AGL worth more than Cannon-Brookes bid: Morningstar

Management at AGL Energy were right to knock back the unsolicited cash bid from a consortium of investors fronted by Atlassian co-founder Mike Cannon-Brookes, says Morningstar senior equity analyst Adrian Atkins.

In a research note published on Monday, Atkins said Saturday’s $5 billion offer would lock shareholders out of any share price revival at Australia’s oldest company. He said AGL earnings are down, but expects rising wholesale electricity prices should see profits double by 2025. More bidders and a better price are also likely once AGL completes the planned demerger of its fossil fuel assets, which are a sticking point for many investors.

“Now is not the right time," he says. "You need to wait at least until the demerger, if not wait a couple of years for the earnings recovery."

“At the moment, because of all the uncertainty, no one will pay a good price. But once you start making some good earnings, you can show the debt can be paid off and the problems can be fixed. That’s when people get a bit comfortable and say, here’s a fair price.”

Wholesale electricity prices are showing signs of recovery in futures markets. New South Wales contracts for 2023 reached above $88 per megawatt hour last week, almost double a year ago. Rising prices for fossil fuels are pushing up electricity prices.

AGL’s (ASX: AGL) board rejected the unsolicited $7.50 per share offer from tech billionaire Mike Cannon-Brookes’ Grok Ventures and Canadian asset manager Brookfield on Monday morning, saying the 4% premium to Friday’s closing price materially undervalued the company.

The bidders plan to accelerate the closure of AGL’s coal-fired power stations and invest up to $20 billion in transitioning the generator to renewable energy. Consortium members they “remain optimistic that an agreement can be reached”.

Atlassian co-founder Brookes has made a name in recent years as an activist for action on climate change. Along with Fortescue founder Andrew Forrest, he is an investor in the Sun Cable project, which aims to transmit solar energy from the Northern Territory to Singapore via undersea cable. Speaking on Monday morning, he called the bid for AGL “the single biggest decarbonisation project” they could find in the world.

Brookfield and Brookes are tilting at Australia’s largest carbon emitter as the company struggles to revive a share price down 20% in the last twelve months and 66% over the last five years. Earnings are being squeezed as cheap renewable energy generation weighs on wholesale electricity prices.

Management is pinning hopes on plans to demerge AGL’s fossil fuel generation and energy retailing businesses into separate entities. Shareholders would receive better value under the proposed demerger plan, due to be completed in June, said Peter Botten, AGL Energy’s chairman in a statement on Monday.

“There’s a lot of big Australian and foreign companies that want to get into the Australian energy sector," Morningstar's Atkins said. "AGL’s got between 4 and 4.5 million, retail customers. That would appeal to a lot of different customers, so you would get a bit of bidding tension and a decent price.

“The problem with selling the business before the demerger is a lot of those companies would stand back and not be interested. They wouldn’t know what to do with the coal power stations.”

Companies interested in growing their energy retail businesses include Telstra, Ampol, Shell and European energy generators Enel and Iberdrola, said Atkins in his note.

The bidding group’s plans to shutter AGL Energy’s coal plants by 2030 comes a week after Origin Energy’s shock announcement that it would close its Eraring coal power plant by 2025, seven years earlier than expected. AGL also brought forward the closure of its Bayswater and Loy Yang A plants by two and three years, respectively.

AGL is the third Australian utility targeted by private money in the last twelve months. Bid leader Brookfield Asset Management is fresh from its $18.2 billion takeover of gas and electricity infrastructure company Ausnet Services in January. Electricity transmission network owner Spark Infrastructure was sold for $5.2 billion in December to a consortium of pension funds and private equity groups.

“They’re not interested in the generators," Tim King, chief investment officer at Melior Impact Investors says. "They want AGL’s retail book, which is full of clients the consortium can convert over to renewable generation. That’s the crown jewel in all this."

Markets reacted positively to the offer as traders anticipated the possibility of future bids. AGL shares closed up 10.6% to $7.92, above the consortium’s bid of $7.50. Saturday’s offer remains well below Morningstar’s fair value of $13.30.

“There’s a lot of water to flow under the bridge yet,” says King, “This is the first shot across the bows.”

Morningstar’s portfolio holding data shows few local actively managed retail funds maintain major positions in AGL.

Martin Currie’s Australia Real Income strategy is the largest non-index fund holder of AGL, according to Morningstar data, with shares worth $21.8 million or 2.2% of the fund’s portfolio as of 31 December. A spokesperson for Martin Currie would not confirm the holdings due to its disclosure policy .

Former shareholder Argo Investments sold its stake in the first half of FY22.

The SelfWealth SMSF Leaders ETF, which is constructed from the top performing SMSF portfolios on SelfWealth, is a top ten owner of AGL Energy by portfolio weight.