Protection or costly fairytale?
Andrea Mandel-Campbell
Financial Post
Ian Lindsay, Vancouver Sun
A new Air Canada Airbus A319 sits at a gate at the Vancouver International Airport. The carrier has a monopoly on some 88% of the domestic market.
A shopper peruses a book in a Toronto bookstore. Most Canadian media have used cultural protection over content to shield themselves from competition.
Jeff Vinnick, National Post
Louis Audet, left, president and chief executive of Cogeco, Ted Rogers, centre, president and CEO of Rogers Communications, laugh after Jim Shaw, CEO of Shaw Communications tells a joke during a panel discussion at a cable industry convention.
Many of Canada's largest companies are protected from takeover by government regulation. In the second instalment of our series on the "hollowing out" of corporate Canada, Financial Post writer Andrea Mandel-Campbell looks at whether this closed-door policy preserves national sovereignty or penalizes consumers and investors.
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For Canada's corporate leaders and institutional investors, the Toronto Stock Exchange, the country's main index, seems more like an echo chamber these days than the epicentre of a thriving capital market.
But even as the debate rages over the "hollowing out" of corporate Canada, some things remain sacred. Acquisition-hungry foreigners are still blocked from taking a majority stake in a swath of industries ranging from banking and insurance to telecommunications, media and aviation.
Foreign ownership rules continue to protect giants like Air Canada, BCE Inc. and Royal Bank of Canada, and as a result, they are largely what's left following an 18-month shopping spree that has seen dozens of the country's biggest companies snapped up.
Already among Canada's largest corporations, their impressive girth now overshadows the TSE's dwindling float. According to figures compiled by the Financial Post, there are 45 such publicly listed companies representing 39.6% of the S&P/TSX Composite index's market capitalization, including seven of the top 10 companies.
The question is whether investors and consumers should be relieved or aggrieved.
For nearly a century it has been the government-endorsed prevailing wisdom that Canadian-owned companies, so-called national champions, were crucial to nation building by providing infrastructure to the remotest areas of the country, while acting as a bulwark to U.S. expansionism.
For many, those arguments still hold true. Gordon Nixon, RBC chairman, recently argued Canadian-owned companies are integral to preserving national sovereignty and ensuring quality of life.
Others point to the need to protect Canada from U.S. protectionism that has decimated home-grown industries like softwood lumber.
But at a time of growing globalization and increasing industry consolidation and innovation, a growing chorus of critics charge Canada's closed-door policy is costing consumers and corporate Canada by discouraging competition.In particular, it is a polite, made-in-Canada way of disguising the country's prolific anti-Americanism, said Douglas Reid, professor of strategy at Queen's University school of business. "It's the only legitimate form of racism that still exists.
"The government works on preserving the myth of national ownership to protect Canada from the United States," he said. "It's a fairytale used to justify a lot of rules and regulations that shield inefficient industry and preserve employment. It's a great con game, frankly."
And Canada, says Mr. Reid and others, is paying the price.
Heritage Canada, the Canadian Radio-television and Telecommunications Commission and Industry Canada were all contacted for this piece but did not provide comment.
However, critics of their policies charge that by shutting out entire industries from raising capital in the United States, the world's richest capital market, new entrants are often starved of funding while more established players pay higher premiums compared to their foreign counterparts.
The higher costs affect companies' investment capabilities as well as their stock price, which is often doubly discounted because it lacks takeover potential. The restrictions also hinder firms from expanding into foreign markets that demand investment reciprocity.
The onerous conditions have sparked a natural concentration of industry into quasi monopolies that by definition, say critics, are inefficient and prejudice consumers. Instead of focusing on consumers, companies focus on currying favour with federal regulators.
As a result, while a captive home market has shielded national champions from globalization by ensuring comfortable returns, it has discouraged them from going abroad. Limited to the Canadian marketplace, they lack the size to become big global players.
"It would have been better in the long-term if the government had let Canadian companies attract capital based on how well they're run," said Fred Lazar, professor at York University's Schulich school of business. "We would have had a lot better run, more successful Canadian companies than we do now."
The most obvious example is perhaps Air Canada. The company Canadians most love to hate, its monopoly on some 88% of the domestic market has prompted a strong push for the relaxation of foreign ownership rules in the world's most regulated industry.
Advocates for foreign investment argue it could have saved both Canadian Airlines and Canada 3000 from bankruptcy and avoided the country's dubious title of boasting the largest domestic market in the world served by one dominant carrier.
