Cannon-Brookes says AGL coal plants will struggle to survive, needs new board

Mike Cannon-Brookes’ investment vehicle Grok Ventures has questioned whether AGL’s coal plants can survive as long as its board says they will, and has suggested the company offer loans of up to $100,000 to customers to electrify their homes.

In an investment memo released publicly on Friday, Grok Ventures fleshes out the concerns that Cannon-Brookes has with the proposed AGL split into two companies, and the inability of the board to understand the implications of the clean energy transition.

“AGL needs a Board that understands the opportunities presented by energy transition,” Grok says in the new document, released just over three weeks before the shareholder vote.

“We believe AGL needs world-class renewable operators to manage the transition and technologists to solve the behind the meter opportunity. Management incentives need to be realigned to deliver on the accelerated transition opportunity.”

Grok also says energy market trends are against the remaining coal generators Bayswater and Loy Yang A, the former because the price of black coal has jumped 10-fold, and the latter because of its inability to cope with the growing impact of more renewables, and solar in particular.

“We strongly believe the long-term cost of black coal for Bayswater and the declining reliability of Loy Yang A will mean these assets will struggle to remain profitable to their current target closure dates,” it says.

“(The) Australian Energy Market Operator’s (AEMO) Draft 2022 Integrated System Plan outlines that market consensus is now that the most likely scenario is that “all brown coal and two-thirds of black coal generation could withdraw by 2032”.

“We are concerned about Accel Energy’s ongoing solvency and in such circumstances Accel Energy shareholders may face a scenario where the share price goes to $0., providing key insight into why the Atlassian co-founder is fighting to keep the energy giant as a single entity.”

Intriguingly, Grok also suggests that AGL focus on its customers by developing products that could offer loans of up to $100,000 to help them electrify their homes, effectively taking the “G” out of AGL, which started life as the Australian Gas Light Company.

“We believe AGL can deliver finance products and offer home energy device management services to help customers as they convert their homes to 100% renewable electricity,” it says.

“We expect AGL can deliver finance products to help customers fund approximately $100,000 of capital expenditures to electrify their homes. We assume the average loan life to be 4–7 years, and the loans to earn market standard net interest margins.”

‍Grok says this transition is best done within a single entity, and it argues that AGL will get a better rating, and more support from investors and financiers, if it has a credible plan to decarbone.

“We believe that voting against the AGL Board’s proposed demerger not only avoids further shareholder value destruction from splitting the company, it presents an opportunity to unlock significant value and share price outperformance,” the memo says.

“The demerger lacks vision and represents a failure to embrace the opportunity presented by decarbonisation.”

AGL is proposing to separate its electricity retail business and portfolio of renewable energy projects from its fossil-fuelled generators – largely in an attempt to de-associate its core brand from its fossil fuel generators.

The split would create two new companies, AGL Australia, which retains the retail business and most clean energy assets, and Accel Energy, which will hold most of AGL’s fossil fuel generators.

But Grok argues that splitting AGL’s retail and generation businesses would ‘destroy’ the value of AGL’s vertically integrated business model, which it says could instead be used to leverage investments in new renewable energy projects.

“AGL’s main argument for the demerger is that the vertically integrated ‘gentailer’ model is no longer fit for purpose,” the investment memo says.

“We disagree that this model is broken, and see significant value in keeping AGL together.

“The demerger destroys the benefits of having a single vertically integrated business covering both generation and retail. Vertical integration reduces the cost and complexity of risk management. AGL has historically reduced wholesale price risks by matching its generation with its customer load.”

Grok also suggests that one half the proposed split, Accel Energy, faces a significant risk of insolvency by being lumped with AGL’s ailing fleet of coal fired generators and their potential remediation liabilities once retired.

It argues that there were greater opportunities to drive the evolution of AGL’s generation portfolio to one consisting of renewable energy projects by keeping the entity together.

“It is not possible to fully quantify the value destruction that comes with unwinding the benefits of AGL’s vertical integration, particularly given much of the downside is in unnecessary complexity and missed opportunity,” Grok Ventures says.

“We believe a combined AGL is best positioned to build a leading renewables developer strategy, which we cover in more detail below.”

“As a combined company, AGL has a natural advantage. It can leverage Australia’s largest customer book to become a leading renewables developer.”

Grok pointed to the experience of German energy giant RWE AG, which retained its coal generation assets under its core brand while grouping its clean energy and retail business into a separate subsidiary, Innogy.

“RWE AG in Europe has demonstrated that an accelerated coal closure and investment in renewables can deliver significant shareholder value,” Grok says.

“RWE plans to retire 12GW coal and replace it with over 30GW of renewables, transitioning the company to over 90% renewable by 203014. Since RWE announced this accelerated transition plan in 2016, RWE’s share price has tripled.”

Responding to the memo, AGL CEO Graeme Hunt dismissed Cannon-Brookes’ proposals as a “thought bubble”.

“This latest thought bubble underlines both the tremendous risk to AGL shareholder value and to a responsible energy transition posed by Grok in their attempt to scuttle the demerger without putting forward a credible alternative plan,” Hunt said.

“There are errors and inconsistencies in what has been released today and AGL will take some time to assess what this means for our shareholders.”

“Mike Cannon-Brookes’ lack of expertise and understanding when it comes to the Australian energy market, the reality facing energy customers and the pressures of the real world, is betrayed by this out-of-touch proposal today.”

Cannon-Brookes has amassed an 11.28 per cent personal stake in AGL Energy and has committed to using that stake to oppose the demerger proposal.

Earlier this week, Cannon-Brookes pointed out that his stake is substantially larger than those of the AGL board, underscoring the seriousness of his takeover bid by demonstrating he has ‘skin in the game’.

The share market has wiped out most of AGL’s market capitalisation over the last five years, with the company’s share price falling from a peak above $26 in 2017, to trading just above $5 per share in late 2021, after the company’s management conceded it had been caught off guard by the pace of the energy transition.

Since Cannon-Brookes launched his takeover bid, the company’s share price has recovered somewhat, now trading above $8.50 per share.