Ontario’s Power Trip: Latest $400 million cash grab is a giant leveraged play that will load debt on consumers
The great Ontario Liberal electricity cash grab isn’t over yet. The government has sold off 30 per cent of its shares in the province’s biggest monopoly power distributor, Hydro One, netting about $3.7 billion. Another 30 per cent will be sold later. The money raised from shareholders in the market will fall into a slush fund the Kathleen Wynne government says will be used to pay for “investment in public infrastructure” and help balance the provincial budget.
But there’s more to come. The province is busy orchestrating another electricity deal to net the government hundreds of millions more. The outlines of the deal were announced in April last year by then energy minister Bob Chiarelli, who spun it as a “win‐win” for all concerned. But Chiarelli didn’t do much to explain how all the alleged wins would accumulate. So far, the only obvious cash beneficiary is the provincial government, which is set to net about $400 million.
The great win‐win is a giant leveraged debt play that will load debt onto electricity consumers
The cash will come by downloading another province‐owned power distributor, Hydro One Brampton, onto a group of municipal governments who may or may not be willing partners. Almost one million Ontario electricity consumers, covering about three million people, are also involuntary participants. So are all Ontario taxpayers.
The million rate paying households are in seven Toronto and central Ontario area communities: Brampton, Mississauga, Hamilton, St. Catharines, Markham, Barrie and Vaughan. Six of these municipalities currently own three different electricity distribution companies in their areas: PowerStream, Enersource and Horizon.
The Wynne Liberals, on the advice of two separate advisory bodies, announced that the three firms would be merged into one company which in turn would buy Hydro One Brampton.
Let’s follow the money, step by step. In April, 2015, before the government sold the first shares in Hydro One into the market, the Liberals instructed Hydro One to transfer its ownership in Hydro One Brampton (H1B), with assets of $400 million and shareholder equity of $128 million, to the province. No cash was paid in a deal that looks a little like a nationalization of a company the government already owned.
In its initial offering prospectus and subsequent annual report, Hydro One stated it “spun off” H1B to the province via a “dividend,” with the province taking over H1B’s $193 million in debt.
This March, Chiarelli announced the province’s sale of H1B for $607 million. Here’s how it works.
First, the six municipalities will acquire 100 per cent equity ownership in the new merged company by paying the province $182 million through 20‐year loans (extendable to 40 years) from the province at below market interest rates. Next, the balance of the $607 million payout will come from $425 million in new borrowing loaded into the merged company. That debt will be financed through two short‐term bank loans and then later converted into long‐term debt.
The great win‐win Brampton takeover is, in other words, a giant leveraged debt play that, one way or another, will transfer cash to the province and load debt onto the shoulders of electricity consumers living in the municipalities.
It’s an expensive takeover. The $607 million values H1B at 42 times earnings ($14.5 million) for the year ended December 31, 2014 and 4.7 times its equity base of $129.3 million. Even after deducting the $193 million in debt the province assumed when it took over H1B from Hydro One, the valuations are out of whack with market values. The end result, according to merger documents, will be an electricity distribution company with $3 billion in assets and $1.8 billion in debt. Revenues of $2.9 billion would generate net income of $84 million.
A pro forma financial statement for the merged company shows assets include “goodwill” of $293 million. That’s an increase of $271 million over the combined balance sheets of the four companies at year end 2014. “Long‐term borrowings” will increase $573 million to $1,723 million from $1,150 million for the year ended December 31, 2014.
The pro forma income statement also shows operating expenses (including administration) plus depreciation and amortization forecast to decrease $14 million, although that would accrue to the benefit of the municipal shareholders, not ratepayers. This assumes that the merged entity will succeed in driving costs down.
A final announcement expected later this year is unlikely to produce this clear summary of the Brampton transaction: The province will increase its borrowings by $182 million to fund the municipal equity injections. The new company will be saddled with $425 million in increased debt. Goodwill, representing 27 per cent of the merged company’s shareholders’ equity, will go from near zero to near $300 million. The province gets at least $400 million in cash by leveraging H1B to the hilt.
The government claims the Brampton debt shuffle will create “downward pressure on electricity rates” due to great cost savings over the next 10 years. But a consultant’s report warned that the merged company faced numerous risks, including the possibility that the projected future synergies and cost savings might never materialize. Another risk is rising interest rates. And then there’s regulatory framework risk and technology disruption risk, not to mention political risk from future governments.
But don’t worry. The Wynne Liberals will have their cash. No risks there.
Parker Gallant is a former Canadian banker who looked at his Ontario electricity bill and didn’t like what he saw.