Hydro One IPO: Managing Risk and Finding Value

John Dalton, President, Power Advisory LLC

On September 17th Hydro One filed the Preliminary Prospectus for its IPO with the Ontario Securities Commission.  The Prospectus confirmed the direction provided the Premier’s Advisory Council on Government Assets that the Province intends to sell down its interest to 40%, but that any one shareholder be limited to no more than 10%.  Interestingly, the Prospectus notes that concurrent with the closing of the offering Hydro One will enter into a Governance Agreement with the Province that will prescribe the role of the Province in the governance of Hydro One.   This Governance Agreement would appear to be critical to investors in assessing the government’s role going forward – calling into question how “concurrent” will be implemented.

The Prospectus indicates that Hydro One will have a dividend policy based on a target payout ratio of 70 to 80% of net income, which initially will be about $500 million annually.  The Prospectus identifies a wide range of risk factors including various regulatory risks.  Of particular relevance to Hydro One are revenue attrition from distributed generation, microgrids and energy storage as well as the potential for reduced capex from the Ontario Energy Board’s (OEB’s) competitive process for developing transmission infrastructure.  (Power Advisory assisted the OEB with the initial development of that process.) Ontario is currently considering alternatives to the feed-in tariff (FIT) regime, which is still being used for small projects (up to 500 kW).  This policy outcome as well as the OEB’s ongoing consideration of distribution rate design alternatives will have implications for load attrition risks faced by Hydro One as a distributor.  (Power Advisory is currently assisting clients formulate alternatives to the FIT.)

In addition, despite teaming with another Ontario incumbent Hydro One wasn’t selected to build the East-West line, which was the first Ontario facility subjected to OEB’s competitive designation process.  While the East-West line development schedule has been delayed, an important question is what are the prospects for other major transmission investments that will be subject to such an OEB designation process.  Clearly, there are lots of issues to sort through in assessing a reasonable value for the Hydro One shares being issued.