Eric Baker is the wealthiest Canadian venture capitalist you never heard of. But you might learn something about him soon. That's because he's close to hitting the jackpot on his investment in Teranet, the monopoly electronic land registry service with close ties to the Ontario government.
Mr. Baker is the president of Montreal's Miralta Capital and has been in the venture capital game since the early 1970s. He was the money behind Altamira, the mutual funds company now owned by National Bank, and the Alberta biotech company Biomira, where he is chairman. He is also the president of Teramira, the private investment company whose sole holding is 100 per cent of Teranet.
Besides his penchant for attaching "mira" to his investments, little is known about him. The Queen's and MIT graduate is probably in his late 60s or early 70s and shuns publicity. He collects horse-drawn carriages.
He obviously loves to make money and is in a nice position to score a windfall profit from Teranet. The only thing that stands in his way is a behind-the-scenes political stalemate at Queen's Park. The debate centres on how the government should monetize the value of Teranet, which is potentially worth billions of dollars, and whether those billions should come out of the pockets of the direct and indirect users of Teranet, that is, almost every voter in the province.
First some background. Teranet was created in 1991 to automate Ontario's paper-based land registry system. In 1993, Mr. Baker's Teramira became a Teranet investor. The project became a success. Almost all of the province's five million or so properties have found their way into Teranet's electronic database. By last year, it was handling as many as 17,000 electronic land registrations a day. Real estate lawyers and mortgage sellers like Teranet because it means they don't have line up for documents at some dreary municipal land office.
So far so good. Then Ernie Eves, the Tory premier who went down in flames in 2003, decided to make things complicated. Facing an election and a budget deficit he claimed didn't exist, he sold the province's 50-per-cent stake in Teranet to Teramira for $370-million. The deal raised Teramira's stake to 100 per cent and valued Teranet at $740-million.
That created the first problem -- did taxpayers get good value? It appears not. Although Teranet's financial statements are not public, we know it has lovely margins. In 2003, it had an operating profit of $118-million on sales of $190-million, for an operating profit margin of 62 per cent (in other businesses, such as retailing, 6-per-cent margins are considered adequate). If Teranet had been turned into an income trust in 2003, it might have been valued at $2-billion or more, depending on the yield it paid.
The $740-million valuation is even more suspect when you consider Teranet's growth potential. The company is considered a technological leader. Licensing its land registry software and selling its expertise across Canada and in other countries could transform it into an e-services powerhouse.
But never mind. Mr. Eves needed to fill a budget hole in a hurry and out went Teranet. Some government conditions were attached to the sale to make it politically palatable. They included a) a freeze on Teranet's fees until 2006 and the right to regulate them thereafter, b) veto power over the sale of Teramira until 2006, and c) the right to take 50 per cent of any increase in Teranet's value should it be resold.
The conditions were designed to protect the Teranet customer and the Ontario taxpayer, but they may backfire. In effect, the conditions made the Ontario government the only logical buyer of Teranet while pretty much guaranteeing it would have to pay a lot more than the 2003 valuation to get it back. Having privatized Teranet too cheaply, the government may find itself compounding the problem by reversing the privatization too expensively.
But that is what may have to happen. Put yourself in the government's position. It knows that after 2006 it loses is veto power over the Teranet sale. It would rather not see Teranet go to an unknown buyer who would naturally try to break the government's regulatory stranglehold, jack up the fees and create fat profits for itself at customers' expense. Far better for the government to buy it back, jack up the fees and create fat profits for the government at customers' expense.
This seems to be the storyboard. The Liberal government has hired Genuity Capital Markets to advise it on value-creating options for Teranet (RBC Dominion Securities is advising Teramira). One option would simply see Teramira selling Teranet to another investor, with the government snatching 50 per cent of the difference between the 2003 price and the new price. The problem is that potential buyers would resist -- indeed are resisting -- buying a business where the government has so much potential to meddle (remember the government flip-flop on the Hydro One privatization?).
This means the government will probably have to buy all of Teranet at a price that would please Eric Baker. Then what? To justify the higher buyback price, it would have to raise Teranet's fees. To create value for the taxpayer, it would have to raise the fees a lot. With doubled or tripled fees, Teranet would make an ideal income trust, potentially valued at several billion budget-hole-filling dollars. Or it would make an ideal non-share-capital corporation, like Nav Canada, which operates the country's air traffic control system (this is RBC's pitch).
But consider the absurdity of this scenario. In 2003, the government did a boneheaded deal, but at least it was a deal that came with some protection for the Teranet customer. Now it's thinking about shredding that protection so it can boost Teranet's value.
If that happens, your mortgage and land transfer fees will soar. This would effectively act as a new tax on the millions of Ontarians who own houses and commercial properties. Wherever Mr. Baker is, he's laughing.
Eric Reguly