The low interest rate environment, combined with a virtually bulletproof competitive position, will make the proposed Ontario government initial public offering of part of Hydro One a huge hit with investors. The extent of the frenzy will depend on the size of the dividend, but over the longer term, management and operational efficiency will likely determine the success of the new stock.
Stocks in the S&P/TSX Utilities Index currently carry an average dividend yield of 4.0 per cent, leaps and bounds higher than the five year Government of Canada bond's meagre 0.93 per cent annual coupon payments. If Hydro One's stock carries dividend payments anywhere close to the sector average, the income-hungry investors in Canada's (increasingly elderly) investing population will jump at the chance to own.
Canadian government entities are, of course, not known for operational efficiency. Anyone Googling "Hydro One, Scandal" has a full afternoon's entertainment ahead of them.
But prospective investors can take solace in the performance of similar spin-offs in the utilities sector. In 1998, crown corporation Nova Scotia Power Incorporated privatized its electrical power assets into a company that would eventually be named Emera Inc. Emera has been a huge win for investors over the past ten years, generating a 13 per cent annual return if dividends were reinvested.
Alberta's Capital Power Corp. was formed through a similar power utility privatization by the city of Edmonton in 2009. It is perhaps the better comparable with the proposed spin-off of 10 to 15 per cent of Hydro One's assets because it was a partial privatization of 25 per cent of the city's electrical utility assets. Capital Power has generated a 7.5 per cent return for investors (again, with dividends reinvested) over the past five years.
It's difficult to speculate with so few details available on the Hydro One deal, but two risks seem apparent. One is pricing. The feverish demand for any kind of income in Canada raises the risk that the initial offer will be expensively priced by the underwriters who have a fiduciary duty to their client, the Government of Ontario, to get the highest price possible. (In reality, this is unlikely to be an issue for most investors. The deal is likely to be extremely popular and oversubscribed, so retail investors' access to the initial offering will be limited.)
Corporate management, depending on who is chosen to run the public entity, is also a potential sticking point. A large segment of the company, at least 85 per cent of the total, is remaining in government hands. The possibility that a government insider with a less market-friendly outlook than competing firms runs the firm less efficiently, relative to other utility stocks, is something else for investors to asses before investing in the new entity.