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Investors and governments rarely make good partners. That's because they have divergent interests. Investors want to make a profit, pure and simple. If they didn't, they would simply hide their money under the mattress.

Governments, on the other hand, want to raise money for spending, budget balancing or debt reduction. Their main interest in investors is using them to increase cash flow, either by selling them something or finding ways to tax their profits more effectively.

These differing objectives explain why partnering up with governments can be risky. You never know what politicians are going to do.

We saw another example of that this month. After the markets closed on May 8, the Ontario government announced it had sold off another chunk of Hydro One. The province said a group of underwriters led by Royal Bank of Canada and Canadian Imperial Bank of Commerce to purchase 120 million shares of the company at a price of $23.25, raising $2.8-billion in the process. It was a bought deal, meaning the underwriting syndicate assumed the responsibility of reselling the shares to the public.

The arrangement turned out to be a windfall for the government but a nightmare for the underwriters, according to a Globe and Mail story. Investors, both retail and institutional, sat on their hands, leaving the banks with an unsold inventory reportedly worth as much as $1.4-billion.

The Globe reported on Friday that the underwriters had priced the remaining shares at $22.60 in an effort to move them out. The stock closed on Thursday at $22.90 but bounced up to $23.16 on Friday on volume of almost 6.5 million shares, suggesting the discount strategy had met with some success. (The stock normally trades between 300,000 and 400,000 shares a day.)

Investors who owned Hydro One when the new sale was announced saw the price drop from $24.03 to as low as $22.93 on the morning of May 9, with almost 5.5 million shares changing hands that day. At that point investors were bailing out faster than the underwriters could feed new product into the market.

This is not to say that Hydro One is a bad stock. It is Ontario's largest electricity transmission and distribution company. Hydro One has more than 1.3 million customers, $25-billion in assets and revenues of over $6.5-billion. It owns and operates 30,000 kilometres of high-voltage transmission lines and a huge low-voltage distribution network.

Prior to the latest offering, the company announced a 5-per-cent increase in its dividend, to 22 cents a quarter (88 cents a year). At the current trading price, the yield is a safe 3.8 per cent.

However, first-quarter results suggest that investors will have to be content with cash flow for the foreseeable future. A significant gain in the share price looks improbable in the light of less than stellar results, even without the stock overhang.

Revenue for the first quarter was down slightly from the same period last year, at $1.66-billion. Net income was off 19.7 per cent to $167-million (28 cents a share) compared to $208-million (35 cents a share) in the same quarter a year ago. Management blamed the underperformance on the mild winter in Ontario, which reduced energy demand. If global warming continues to accelerate, we should expect this to happen more often in the future (although increased air conditioning demand in the summer may bridge the gap).

After the latest issue, the Ontario government holds slightly less than half the outstanding stock. That amounts to almost 300 million shares. The province is unlikely to dump more into the market any time soon, and the underwriters will be extremely wary as a result of what has just happened.

But the risk of a cash-starved future government divesting more shares and driving down the price once again should be a concern for anyone considering this stock. It's a solid source of steady income but when it comes to capital gains potential, look elsewhere.

Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to buildingwealth.ca.

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