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What Now For AGL?

Australia | May 31 2022

This story features AGL ENERGY LIMITED. For more info SHARE ANALYSIS: AGL

The abandonment of AGL Energy’s demerger plans and subsequent board upheaval has left the company in an uncertain position due to its need to act on its substantial debt burden.

-Post no spin-off, AGL Energy now in limbo
-A new-look board required
-Debt remains the company’s pressing issue
-What will Mike do?

By Greg Peel

In early 2017, AGL Energy ((AGL)) traded at $26.76 per share. In November last year it traded at $5.13. Straining under the weight of debt, the company was able to begin a bounce off the bottom when oil and coal prices began to surge, implying higher gas and electricity prices for the power generator.

That thesis remains in place, with the regulator recently approving substantial power price increases.

But AGL’s problem remained one of being perceived as an ESG pariah, indeed the lowest of the low in Australia given it is the country’s biggest carbon emitter. To that end the board came up with a plan – demerge the company into two separate entities. AGL Australia would take the company’s energy retailing business and renewable energy assets and Accel Energy would keep the legacy coal-fired power plants.

The perception was that AGL Australia would be ESG-viable and a valuation re-rating would follow. Accel would be sold off to solve the company’s debt problem. Simples. Brokers for the most part agreed the strategy was in shareholder interest, although the question of securing a buyer for the coal plants remained in some doubt.

Then in stepped Atlassian co-founder and billionaire green warrior Mike Cannon-Brookes who, via his Grok Ventures and in consortium with private equity firm Brookfield, made a takeover offer at $7.50 per share. The proposal was swiftly rejected by the board. The offer was then upped to $8.25, and again rejected.

Cannon-Brookes’ primary goal was to shut down the coal plants. AGL’s CEO suggested, in comparison to the demerger plan, “The alternative is a lot of rhetoric but little detail from someone who has not provided a plan, and whose interests are not aligned with the interests of thousands of our other long-standing shareholders”.

Cannon-Brookes pointed to the long term share price decline.

Then having been knocked back at $8.25, he secured 11.27% of AGL shares instead, and became its largest shareholder.

Counting the Beat

A shareholder vote on the demerger proposal was scheduled for June. Yesterday the board announced it had abandoned the demerger plan. Four of eight board members announced their resignations, including the chairman and CEO.

Cannon-Brookes’ shareholding clearly brought the board unstuck, as it insisted the proposal “would have been supported by a majority of shareholders, both retail and institutional”. Given the proposal required a 75% majority of shares on issue, that shareholder majority obviously did not add up to 63.73%, or 75% minus Cannon-Brookes.

Conceding a groundswell of opposition, brokers had warned that were the vote to have been to reject the demerger plan (not anticipating an abandonment beforehand), the risk was AGL’s share price would collapse into a fog of uncertainty. As it was, the stock lost only -1.7% on yesterday’s announcement.

The assumption is a takeover is now back on the table.

For what’s left of the AGL Board (although they’re not all leaving immediately), the challenge is now to find replacements, ahead of a planned strategy update in September. The abandonment has cost the company -$160m, although that would have been -$260m had the demerger gone ahead.

Then there’s that debt load

Ord Minnett believes establishing new debt facilities for the combined entity will be AGL Energy's key near-term focus given what had been arranged for the demerged entities will be cancelled. This may be difficult and more expensive considering the current interest rate environment and increased environmental focus.

All brokers nevertheless agree the outlook is currently positive for the company thanks to higher electricity forward prices.

But Morgan Stanley cautions against over-capitalising AGL's price tailwinds in view of fuel cost headwinds and smelter contract renewals over FY26-28, as well as lower anticipated plant output and/or reliability generally (noting the ancient Loy Yang A coal-fired plant suffered an outage in early May and may not be back online until August, potentially costing the company -$73m).

Is Cannon-Brookes just a nutter?

It would be easy to dismiss Cannon-Brookes as just a young environmental warrior who after listing his co-founded Atlassian software business on Wall Street, found himself with too much money and too much time on his hands. In recent months he has been seen running around buying up rural properties to convert into carbon sinks, particularly in the highly-prized Southern Highlands region of NSW.

UBS decided it would be a good idea to have a chat to the guy, or more specifically, to Grok Ventures.

We believe that in addition to wanting a stronger decarbonisation pathway, Grok sees considerable value in AGL's underlying business as a platform to develop a new Distributed Energy Resource product that orchestrates power behind-the-meter (BTM) and aggregates it onto a new scalable trading platform. While we do not believe a scale product exists yet in Australia, the right tech could fundamentally change the future of energy generation & retailing.

We believe Grok sees a major future opportunity in orchestrating BTM power flows at scale (power generated via rooftop solar and stored in home batteries/EVs). If a new scalable trading platform could be developed, using AI to solve multiples of instantaneous customer load profiles into trading algorithms, it could win the race for orchestration. AGL's industrial customer book and low-cost wholesale generation portfolio may provide an ideal testing ground for such a product and its 4.5m energy and telco customers an opportunity to apply at scale if successful.

So no, he’s not just a nutter. Other FNArena database brokers are so far happy to wait and see what comes out of September’s strategic update, and to find out who might end up on the board of AGL.

UBS expects the stock to trade range-bound to the last bid price from the Grok/Brookfield consortium ($8.25) and anticipates reinvigorated corporate interest in AGL.

UBS retains its $8.50 target and Neutral rating, and similarly Ord Minnett retains Hold and $8.70.

Two years of higher electricity margins leads Morgan Stanley to increase its price target to $9.38 from $8.48, but the broker concedes higher-end user prices also leads to a higher risk of policy intervention for all utilities.

Macquarie is advising so it is currently on research restriction.

Credit Suisse has an Outperform rating and Morgans Add, as of earlier in the month, but have yet to update on yesterday’s developments.

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