March 11, 2002 - Natural conflicts in Hydro issue
Managers want to maximize value of their options
Barry Critchley
Financial Post
The initial public offering by Hydro One -- the transmission and distribution business of the former Ontario Hydro -- is at least a few months away.
And while the investment bankers are focusing on the many other deals that will get done before then, they have also given some preliminary thought to how Hydro One's blockbuster offering could be structured.
And like all other privatizations, the bankers see both opportunities and challenges. And how those challenges get resolved will determine the so-called success of the offering, which many believe will be at least $5-billion.
There is an inherent conflict between the wishes of the seller (in this case the government of Ontario) and the wishes of the buyers.
Clearly the government wants to maximize the proceeds from selling the entity. And that motivation is increased because the government intends to use the net proceeds to reduce the so-called stranded debt -- the debt that was left over after Ontario Hydro was restructured. And the more that the government can reduce the stranded debt via Hydro One's IPO, the less it will have to use other measures.
But investors want as low a price as possible.
Of course the seller can't really determine the price: the forces of supply and demand still prevail.
Making life a little tougher for the seller is the perception that the buyers should get a decent break on privatizations. That example was set in Britain in the 1980s and continues.
The dilemma facing Hydro One's issue is similar to what happened a few years back when five Canadian insurance companies demutualized. On those deals, the selling policyholders wanted as high a price as possible, while investors wanted as low a price as possible.
The insurers felt some obligation to their policyholders who were selling into the IPO and they didn't want to give an equity stake for too low a price. A saw off was reached and the deals got done -- though in some cases at the low end of the price range. And those who piled in have been amply rewarded.
There is also an inherent conflict between the wishes of the issuer (Hydro One) and the wishes of the seller.
This conflict arises because managers want to maximize their interest in the company, which necessitates a low price. After all, many of them have been with the company for many years and are expecting something of a payday now that their employer is public. "They are interested in maximizing the value of their options," is how one investment banker summed up the dilemma.
There are also conflicts between the company's wishes to be a player in the U.S. electricity market and its ability to attract investors south of the border. The ideal way to achieve that objective would be to offer a big slug of the issue to U.S. investors. But U.S. investors traditionally attach lower multiples to utilities than do Canadian investors, so the U.S. investors won't pay up.
Accordingly, if the government wants to maximize the proceeds then it follows that most of the stock will be issued in Canada.
All the dilemmas will be resolved: the deal will get done, the government will get the proceeds and hopefully Hydro One ends up with a group of happy shareholders.
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If timing is everything then hats off to the gang at Canada Life Capital Trust for its pricing of a $450-million offering of innovative Tier 1 capital securities known as CLiCS.
The issuer sold two tranches of securities, one with a term of 10 years and the other with a 30-year term. The 10-year rated securities carry a yield 6.679%, a tad below the 6.7%, the rate that higher-rated Manulife paid for a similar issue last December.
While the two deals featured a similar coupon, there was a large difference between the the so-called spread for the two financings. Canada Life priced its 10-year offering at 108 basis points above comparable Canada bonds.
For its part, Manulife -- which priced its offering of $940-million of securities on the worst day for 10-year bonds in about five years -- had to pay 140 basis points above comparable Canada bonds. Investors in Manulife's offering have been well rewarded: the spread above Canadas has narrowed by about 40 basis points.
Merrill Lynch led the CLiCS offering. The issue also marked another first: the 30-year tranche is a real 30-year tranche meaning investors are locked in for that length of time. While Manulife issued a 50-year piece of paper, the issuer can call it after a decade.
bcritchley@nationalpost.com
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