"We have almost a competitive crisis on our hands and the extent to which foreign competition can help, I think we have to consider it, even if that means unilateral liberalization," said Tom Ross, professor with the University of British Colombia's faculty of commerce.
Instead, consumers complain they are being gouged by high prices; travel agents charge the carrier is cutting their commissions; and, smaller rival airlines accuse Air Canada of predatory pricing.
And while some analysts praise the leadership of Robert Milton, Air Canada's president and CEO (and himself an American), his hands are somewhat tied by a government appointed board more interested in travelling perks and middle managers left over from the carrier's Crown corporation days.
The company's near monopoly also leaves it more vulnerable to union demands, note analysts. "A monopoly is not necessarily a great thing for shareholders," said Mr. Ross. "They don't tell you where the monopoly profits go, which can be to higher labour costs and inefficiencies."
Shareholders are currently paying the price for the missteps of another long-time national champion, BCE. The telecoms giant has been criticized for its scatter-shot venture in media and is expected to take a $800-$900-million write-down on Teleglobe, its now bankrupt international long distance operator. Unlike Air Canada however, consumers have little to gripe about. Bell provides some of the lowest telephone rates in the world and has led North American carriers in developing DSL high-speed Internet technology.
But while its management team is considered nothing like the fat, complacent company of a decade ago, Bell's cozy position at home may have prompted it to spend its extra cash flow on high priced, non-core assets it knew little about, say analysts.
"It was easier to pay too much for CTV (the Canadian broadcaster) than to go to the United States and buy telecommunications assets down there. Obviously, they didn't have the gumption to do that," said Eamon Hoey, senior partner at Hoey Associates.
Meanwhile, analysts warn that cheap phone rates cannot be guaranteed as new telecoms entrants are strangled out of the market by Bell's incumbent position, combined with foreign ownership rules that limit their access to financing.
Douglas Cunningham of Network Research Inc., estimates the 47% foreign ownership cap in the sector raises the cost of capital by 130-150 basis points and has prompted the insolvency of numerous local service and wireless providers that otherwise would have survived.
Added to speculation that AT&T Canada, one of the bigger players, may exit the market after incurring large losses, experts warn the sector could be "remonopolized," with the two incumbents, BCE and Telus Corp., carving up the market.
"The smaller upstarts have disappeared and the more significant players could even shut down operations," said Stuart Isherwood, analyst with UBS Warburg. "It is not a good trend and if it continues then we could be seeing a world that is substantially just Bell.
"In three-to-five years from now, will (Bell) have the same incentive to give us the same world class service it does today?" he asked.
For the cable industry, which is also limited to 47% foreign ownership, the question is whether the largely family-owned companies will be able to keep up with new technology and expand at the same pace that has left most highly leveraged and cash-flow negative.
"Could we do more (to expand services)? Absolutely. Is the cost of capital a factor? Absolutely," said Janet Yale, CEO and president of the Canadian Cable Television Association.
The industry, which has been lobbying for a loosening of the foreign ownership rules, says the caps not only make capital more expensive, but lower the value of cable shares. Companies like Rogers Communications Inc. and Shaw Communications Inc. trade at a 40% discount compared with the U.S. average, she said.
The rules also hinder Canadian firms from expanding into other cable markets, which are open to foreign investment but demand reciprocal treatment. Similarly, cable owners have their hands tied when they want to sell out.
Analysts say the Chagnon family, the former owner of Le Groupe Vidéotron Ltée, was forced to sell the Quebec cable company to Quebecor Inc., the media conglomerate, at a 20%-30% discount because of a lack of potential buyers.
"I don't see why we care who owns the cable companies," said Ms. Yale. "We have huge multinational operations in this country in many sectors and no one would dare to suggest they are not good corporate citizens.
"I don't see why the only place they would not be good corporate citizens is when it came to following broadcasting regulations."
But it is not as if the cable companies have not benefited from the current arrangement. Together with most other Canadian media, including broadcasters and film producers, they have used cultural protection over content to milk the system and shield themselves from competition, say analysts.
Critics charge cable operators and broadcasters act as "monopoly middlemen" by simply airing U.S. programs banned from directly entering the Canadian market. In return, they contribute a portion of these "easy profits" to government funds aimed at producing made-in Canada imitation U.S. sitcoms that no one watches.
