Ontario’s Hydro One privatization plan could scare off investors

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Ontario's privatization plan for Hydro One is raising questions among market experts who say the government's continued control of the electricity giant will be difficult for private investors to swallow.

On Tuesday, The Globe and Mail reported that Ontario Premier Kathleen Wynne is exploring a plan to sell shares in Hydro One, starting with a 10 per cent to 15 per cent stake in the electric utility. That initial public offering could be followed by additional stock sales that would further reduce the government's stake, although it would look to maintain certain controls on the company and possibly stop short of selling a majority of its interest. The proposal has not yet been presented to cabinet, but Energy Minister Bob Chiarelli said Tuesday the province "will continue to have a significant ownership interest" in Hydro One no matter what option it takes.

Any option that leaves government with control and active say in the company is likely to turn off investors, said Leo de Bever, who served as the point man for the Ontario Teachers' Pension Plan Board in the early 2000s, when it tried, along with the Ontario Municipal Employees Retirement System, to buy the utility from the government. Then-premier Ernie Eves shelved privatization plans in 2002 in the face of mounting political pressure.

"Privatizing 10 per cent or 20 per cent keeps control with government," said Mr. de Bever, the recently retired chief executive officer of Alberta Investment Management Corp. "You can't have it both ways: controlling the assets and not owning it at the same time. Selling means giving up control and relying on fair regulation to balance public and private interests."

In the 1980s and 1990s, when Canada privatized many of its Crown corporations, the government often favoured selling off large stakes at once. Many of this era's deals were knocked out in one or two hits. In 1995, federally controlled Canadian National Railway Co. went public in a single IPO worth more than $2-billion – still one of the country's largest new issuances. Air Canada was sold off in two chunks, an IPO in 1988 and another stock sale in 1989. A sale of just a small stake of Hydro One would be an unusual move.

Mr. de Bever said owning a minority stake in a government-controlled company "to me feels more like owning a bond" than a stake in a public company committed to growing value for shareholders. "The rationale for private ownership of infrastructure is having the opportunity to improve operational efficiency. That is hard to do with a minority stake" in a government controlled-business, he said.

The government has not ruled out selling a stake to an institutional investor and many pension plans have an appetite for increased exposure to infrastructure and utilities. These assets have been sought by investors as a source of yield in an environment of low interest rates and volatile resource prices. They also align well with the long-term obligations of these funds. "The infrastructure asset class is very popular with pension plans" which, with huge amounts of capital to invest, "may well be desperate enough to bite on this," Mr. de Bever added.

A senior Bay Street source said investors are less interested in buying into a company controlled by government because they would have less opportunity to make the company more efficient.

With the government in charge, there will always be the risk of political interference – decisions that are not in the company's best business interests – as well as less opportunity for the private investors to make changes necessary to get the company running more efficiently and turning a bigger profit.

One government source acknowledged this reality, saying private firms would generally pay more for a stake in a company where they have more control. In particular, the source cited Hydro One's labour costs – including an expensive pension system – and the setting of energy rates as two factors that drive the Crown corporation's bottom line. But the source cautioned that the province must also balance public policy concerns, such as electricity rates, with the simple desire to make money.

Tom Adams, an energy consultant and long-time proponent of market reforms in the sector, said he was in favour of privatizing the utility, but added: "I want to see less government decision-making driving the capital allocation at Hydro One." The ideal model for Hydro One would resemble that of natural gas utilities that "are owned by parent companies and they're very broadly held," he said.

Mr. de Bever, who has worked with pension funds around the world and invested in former publicly owned infrastructure assets on several continents, said it's common for governments to have difficulties letting go of certain businesses, particularly where there is a "local tradition" of regarding certain assets as naturally belonging under government control.

"Many Ontarians seem to feel that transmission wires should be publicly owned," he said. "In Alberta, transmission has always been private, but its population has not been enthusiastic about private roads that are acceptable in Ontario, Australia, Chile and France."But he added that cash-strapped democratic governments, despite wanting to invest in infrastructure – as the Ontario government hopes to do with proceeds from any Hydro One sale – "more often than not end up doing nothing" because "engaging private capital creates fear of a political backlash."

With files by Adrian Morrow