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Power lines run out of the Hydro One Claireville Transfer Station in Vaughan, On. on Mar. 9, 2015.

Tim Fraser/Globe and Mail

Ontario’s Conservative government defended its decision to replace the board and top executive of Hydro One Ltd., after the State of Washington cited political interference as it turned down a $4.4-billion acquisition by the company.

The decision by the state’s utilities regulator to say no to Hydro One’s proposed acquisition of Avista Corp. puts the deal in serious peril and throws its growth strategy into disarray. Without the state’s blessing, the deal cannot proceed, although Hydro One and Avista can appeal the decision. If the acquisition dies, Hydro One, which is 47-per-cent owned by the provincial government, will be on the hook for a US$103-million termination fee to Avista. It has already spent tens of millions of dollars on legal and banking fees as part of the acquisition.

Hydro One has been searching for a chief executive since Ontario Premier Doug Ford forced out CEO Mayo Schmidt this past summer. On the same day, the previous board of directors also resigned en masse.

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In its decision, the Washington state regulator said: “It became clear on and after July 11, 2018, [when the CEO and board left] that Hydro One’s directors cannot be considered independent and the province’s role is not limited to that of a minority shareholder in a publicly traded corporation. … There appears to be nothing that would prevent this level of interference from occurring again."

But Energy Minister Greg Rickford said the government has the right to make decisions it feels will lead to lower hydro rates. “We’re a shareholder, a significant shareholder. This a private company, but in many respects resembles a public utility and we have a corresponding obligation to live up to a campaign promise that would reduce hydro rates” by 12 per cent.

Opinion: Doug Ford gets rid of the $6-million man — and costs Hydro One $185-million

In a statement, Mr. Ford said: “While some critics might believe that the concerns of Ontario families, seniors, and businesses should take a back seat to foreign regulators, our government remains unwavering in our commitment to the people of Ontario to reduce hydro rates and provide a reliable energy system.”

Investor reaction on Thursday suggests the deal has little chance of surviving. Avista’s U.S.-listed shares fell 13 per cent, while Hydro One’s shares went up 5.7 per cent. Some investors had said the deal was too expensive for Hydro One and created new risks in markets in which it has little experience.

However, analysts offered diverse views on the longer-term implications. In the near future, Hydro One’s core earnings are expected to be better off without the cross-border deal. Circumstance have changed since the deal was first announced in July, 2017, and a number of forces, including changes to U.S. corporate taxes and a recent debt downgrade for Hydro One attributed to “governance deficiency" made the deal mildly dilutive to Hydro One’s earnings in its first year, meaning it would be a drag on the utility’s earnings per share.

However, there are also questions about Hydro One’s growth potential in the long run. “While some shareholders may be relieved if the Avista merger does not proceed, the reasons cited in the order are damning, making it hard to conceive the company could meaningfully expand beyond Ontario," CIBC World Markets analyst Robert Catellier wrote in a report.

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Because Washington State took such a strong stance, “it will be difficult for the company to find other merger partners with rate-regulated businesses, as all would likely have at least some reluctance in light of this decision," Mr. Catellier added.

Remaining confined to its home province provides Hydro One with very little geographic diversity in its earnings. When the Avista takeover was first announced, Mr. Schmidt argued that spreading earnings over multiple jurisdictions was a major reason to do it.

Hydro One has continued to make this argument. During a conference call in November, acting CEO Paul Dobson said: "The most significant element that initially motivated the merger discussions we had with Avista remains unchanged, and that is diversification.” The company declined to comment for this story.

Within Ontario, Hydro One does have some opportunities to boost revenue. The rates it charges are regulated by the Ontario Energy Board (OEB) and in its latest applications to the OEB, the utility requested to use “incentive rate-making” for its transmission business, which delivers electricity on high-voltage lines over long distances. If approved, it would allow for better returns if the company delivers good performance. (Incentives already exist on Hydro One’s distribution business, which carries electricity directly to homes and businesses.)

Yet, there is also a chance the government enacts legislation that hurts Hydro One as the Ford government tries to cut rates. “What remains is a Hydro One focused on Ontario with the benefit of being simple [with a] single jurisdiction, but, at the same time, the added risk of no diversification,” Massimo Bonansinga, portfolio manager at Signature Global Asset Management’s and a former owner of Hydro One shares, said in an e-mail.

While Mr. Bonansinga was not a fan of the Avista deal, he noted that political overhang could persist on Hydro One’s stock and, if so, would make the utility trade at a discount to its peers. This risk, coupled with constrained growth, makes it "difficult to see much more upside from today’s level,” he noted. The shares closed at $21.53 in Toronto.

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With files from David Berman

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