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The bid for AGL Energy: Good value or opportunism?

To answer that question, we probed industry insiders to find out whether carbon externality has been adequately priced in to AGL.

The tech billionaire Mike Cannon-Brookes called it the “world’s biggest decarbonisation project”.

The entrepreneur, who made his fortune as the co-founder of enterprise software company Atlassian, was the public face of a recent bid to acquire AGL Energy, Australia’s oldest and largest fossil fuel generator and energy retailer, that raised eyebrows across the country.

His private investment firm, Grok Ventures, put up 20 percent of the capital for the bid, with Brookfield Asset Management’s soon-to-close $15 billion Global Transition Fund putting up the other 80 percent.

The consortium’s first bid of A$7.50 ($5.43; €4.93) per share was swiftly rejected by the AGL board, as was a revised offer of A$8.25 per share that valued the business at A$8.5 billion, with AGL’s directors arguing it was “well below fair value”.

Cannon-Brookes and Brookfield were bullish, arguing that their plan was better value for shareholders than AGL’s current strategy, which will see it complete a demerger this year to establish two separate listed businesses: AGL Australia, which will be home to the company’s retail electricity business and its clean energy generation assets; and Accel Energy, which will house its legacy coal-fired power stations.

But was the bid realistic, both in its ambitions and timescale for closing coal-fired generation? And is it a sign of things to come, as infrastructure investors look to deploy more capital into the energy transition space?

Most sources affiliate publication Infrastructure Investor has spoken to agree with the bidding consortium’s belief that the energy transition needs to be accelerated – with coal likely to become uneconomic more quickly than AGL Energy’s demerger plans anticipate.

“The general plan was right, that you can bring capability and some capital to the table to accelerate the transition of these types of companies,” says the chief executive of one Australian energy firm, who asked not to be named when discussing a competitor. “I’m not sure you can just shut down coal-fired power – but I also don’t think Brookfield and Grok were intending to only do that. There was more to it.”

“We’re seeing a recognition that there are many businesses that will become stranded over time if they continue on their current journey”
Martijn Wilder, Pollination

Jeremy Burke, partner at advisory firm Ecotone Partners and trustee at CDP, the not-for-profit charity running the global environmental disclosure system, agrees that the sentiment behind the bid was the right one and that it is aligned with the general direction of travel.

“I think, so far, we’re seeing things play out as the Australian Energy Market Operator thought it might,” he says. “There’s no shortage of people within the Australian energy sector who have forecast early coal closures and now the economics are making that a reality.

“The bid shows the potential private investors think the transition holds. Big capital is looking to deliver deep decarbonisation on a global scale and Australian corporates need to move to grasp this opportunity quickly. This bid simply looked like a plan that would align with science-based emissions reduction targets. So, I think it looked very realistic.”

Martijn Wilder, founding partner of climate change advisory firm and asset manager Pollination, tells Infrastructure Investor that the bid was reflective of the differences in outlook between corporations over how well, and how quickly, they are managing the inevitable energy transition.

“There are businesses in the marketplace that are highly progressive and are carefully considering how to transition going forward,” Wilder says. “Those who aren’t perhaps don’t appreciate how fast things are moving and are more susceptible to the types of aggressive bid that we’ve seen for AGL. In the view of Brookfield and Cannon-Brookes, their proposition for the business was better than what AGL’s board was offering shareholders.”

As evidence, he points to the fact that coal-powered generation is now beginning to exit Australia’s National Electricity Market faster than was originally planned. Origin Energy, another large, listed power generator, announced the early closure of its Eraring coal-fired power station just a week before the AGL bid.

“For coal-powered generation assets in Australia, we are increasingly seeing those close sooner than anticipated because of the significant increased capital cost required to keep them running and upgrade them,” Wilder adds. “Companies are deciding it’s not in shareholders’ economic interest to keep them operating, and the exact timing depends on a range of factors, including age of plant and the cost of capital to keep them running.

“We’re seeing a recognition that there are many businesses that will become stranded over time if they continue on their current journey. But if they start to consider opportunities for transition, there is significant upside. I think this bid had a vision for AGL that they believed would allow it to transform and allow the high-emission part to be shut down.”

Differing views

Cannon-Brookes gave a series of interviews to Australian media after the first bid was rejected. In these, he set out his view that the country’s power prices are low precisely because there is so much renewable power generation in the grid, and that removing coal earlier would keep those prices low, not increase them.

Not everyone agrees that it would be this simple, however.

“You can only get solar penetration to a certain level before you need to add in firming, in the form of either batteries or gas – and when that happens the price of power will have to go up,” says Tim Hannon, managing director at fund manager Conrad Capital Group.

