Hydro One receipts a hot ticket on TSX, statistics show
Purchase of U.S. energy company Avista helps bolster utility’s trading activity
Investors’ never-ending hunt for yield may have helped turn a security that isn’t even a stock yet into one of the most popular tickets on the Toronto Stock Exchange.
Over the past month or so, instalment receipts tied to Hydro One Ltd.’s acquisition of U.S. energy company Avista Corp. have been among the most-actively traded listings in Toronto, according to statistics from FP Data Group.
The Toronto-based electricity utility announced an estimated $6.7-billion purchase of Avista in July, with the deal to be financed in part by $1.54 billion in debentures.
Hydro One’s debentures can ultimately be converted into common shares of the company once the criteria needed to close the transaction have been met.
In the meantime, instalment receipts representing those debentures have been trading at a healthy clip, in large part due to the structure of the deal.
For every $1,000 in face value, investors paid $333 up front, at the close of the debenture offering, with the remaining $667 due on the final instalment date, which will be set after the conditions needed to close the Avista deal have been met. The expectation thus far is that the deal will be completed in the second half of 2018.
Until that date, however, the instalment receipts pay four per cent interest, based on the full face value of the debenture.
“You’re getting full interest on one-third of the payment,” said Laurence Booth, professor of finance at the University of Toronto’s Rotman School of Management, noting that that amounts to an effective yield of 12 per cent in this case. “It’s a way of basically buying Hydro shares, essentially, almost as a futures contract,” Booth said. “Why they do this is … presumably because the transaction is not until the future and they don’t know exactly when it’s going to go through, so it adds a bit of flexibility.”
Following the final instalment date, when the receipt holders must pay the outstanding $667, the interest rate on the debentures will fall from an annual rate of four per cent to zero per cent. At that point, the debentures can be converted into common shares of Hydro One at a conversion price of $21.40 per share, or 46.7290 shares per $1,000 debenture.
That is a discount to Hydro One’s opening share price on Monday of $22.58, meaning there is an additional incentive to owning the receipts, which closed Monday at $38.
According to numbers from FP Data Group, volume for Hydro One instalment receipts was 46.2 million for the week ended Aug. 25, making it the most traded security, with nearly double the activity of the next closest stock. The instalment receipts were again the most active stock for the week ended Sept. 1, with 34.25 million units on the move.
Activity in the instalment receipts began dropping off the week ended Sept. 8, but volume was still over 14 million. Last week, volume was back up to nearly 21.98 million, more than that of TSX heavyweights such as Royal Bank of Canada (19.67 million) and Canadian Natural Resources Ltd. (19.24 million).
One factor boosting the trade volume of the receipts, which are quoted based on a per/$100 in face value, is that according to the prospectus they must be purchased in lots of 10 units each, to match the value of the underlying debentures.
The instalment receipt concept has been used by Canadian utilities before, in connection with purchases made south of the border.
In 2015, Halifax-based Emera Inc. agreed to sell approximately $2.185 billion in debentures, using the same $333 upfront cost as the Hydro One offering, a release said, with the remainder to be paid after the company’s purchase of U.S. utility TECO Energy Inc. closed.
“They sort of happen quite often in Canada in terms of takeovers, and I suspect a lot of it may be taxmotivated,” said Booth. “Whenever you see things occur in one market but not another, then you point to two things: regulations and taxes. So there must be a regulatory or a tax angle to this that doesn’t exist in the U.K., in the U.S.”
Analyst Andy Smith noted the utility’s debt remains A-rated, which he said makes for a “pretty safe” investment.
Smith also said the Avista purchase makes sense for Hydro One.
“All of the Canadian utilities have been buying U.S. utilities just because the equity allowed down here is higher percentage-wise and
Whenever you see things occur in one market but not another, then you point to two things: regulations and taxes.
the allowed returns are higher so it’s been a very popular type of investment for Canadian utilities to make.”
Avista and Hydro One said last week that they had filed applications to approve their merger on or before August 14, 2018 in Washington, Idaho, Oregon, Montana, and Alaska. The companies must also seek approvals from the U.S. federal government, as well as Avista shareholders.
“Most utility mergers do eventually go through and some of them have more acrimony than others,” said Smith. “But I would say that this one, we think, it will go through eventually.”