A Close Reading of the Future: ESG and Engine No. 1 Arrive at XOM

Disclaimer: https://www.transactionaldelights.com/disclaimers

How do I think about ESG? It is environmental, social, or governance issues at a Company that could affect the company’s value. These factors apply to any company in the whole universe of companies. It could be Apple, Amazon, Facebook, Tesla, Home Depot, Verizon, Adobe, Coca-Cola, Walmart, or Exxon. Just like every company has a balance sheet, income statement, and statement of cash flows, in the future every company may have an ESG equivalent[1].  

Compare that with how I think about impact investing. Impact investing is limited in the possible universe of companies that one could invest in because impact investing is searching for companies that are contributing towards a social good, measured by investors as to how the company is affecting a social or environmental goal (in addition to returns).

Accordingly, in comparison with impact investing, the concept of ESG is pervasive and almost without limits, which is why it gets those that are forward-looking so enraptured, even if the concept and execution of it is still in its infancy[2] and the momentum is due, in part, to it being such an amorphous concept. People understand what it means generally. They don’t really know what it means specifically.

But, there is an activist now that is involved in a campaign that is trying to bring those two ideas closer together: Engine No.1’s campaign at $XOM.

Engine No. 1’s campaign at $XOM is summarized in its press release and letter to the Board. It seeks to:

• “Refresh the Board with highly qualified, independent directors” and “overhaul management composition” -  Cites 3, 5, and 10 year TSR compared with comps and sell-side analysts ratings compared with comps. This is a fundamental activist tool.

• “Impose greater long-term capital allocation discipline” – Notes a declining Return on Capital Employed for Upstream projects from an average of ~35% from 2001-2010 to ~6% from 2015-2019. Also another fundamental activist tool.

• “Implement a strategic plan for sustainable value creation” – Puts forth the hope for a new strategic plan without actually outlining a strategic plan. The use of the word “sustainable” is new and a signal to sustainable/impact/ESG.

So, this is a letter with some valid critiques of $XOM, but it isn’t anything new, except for the signal to “sustainable value creation”. The form of the message (the letter to the board) itself is a typical activist tool used to garner publicity[3].

Is the letter too early? Should it have been more ambitious?  

Being the first is never easy, but it does feel like a missed opportunity for Engine No. 1. They were given the opportunity to fly, and all they took was a big jump. That jump might be a bit more practical (if half of their investor base is retail), it may get them a board seat or two, and reason to pound their chest when they try to attract new investors but, wouldn’t it be great to fly? Put forward a strategic roadmap of just how ESG factors affect $XOM’s shareholder value?  It doesn’t even attempt to outline the contours of “sustainable value creation”.

To be fair, the issues that plague Engine No. 1’s letter are the same issues that plague ESG. Objectively, nobody knows what the hell it means. Subjectively, some sophisticated investors have different ways of measuring and evaluating, but how does an activist use that for a collective action issue (i.e., getting retail and institutional votes for a board seat?)

Well, this may be just the first step. The momentum behind ESG[4] is starting to push old actors into new fields: Engine No. 1, Impactive Capital, and Inclusive Capitalism. So maybe $XOM is more about momentum, and not inertia. Jiu-Jitsu, and not karate. Which is to say, despite Engine No. 1’s direct message and small investment, this campaign is what distinguishes effective activists from less effective activists – an investment guided by market forces and finding a wedge to push, vs. forcing the issue by pulling[5].

And in the future, as we see more effective concepts of ESG disclosure put forward, we may see more activism blurring the lines by expanding the universe of companies that can be impacted through environmental, social, and governance issues.

[1] And just like we focus on different financial metrics at a company depending on its space (like sector specific multiples) we may also focus on different ESG factors depending on how a company is situated.

[2] There could be a convergence of the concepts in the future. For now, ESG is mostly about environmental and social disclosure. What investors choose to do with that disclosure could shift the two concepts closer together (I mean, look at any of the new ESG activist investors). In the present, people sometimes use the two concepts interchangeably, which gets even more confusing. But when enough people do a thing, that thing becomes a thing? Right “irregardless”?    

[3] Although kind of a nice touch to sign the letter “E#1” rather than any individual.

[4] In my view, it really is more of a feeling than a properly defined concept right now.

[5] The idea is good. Whether they get a board seat or not will come down to execution of the concept.