As investors fret about the fallout from a weak Chinese economy, stable, dividend-paying utilities have become very desirable.Tim Fraser/The Globe and Mail
The knives are out inside Ontario's provincial political bubble. With Hydro One's initial public offering about to hit the market, everyone is turning against the ruling Liberals – and no dig is proving to be too petty.
At a media briefing Friday, the IPO's top financial and legal advisers addressed the press gallery, allotting time afterward to address substantive concerns about the country's largest privatization in years.
Despite filing a 322-page prospectus chock full of colour on strategy and the market's appetite for utilities, they fielded incessant, angry questions about executive pay. Hydro One's new chief executive officer is slated to make up to $4-million annually, and political reporters couldn't get past it.
The circus continued when NDP energy critic Peter Tabuns followed up with his own news conference, making a scene by ripping the Liberal sign off the podium. Then he resorted to fear-mongering, warning that the IPO is bound to lead to higher electricity rates. Never mind that such rates are controlled by the arm's-length Ontario Energy Board.
Amid all the noise and the politicking, something crucial keeps getting missed: This deal makes perfect sense.
Selling off government crown jewels is always tough – particularly when they generate $708-million a year in profit. Hydro One provides relatively stable revenue streams that a ruling party can rely on to help fund future budgets.
But these are unusual times.
Ontario is broke. The province is drowning in debt, despite decent real gross domestic product growth, and it keeps churning out deficits – including a $10.9-billion shortfall last year.
Premier Kathleen Wynne was re-elected last fall with a mandate to reinvest in the province, particularly through transit and infrastructure projects that are expected to fuel growth. The only problem: The government has no more room to borrow. With debt already 39.4 per cent of GDP, rising for seven successive years and prompting multiple debt-rating downgrades, bond investors can't keep filling budget holes.
Desperate to raise money, selling off Hydro One is the least bad option. Ms. Wynne was initially against the plan, but she wisely came around after former Toronto-Dominion Bank CEO Ed Clark, who is leading a provincial asset review, helped her see the light. Much respect to the Premier for embracing such a difficult choice.
"Privatization" is typically a dirty word in political circles, gaining a reputation as another word for fire sales. The opposite is true for Hydro One: The timing could hardly be better. With commodity prices in the gutter, investors are desperate to get their hands on non-resource companies, contributing to incredible demand for IPOs for the likes of Cara Operations Ltd. and Shopify Inc.
Regulated utilities are also particularly sexy right now. As investors fret about the fallout from a weak Chinese economy, stable, dividend-paying utilities with fixed electricity rates are very desirable. Despite market jitters, Emera Inc. just raised $1.9-billion to help fund its latest acquisition of a regulated utility – which has to be encouraging for an Ontario government looking to unload 15 per cent of Hydro One for roughly $2.25-billion.
Public companies have faced similar gut-wrenching decisions. In 2012, Bank of Nova Scotia opted to sell its headquarters for $1.33-billion. Soon after, retailers such as Canadian Tire Corp. Ltd. and Loblaw Cos. Ltd. took their real estate public through IPOs. Even though these deals meant the companies could no longer control their rents, the sellers all realized the real estate market was incredibly hot and may not stay so forever. The Ontario government wisely came to the same conclusion.
The Liberals – advised by Mr. Clark, Alan Hibben and Torys LLP – are executing this beautifully. They've persuaded Bay Street to accept some of the lowest IPO underwriting fees imaginable, closed the relevant legal loopholes so the deal can't get scuttled the same way it was when the provincial Progressive Conservatives tried to take Hydro One public in 2002, and they've addressed the biggest problems that made the privatization of the 407 toll highway such a boondoggle.
In Ontario, the 407 sale is constantly used as the textbook case of a bad privatization because it was sold for only $3.1-billion and is now a prized asset worth multiples of that because pension funds and institutional investors clamour for infrastructure projects. But that highway was sold all at once, while Hydro One will be unloaded in stakes, which means the government will benefit from any valuation bumps. (It will also suffer from any future market turmoil.) The 407's fees also weren't regulated, allowing the private owners to jack them up, while Hydro One's are regulated.
Mr. Clark, who strongly believes Canadians need more solid public companies to invest in, is adamant the Hydro One deal will be a winner. "There's no question in my mind that we'll look back in five or 10 years and say, 'Wow, that was a really great idea,'" he said on Friday.
So far there's nothing to suggest he's bluffing. This is a well-run process. Now the Liberals and their underwriters simply have to hope investors show up.
Tim Kiladze