Reject takeover until after demerger

We're strongly against an AGL Energy takeover both at this time and at the current share price. In our opinion, AGL is heavily undervalued, and a better takeover price would be achieved after the demerger, or better still, after earnings recover over the next couple of years. The bid price is 5% above the last closing price but 44% below our fair value estimate and represents a fiscal 2024 P/E ratio of 9 times on our forecasts.

The non-binding, indicative cash offer of AUD 7.50 per share was made by a Brookfield-led consortium, which includes Mike Cannon-Brookes' Grok Ventures. AGL directors rejected the offer, saying it materially undervalues the company. Even if a higher bid eventuates, we doubt it would approach our fair value estimate. The demerger and expected earnings recovery would significantly de-risk the business and improve takeover prospects.

After demerger, we think AGL's retail business--to be known as AGL Australia--would be an attractive takeover target for large domestic and foreign enterprises trying to grow in the Australian energy sector, such as Telstra, Ampol, Shell, Total, Enel, and Iberdrola. With so many potential suitors, we would expect an attractive takeover price. These firms would be less likely to enter a bidding war for AGL Energy as it currently stands because of the risks of divesting the coal power stations, which they would be unlikely to keep.

While most acquirers probably wouldn't want the coal power stations, we think AGL's generation business--to be known as Accel Energy--has a good medium-term earnings outlook given strength in wholesale electricity prices. Futures prices in New South Wales average AUD 83 per megawatt hour to 2025, inclusive. Further, Origin Energy's intention to close Eraring in 2025 (seven years early) only improves the prospects for a tight electricity market through the 2020s.

-MorningStar