“You could try to shut coal down in a few years, but power prices will go up materially. You need baseload power to replace it, and you would get there eventually – but [in the short term] you would have a completely unstable grid, and power prices would go through the roof.”

Hannon’s argument that power prices will inevitably increase means that he is “bullish” on AGL when combined with another observation on energy markets.

“There’s no shortage of people within the Australian energy sector who have forecast early coal closures and now the economics are making that a reality.”
Jeremy Burke, Ecotone Partners

“Electricity use is also going to go up materially. Power use hasn’t kept up with GDP over the last 15-20 years, and the influx of electric cars will see an increase. So, I think Brookfield and Cannon-Brookes would have been getting AGL on the cheap,” he says, adding that inflation may also increase the costs of batteries and other equipment needed for renewable installations.

“AGL’s leaders are decent people and they’re trying to do the right thing, balancing the interests of shareholders as well as meeting net zero. It’s a really difficult path and I think they’ve tried hard enough. The share price has already fallen 70 percent over the last five years or so, which suggests they might be going fast enough already.”

After the bid was revealed, the Australian federal government was quick to express its concerns, too, with numerous media outlets reporting that it would consider blocking the bid on foreign investment grounds.

Prime Minister Scott Morrison said soon after the bid: “Let me be really clear about something. We need to ensure that our coal-fired generation of electricity runs to its life because if it doesn’t, electricity prices go up. They don’t go down. Our government is very committed to ensure we sweat those assets for their life to ensure that businesses can get access to the electricity and energy that they need at affordable prices to keep people in jobs.”

Whether you agree with Morrison’s analysis or not, the fact that he feels emboldened enough to lay it out so clearly is indicative of where the government’s priorities lie.

“This bid is occurring in a volatile political environment where the government’s main priority is stability of the grid and ensuring there is a long-term energy supply, without necessarily accepting the likelihood that renewables, storage and hydrogen will be able to provide that sooner than anticipated,” Wilder says.

The demerger question

This debate is fundamental to assessing the merits or otherwise of the bid, which essentially boils down to one fundamental question: does Brookfield and Cannon-Brookes’s proposal provide greater value to shareholders than if they held on and received shares in the two demerged entities?

The board’s quick rejection of the bid, followed by the consortium’s declaration that they would not return with a higher offer, means that the onus has shifted, in the view of one Australian fund manager with renewables expertise who did not wish to be named.

“The alternative to the bid is that you have to re-examine your faith in the management’s demerger plan, asking them why one plus one equals three,” this person says.

“In other words, why does management feel the bid undervalues the company relative to the demerger – and this is where I think AGL’s board has got a problem. No one is really talking about whether the carbon externality has been priced in to AGL, even at its currently relatively low share price.

“If it isn’t priced in, then the board should have done the deal, or at least have been more receptive to it. So the board has put itself on the line, arguing there is no need to price in a carbon externality, or arguing that it is already fully priced in so that there is only upside to the sum of the parts of the valuation going forward.”

Brookfield and Grok’s proposal to carve out the coal-fired assets and close them early also puts AGL’s current strategy in stark relief, the fund manager argues.

“The only way the board wins the argument now is if they show there is no finite or near-term expiry on the coal business, and that the carbon externality has been fully priced in. Nobody lists a business if there is no upside, as you would condemn it to a slow death. And I genuinely think: good luck with that argument.”

Infrastructure Investor understands that part of the Brookfield-Grok consortium’s bid, not articulated explicitly in public, centred on a belief that AGL Energy’s coal assets will have significant remediation costs to come that have not been fully identified yet – to the point that they even believe it could lead the coal business into significant financial strife as those assets come offline.

For his part, AGL’s chairman Peter Botten said in a statement after rejecting the second bid that the consortium’s revised proposal “continues to ignore the opportunity that AGL Energy shareholders have through our proposed demerger to realise potential future value”.

Burke sums up the view among many investors, including those who have been supportive of AGL’s plans: “It is now incumbent on the AGL board to demonstrate how their demerger plans fit with a rapid reduction in emissions while creating shareholder value. That’s the future investors want to be invested in. The writing is on the wall for fossil fuel generation because we know investors want to back deep decarbonisation on a global scale and we know that the Australian energy market is changing quickly.”

Further information on the demerger is set to be released to AGL shareholders in mid-May ahead of a vote that, if successful, would see the separate businesses established before the end of June. This is the next test – and Brookfield and Grok have not ruled out coming back to the table at the same price should the demerger fail.