Bay Street prepares for Hydro One IPO

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Ed Clark is warning his former Bay Street colleagues not to expect a bonanza of fees from the initial public offering of Hydro One, which could be the largest Canadian new stock issue in 15 years.

"We are quite determined that when we do go public, you will see a fee structure that the industry has never seen before. So there is not going to be a lot of money made off this in Bay Street, I can tell you that," said Mr. Clark, the retired chief executive officer of Toronto-Dominion Bank who is leading the Ontario government's asset sale efforts.

The Ontario government on Thursday confirmed it plans to sell 15 per cent of its electricity transmission and distribution utility within the next year to public investors. It also plans to allow hundreds of supermarkets to sell beer, a move that will weaken the market clout of the Beer Store, owned by major breweries.

But even if the government can press investment banks to cut their underwriting rates, the initial public offering of Hydro One and subsequent share sales is still likely to shower Bay Street with lucrative fees from the sale of equity the government figures is currently worth at least $8.1-billion.

Investment banks typically earn a percentage in the mid-single digits from IPO proceeds, although giant-sized IPOs for hot tech stocks like Facebook have paid as little as 1.1 per cent. One banker familiar with the government's plans said Hydro One could "grind down" fees to the low 3-per-cent range, similar to what Twitter paid on its 2013 initial share offering.

Even at that rate, underwriters would fetch $60-million in fees from an expected IPO of $2-billion worth of stock plus $180-million or more from subsequent share sales over four years, which would take the government's stake down to 40 per cent. Requests for proposals for investment banks to work on the IPO have already gone out to Bay Street.

The Hydro One privatization is part of a broader effort by the fiscally challenged province to help pay for Premier Kathleen Wynne's $29-billion transportation and infrastructure plan. Mr. Clark said in an interview that the utility's board will interview the big Canadian banks and likely select two to co-lead the offering. Several other dealers will be invited to the underwriting syndicate to ensure the stock gets broad distribution, with 25 to 30 per cent earmarked for individual investors. "We obviously want to play to the retail market, because I think you'll get better pricing with this type of issue," he said.

The goal is to complete the IPO and bank the proceeds by the end of the current fiscal year, which ends next March 31, Energy Minister Bob Chiarelli told The Globe and Mail. He said Hydro One stock would be seen as "a reliable, predictable investment, particularly for long-term" investors thanks to its status as a regulated entity with steady rates of returns.

With an expected market capitalization of between $13.5-billion and $15-billion, Hydro One will be one of the 40 largest Canadian companies by market value, and is expected to pay a dividend of between 3 and 4 per cent, Mr. Clark said. "This is a yield-hungry market, so we'll obviously have a good dividend rate on it. For the institutions this will be a sufficiently large market cap, and will be a must-have stock."

"A 3-per-cent-plus yield is still way better than a five-year bond" and similar to other utility stocks, said Bruce Campbell, president of Campbell Lee & Ross Investment Management Inc., a private wealth management firm in Oakville, Ont. "Equities with yield are still king of the castle."

But several fund managers said they were wary of investing in a company where the government will continue to exercise considerable control (outside investors will be limited to holding 10-per-cent stakes), including its ability to name directors. Some worried that the government might not follow through on its promise to sell a majority of its stake.

"If I were an investor, I wouldn't touch it at any price," said CI Financial chairman Bill Holland. "I don't want to be partners with the Ontario government."

Others questioned the willingness of government to free the company to boost earnings by slashing costs. "Any Crown corporation that goes public you definitely want to look in on the expenses side," said Stephen Takacsy, chief investment officer with Lester Asset Management in Montreal.

With former Canada Pension Plan Investment Board CEO David Denison joining the board, the government is hoping the market will view Hydro One as a credible, independent public company. "He's probably one of the top five corporate managers in Canada," Mr. Chiarelli said of Mr. Denison. "He will create a business plan that is growth oriented."

Meanwhile, the status of current CEO Carmine Marcello appears in flux. Mr. Clark indicated the CEO would have to compete for his own job. "I told him, 'run for it, prove to the board, make it impossible for the board not to choose you," Mr. Clark said.

With a file from reporter Tim Kiladze