One of the biggest benefactors of this virtuous circle is Alliance Atlantis Communications Inc., Canada's dominant film producer. Doubly protected by foreign ownership rules and content provisions, the publicly listed company relied on government grants for all its cash flow between 1998 and 2000.
According to Anthony Scilipoti, analyst with Veritas Investment Research, Alliance Atlantis received $85.8-million in government assistance in 2001, which it included as revenue, representing 11% of its total revenues.
"If you wipe out its government grants, the company would likely have had negative earnings on a before tax basis for each of the last four years," said Mr. Scilipoti.
The same critique cannot be made of what is considered to be Canada's most powerful national industry - banking. The five major banks, shielded from foreign takeovers, have claimed to forge one of the world's most efficient banking systems.
But despite their world-class service, they have become less globally relevant, say analysts. A big fish in a relatively small pond, RBC, the largest bank, now ranks 53th in the world in terms of assets compared to 23rd in 1975.
"When the banking world globalized, Canada didn't," said Roger Martin, dean of the Rotman School of Business at the University of Toronto. "The banks waited 15 years to start complaining, in part because they had a protected home market, and now its too late to be a major global player."
To avoid a similar fate in other sectors, Canada should loosen ownership restrictions as soon as possible, say advocates. They point to a worldwide trend towards liberalizing regulated industries that could leave Canada playing catch-up and vulnerable to trade barriers.
The strongest support comes from the cable industry, which has offered to separate its distribution services from programming content in order to avoid touchy cultural issues. A strong case has also been made for telecommunications and aviation.
"Canada is one of the holdouts in the world. We are the exception, not the rule," said Ms. Yale. "The government originally thought they'd use it as a bargaining chip in trade negotiations. The problem is they are going to wait a long time and we're going to pay the price in the interim."
But while some argue Canada will suffer by having most of its national champions snapped up by foreign, mostly U.S. buyers, others are not as convinced. In such a mature market, with limited growth prospects and a small population, the interest would be muted.
Whatever the outcome however, observers on both sides of the divide agree the federal government has little impetus to change the status quo. After an Industry Canada task forced last year urged the review of foreign ownership rules in cable, satellite and wireless telephony, efforts at liberalization seem to have fizzled.
"Haven't we grown up yet? Should we not take the next step to encourage efficiency, creativity and innovation?" said Mr. Lazar. "Unfortunately there is no will in government - there are too many vested interests and bureaucrats want to avoid risk.
"At the end of the day, change will be forced upon us by the United States."
PROTECTED HEAVYWEIGHTS:
Seven of the Top 10 S&P/TSX Composite index members* have foreign ownership restrictions
1. Royal Bank of Canada: 5.284%
2. Bank of Nova Scotia: 3.853%
3. Toronto-Dominion Bank: 3.526%
4. EnCana Corp.: 3.201%
5. Manulife Financial: 3.093%
6. BCE Inc.: 3.059%
7. Alcan Inc.: 2.799%
8. CIBC: 2.628%
9. Bank of Montreal: 2.562%
10. Barrick Gold Corp.: 2.544%
Source: Bloomberg News
INDUSTRIES SUBJECT TO FOREIGN OWNERSHIP RESTRICTIONS:
- Telecommunications
Non-Canadians cannot control more than 20% of the voting shares of a subsidiary and not more than 33 1/3 of the voting shares of the parent corporation, which is equivalent to a total of 47% ownership. Non-Canadians cannot control more than 20% of the board of directors and CEO must be Canadian.
- Media (cable and broadcasting)
Non-Canadians cannot control more than 20% of the voting shares of a subsidiary and not more than 33 1/3 of the voting shares of the parent corporation, which is equivalent to a total of 47% ownership. Non-Canadians cannot control more than 20% of the board of directors and CEO must be Canadian.
- Aviation
Foreign ownership capped at 25%.
- Banking
Foreign ownership limitations were raised last year from 10% to 20%.
- Insurance
Foreign ownership is limited to a minority stake for companies with a $5-billion market capitalization or more.
- Book publishing and distribution
Foreign ownership of existing businesses is prohibited except in cases of clear financial distress and other Canadian groups have been given a fair opportunity to acquire.
- Film and video production
Takeovers of Canadian-owned distrubition businesses are not allowed
- Newspapers
In order to benefit from tax deductions on advertising, newspapers must be published in Canada and 75% Canadian-owned, have a Canadian chair and Canadians must occupy 75% of the board of directors. |
