Is AGL’s Bid For Vocus A Game Changer?

Australia | Jun 13 2019

As earnings levels peak, AGL Energy has sought a tie-up with telco infrastructure, making an offer for Vocus Group.

-AGL is filling a prospective earnings “hole”, amid lack of growth options in core business
-Investors query whether this is the best use of AGL's capital
-Risk that AGL sparks a price war in broadband, potentially spilling to electricity, gas


By Eva Brocklehurst

Interest in the link between energy and telecommunications infrastructure is heightened as AGL Energy ((AGL)) becomes the latest suitor for Vocus Group ((VOC)), filing a proposal just weeks after Sweden's EQT Infrastructure pulled its offer. This is the first time an energy company has made a bid public for Vocus. AGL's $3bn cash offer, at $4.85 a share, is less than the $5.25 offered by EQT and there is now four weeks of exclusive due diligence.

Ord Minnett estimates AGL Energy is offering a multiple of 9.5-10.0x enterprise value/operating earnings (EBITDA) and assesses this to be "full", because earnings accretion would depend largely on a lower cost of debt. While there are cost savings and revenue benefits from the combination, the proposal also highlights the lack of growth available in AGL's core business and the broker is concerned that other parties have conducted due diligence and decided against a transaction.

Citi estimates the acquisition could be 4-14% accretive to FY22 earnings, based on AGL Energy being able to deliver on consensus earnings forecasts for Vocus, before considering further growth in the assets in the longer term.

Several brokers assert AGL Energy is intent on filling an earnings “hole”, as earnings are at a peak. This creates revenue synergy around retail growth and a new avenue for growth in enterprise and wholesale data, Macquarie explains. The latter enables AGL, as one of the main four network providers in Australia, to avoid being a second or third-tier player in the telco space.

Balance Sheet Utilised

Headroom in the balance sheet is now fully utilised, e.g. new acquisitions in upstream gas would require equity, and Citi believes consensus expectations have some way to fall in FY20. The broker points out investors are concerned about whether this is the best use of capital.

While execution risks are high – this acquisition is outside the company's core competency -- Citi believes they are manageable, asserting that the defensive nature of fibre earnings as well as the lack of correlation to wholesale electricity prices reduces the risk.

Macquarie expects buybacks are likely to become a distant memory, as AGL Energy seeks to develop a telco business. In justifying the company's viewpoint, standing still is not an option. The broker expects net profit will fall to $750-850m over the next five years, from $1.01bn, as the benefits of the LREC contribution and Liddell power station decline.

At the same time super profits from legacy gas and coal contracts will end and there will be tighter regulation around power prices. A capital return would, therefore, add value but not address the fundamental challenges.

Credit Suisse retains an Underperform rating, noting the outlook is for diminished capital returns, should the bid eventuate, which compounds an already weak earnings outlook. Macquarie agrees the risk is significant, although migrating Vocus retail customers is logical and relatively low risk. The main issue is migrating enterprise customers from 6-7 individual platforms to a single platform.

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