. Of a projected liability reserve estimate for a site, 80% of the spending associated with implementing this strategy is usually front-end loaded within the first 36 months of the project.
After working on more than 10,000 contaminated sites and hundreds of client portfolios, Antea Group has learned that typically the total lifecycle cost of successfully closing a site in an aggressive timeframe, whereby out year risk and site management costs are eliminated or greatly reduced, is consistently less than the total cost incurred applying either a compliance-only or lifecycle cost optimization strategy. Regardless of which strategy you choose, thorough evaluation and validation of these options on a client- and liability-portfolio basis is the best way ensure your company’s dollars are properly delivering their maximum ROI potential.
Contact us for more information on how we can support your organization in developing a monetized strategy for effectively managing your environmental liabilities and preserving the “sunny disposition” of your balance sheet!