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Hydro One IPO and the Beer Store restructuring: Ontario gets down to business

Author(s): Terrence Burgoyne, Steven Smith

Dec 9, 2015

Like many other provincial governments in Canada, Premier Kathleen Wynne’s Ontario government is struggling to find ways to deal with mounting debt and fund its “activist agenda,” including its efforts to address Ontario’s infrastructure deficit, in the face of a soft economy. Part of Premier Wynne’s approach has been to turn to innovative individuals and strategies for guidance and solutions.

Premier’s Advisory Council on Government Assets

In 2014, Premier Wynne enlisted a unique ally in her endeavours when she appointed Ed Clark – a seasoned business executive who was about to retire as CEO of TD Bank and who also has a solid grounding in public policy – as the Chair of her newly formed Premier’s Advisory Council on Government Assets. More recently, she expanded Mr. Clark’s role by appointing him as her special Business Advisor.

The Council’s brief was to advise the government on how to wring more revenue from its assets, to help reduce Ontario’s deficit and support the Government’s ambitious program of infrastructure investment. The Council’s initial focus was to review the Liquor Control Board of Ontario (LCBO), Hydro One and Ontario Power Generation (OPG).

The Preliminary Report

The Council released a preliminary report late in 2014. In it, the Council rejected privatizing the LCBO in favour of other recommendations that would improve its profitability while introducing incremental improvements to customer experience and competition. The Council also suggested a broader examination of beverage alcohol distribution in Ontario, focusing on the privately owned quasi-monopolies of the Beer Store (owned by Labatt, Molson and Sleeman, each of which is foreign controlled) and off-site winery retail stores, with a view to adding selective competition and ensuring that the public gets its fair share of the profits from these channels.

In its preliminary report, the Council also considered opportunities for operational improvements in Hydro One’s businesses. The Council suggested, among other things, that the government dilute its interest in Hydro One’s distribution business by bringing in private capital to facilitate more efficient electricity distribution.

Electricity Sector Report

In April 2015, the Council issued its final electricity sector report, “Striking the Right Balance: Improving Performance and Unlocking Value in the Electricity Sector in Ontario.” The Council recommended, among other things, that

  • the Province should proceed with a partial sale of its interest in Hydro One to create a growth-oriented company centred in Ontario;
  • the partial sale should occur by way of a public offering, with approximately 15% of the shares of Hydro One offered to the market initially; and
  • the Province should indicate its intention to retain its remaining shares after selling down to 40% ownership, and that the balance should be widely held with no other individual shareholder having more than a 10% holding.
On November 5, 2015, Hydro One and the Province completed the initial public offering of 81,100,000 common shares of Hydro One Limited by way of secondary offering by the Province at a price of $20.50 per common share. The underwriters for the offering exercised their option to purchase 8,150,000 additional common shares from the Province at the initial offering price on November 12, 2015. The offering resulted in total gross proceeds to the Province of approximately $1.83 billion, making it not only the largest IPO in Canada in 2015 but also the largest in the last 15 years. The Province has retained 84% of the Company’s issued and outstanding common shares but, further to the Council’s recommendations, it has indicated that it intends to sell additional common shares over time, until it holds approximately 40% of Hydro One Limited.

Beer Retailing and Distribution Report

In April 2015, the Council issued a further report, “Striking the Right Balance: Modernizing Beer Retailing and Distribution in Ontario.” The Report attached a term sheet, or “Framework of Key Principles” (Framework), that the Council had negotiated with the Beer Store and its owners. That Framework formed the basis for further negotiations with the Beer Store and its owners, culminating in a series of agreements that were signed and announced in September (the New Beer Agreements).

The New Beer Agreements, when fully implemented, will make a number of changes to the way that beer is retailed and distributed in Ontario:

  • Ownership of the Beer Store will be opened up to all brewers with Ontario facilities that sell beer through the Beer Store.
  • Governance of the Beer Store will be more transparent and accountable – smaller brewers will have board representation, and four independent directors (selected jointly by the Province and the original owners of the Beer Store) will represent the broader public interest.
  • The Beer Store will be operated on a cost-recovery basis, with all brewers paying a fair share.
  • The Beer Store will invest $100 million in capital expenditures to improve customer experience.
  • 12-packs will be piloted in LCBO stores.
  • Beer will be available for sale in up to 450 grocery stores in Ontario.

These changes represent a typically Canadian compromise: They preserve the benefits of Ontario’s current retail and distribution regime – relatively low costs, and a good balance of public revenue and lower consumer prices when compared to other Canadian jurisdictions – while making the system more fair for all participants and providing some enhancements to consumer convenience.

The Premier’s Business Advisor: Ontario Now Has a Chief Development Officer

In his ongoing role as the Premier’s Business Advisor, Ed Clark is lending his considerable reputation within the North American business community (he has been twice named by Barron’s as one of the world’s top 30 CEOs) to Premier Wynne’s agenda. He has recently signalled some of the initiatives that he feels are needed for Ontario to overcome its complacency and build upon its strengths (such as its public health and education systems, its open and tolerant society, and its world-competitive tax system):

  • becoming a leader in “smart” manufacturing and innovation
  • helping small businesses to become more export-oriented, so they can achieve scale and focus on continued growth rather than selling out
  • reducing unnecessary red tape by taking an outcome-based approach to regulation – with the goal of making government a source of competitive advantage
  • shifting the Ontario economy to one that is knowledge-based and focused on the export of services
  • Opening up Ontario’s excellent hospitals and linking them more closely with the private sector, turning them into exporters of health services
  • focusing on competing in industries where people are paid more, not less – such as advanced manufacturing, health, universities and consulting
  • better capitalizing on Ontario’s huge innovation base in Ottawa, Toronto and Kitchener-Waterloo

These initiatives, if successful, could have a fundamental impact on the economy of Ontario, and Canada as a whole.

Other Provinces

Other provinces are struggling with comparable issues – or their own unique challenges – but not many of them will have an Ed Clark ready to help. We can expect to see other provinces looking at some of the initiatives that Ontario will be pursuing and asking similar questions: What government assets may help fund needed infrastructure investments? How can governments attract and grow businesses by easing their regulatory burden? How can their economies pivot from old industries to new? We will continue to monitor the situation across the country to determine the success of the initiatives that will undoubtedly be implemented in the months and years ahead.

Note: Osler acted for Hydro One on its IPO and for the Premier’s Advisory Council on Government Assets with respect to its work with the Beer Store.