On­tario de­fends Hy­dro One board re­place­ment after Avista deal re­jected

Likely fail­ure of Avista ac­qui­si­tion raises ques­tions about util­ity’s growth strat­egy

The Globe and Mail Metro (Ontario Edition) - - FRONT PAGE - TIM KILADZE LAURA STONE DAVID MILSTEAD

On­tario’s Con­ser­va­tive gov­ern­ment de­fended its de­ci­sion to re­place the board and top ex­ec­u­tive of Hy­dro One Ltd., after the State of Wash­ing­ton cited po­lit­i­cal in­ter­fer­ence as it turned down a $4.4-bil­lion ac­qui­si­tion by the com­pany.

The de­ci­sion by the state’s util­i­ties reg­u­la­tor to say no to Hy­dro One’s pro­posed ac­qui­si­tion of Avista Corp. puts the deal in se­ri­ous peril and throws its growth strat­egy into dis­ar­ray. With­out the state’s bless­ing, the deal can­not pro­ceed, al­though Hy­dro One and Avista can ap­peal the de­ci­sion. If the ac­qui­si­tion dies, Hy­dro One, which is 47per-cent owned by the provin­cial gov­ern­ment, will be on the hook for a US$103-mil­lion ter­mi­na­tion fee to Avista. It has al­ready spent tens of mil­lions of dol­lars on le­gal and bank­ing fees as part of the ac­qui­si­tion.

Hy­dro One has been search­ing for a chief ex­ec­u­tive since On­tario Premier Doug Ford forced out CEO Mayo Sch­midt this past sum­mer. On the same day, the pre­vi­ous board of di­rec­tors also re­signed en masse.

In its de­ci­sion, the Wash­ing­ton state reg­u­la­tor said: “It be­came clear on and after July 11, 2018, [when the CEO and board left] that Hy­dro One’s di­rec­tors can­not be con­sid­ered in­de­pen­dent and the prov­ince’s role is not lim­ited to that of a mi­nor­ity share­holder in a pub­licly traded cor­po­ra­tion. … There ap­pears to be noth­ing that would pre­vent this level of in­ter­fer­ence from oc­cur­ring again.”

But En­ergy Min­is­ter Greg Rick­ford said the gov­ern­ment has the right to make de­ci­sions it feels will lead to lower hy­dro rates. “We’re a share­holder, a sig­nif­i­cant share­holder. This a pri­vate com­pany, but in many re­spects re­sem­bles a pub­lic util­ity and we have a cor­re­spond­ing obli­ga­tion to live up to a cam­paign prom­ise that would re­duce hy­dro rates” by 12 per cent.

In a state­ment, Mr. Ford said: “While some crit­ics might be­lieve that the con­cerns of On­tario fam­i­lies, se­niors, and busi­nesses should take a back seat to for­eign reg­u­la­tors, our gov­ern­ment re­mains un­wa­ver­ing in our com­mit­ment to the peo­ple of On­tario to re­duce hy­dro rates and pro­vide a re­li­able en­ergy sys­tem.”

In­vestor re­ac­tion on Thurs­day sug­gests the deal has lit­tle chance of sur­viv­ing. Avista’s U.S.listed shares fell 13 per cent, while Hy­dro One’s shares went up 5.7 per cent. Some in­vestors had said the deal was too ex­pen­sive for Hy­dro One and cre­ated new risks in mar­kets in which it has lit­tle ex­pe­ri­ence.

How­ever, an­a­lysts of­fered di­verse views on the longer-term im­pli­ca­tions. In the near fu­ture, Hy­dro One’s core earn­ings are ex­pected to be bet­ter off with­out the cross-bor­der deal. Cir­cum­stances have changed since the deal was first an­nounced in July, 2017, and a num­ber of forces, in­clud­ing changes to U.S. cor­po­rate taxes and a re­cent debt down­grade for Hy­dro One at­trib­uted to “gover­nance de­fi­ciency” made the deal mildly di­lu­tive to Hy­dro One’s earn­ings in its first year, mean­ing it would be a drag on the util­ity’s earn­ings per share.

How­ever, there are also ques­tions about Hy­dro One’s growth po­ten­tial in the long run. “While some share­hold­ers may be re­lieved if the Avista merger does not pro­ceed, the rea­sons cited in the or­der are damn­ing, mak­ing it hard to con­ceive the com­pany could mean­ing­fully ex­pand beyond On­tario,” CIBC World Mar­kets an­a­lyst Robert Catel­lier wrote in a re­port.

Be­cause Wash­ing­ton State took such a strong stand, “it will be dif­fi­cult for the com­pany to find other merger part­ners with rate-reg­u­lated busi­nesses, as all would likely have at least some re­luc­tance in light of this de­ci­sion,” Mr. Catel­lier added.

Re­main­ing con­fined to its home prov­ince pro­vides Hy­dro One with very lit­tle ge­o­graphic di­ver­sity in its earn­ings. When the Avista takeover was first an­nounced, Mr. Sch­midt ar­gued that spread­ing earn­ings over mul­ti­ple ju­ris­dic­tions was a ma­jor rea­son to do it.

Hy­dro One has con­tin­ued to make this ar­gu­ment. Dur­ing a con­fer­ence call in Novem­ber, act­ing CEO Paul Dobson said: “The most sig­nif­i­cant el­e­ment that ini­tially mo­ti­vated the merger dis­cus­sions we had with Avista re­mains un­changed, and that is di­ver­si­fi­ca­tion.” The com­pany de­clined to com­ment for this story.

Within On­tario, Hy­dro One does have some op­por­tu­ni­ties to boost rev­enue. The rates it charges are reg­u­lated by the On­tario En­ergy Board (OEB) and in its lat­est ap­pli­ca­tions to the OEB, the util­ity re­quested to use “in­cen­tive rate-mak­ing” for its trans­mis­sion busi­ness, which de­liv­ers elec­tric­ity on high-volt­age lines over long dis­tances. If ap­proved, it would al­low for bet­ter re­turns if the com­pany de­liv­ers good per­for­mance. (In­cen­tives al­ready ex­ist on Hy­dro One’s distri­bu­tion busi­ness, which car­ries elec­tric­ity di­rectly to homes and busi­nesses.)

Yet, there is also a chance the gov­ern­ment en­acts leg­is­la­tion that hurts Hy­dro One as the Ford gov­ern­ment tries to cut rates. “What re­mains is a Hy­dro One fo­cused on On­tario with the ben­e­fit of be­ing sim­ple [with a] sin­gle ju­ris­dic­tion, but, at the same time, the added risk of no di­ver­si­fi­ca­tion,” Mas­simo Bo­nansinga, port­fo­lio man­ager at Sig­na­ture Global As­set Man­age­ment’s and a former owner of Hy­dro One shares, said in an e-mail.

While Mr. Bo­nansinga was not a fan of the Avista deal, he noted that po­lit­i­cal over­hang could per­sist on Hy­dro One’s stock and, if so, would make the util­ity trade at a dis­count to its peers. This risk, cou­pled with con­strained growth, makes it “dif­fi­cult to see much more up­side from to­day’s level,” he noted. The shares closed at $21.53 in Toronto.

TIM FRASER/ THE GLOBE AND MAIL

Power lines run out of the the Hy­dro One Claire­ville Trans­fer Sta­tion in Vaughan, Ont., in 2015. Re­main­ing con­fined to its home prov­ince of On­tario would pro­vide the util­ity with very lit­tle ge­o­graphic di­ver­sity in its earn­ings. At the same time, how­ever, core earn­ings would be ex­pected to be bet­ter off.

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