McGuintyâ€™s Super Privatization
The front page of todayâ€™s Toronto Star reports, â€œThe Ontario government is looking at creating a publicly held $60 billion â€˜super corporationâ€™ of assets such as the Liquor Control Board of Ontario and Hydro One and then selling a minority share to private investors.â€ It would also include the provinceâ€™s other major Crown corporations: Ontario Power Generation and Ontario Lottery and Gaming.
More than a month ago, my pre-budget testimony at Queenâ€™s Park noted, â€œAnother proposal has been to raise money by selling provincial assets. . . . just to break even on privatizing Crown corporations, the Government of Ontario would need to sell them for $72 billion.â€
Apparently, I was correct to suggest that the McGuinty government was contemplating selling allÂ of Ontarioâ€™sÂ major public enterprises as a package. And my estimate of what that package might be worth was in the right ballpark.
However, the government is proposing to sell only a minority stake, while retaining control of the assets and most of the profits. AlthoughÂ it is obviously trying to avoid the usual objections to privatization, many people will legitimately worry that this scheme is a slippery slope toward a more complete sell-off. Even if one believes that Liberals would never sell more than half of the â€œsuper corporationâ€ shares, setting up the entity and issuing shares would make it easy for a potential future Conservative government to finish the job.
In (temporarily) avoiding the worst pitfalls of privatization, the governmentâ€™s proposal also misses the supposed benefit of privatization: replacing public-sector management with allegedly superior private-sector management free from political influence. Rather than changing how Crown enterprises are managed, the â€œsuper corporationâ€ would mostly be a way to convert a portion of future revenues from Crown enterprises into up-front cash.
Essentially, the Ontario government is considering a reverse mortgage from Bay Street:Â the governmentÂ gets cash today and retains control ofÂ its house, but loses some of the ownership.Â Would thatÂ be a good financial deal for the provincial treasury?
As I noted in my pre-budget testimony, if the Ontario government writes long-term bonds at 5% interest and levies a 10% corporate tax on privatized profits, the $4 billion of annual Crown-corporationÂ profits are worth $72 billion of up-front cash. However, The Star reports that the super corporation â€œcould be worth between $50 billion and $60 billion.â€
If the government sold one-third of the shares based on a $50-billion valuation, it would shrink the current yearâ€™s deficit by $16.7 billion. That would reduce future debt-servicing costs by $0.8 billion per year. But giving up one-third of Crown corporation profits would reduce provincial revenues by $1.2 billion per year. On balance, Ontario taxpayers would come out nearly half a billion dollars poorer.
So,Â partially privatizing public enterprises seems politically clever, but financially stupid. The Star quotes a Liberal insider almost admitting as much: â€œIt would satisfy the left because you would still have unionized workers at these publicly owned entities and it would satisfy the right, which always wants to privatize things . . . The only downside is if the market doesnâ€™t react positively to it.â€ Indeed, there are a couple of reasons why the market might evenÂ value the â€œsuper corporationâ€Â below $50 billion.
First, the stock market generally discounts conglomerates relative to pure plays. On New Yearâ€™s Eve, I appeared on the Business News Network regarding privatization (watch video). My co-panellist was John Sadler, an advocate of privatization. He concluded the discussion by rejecting the idea of amalgamating Ontario Crown corporations and then selling shares in the conglomerate because the market would apply a steep discount.
Second, The Star reports, â€œThere would be foreign ownership limits, no single shareholder would be able to own more than 5 per cent.â€ While such restrictions may serve legitimate public-policy goals, they would also limit the field of potential buyers and hence the likely sale price.
A final question is whether the super corporation would have to pay federal corporate income tax. Doing so would reduce the profits it could remit to both the provincial government and private investors (and hence the amount that they would pay for shares.) However,Â it is possibleÂ that retaining control and majority ownership would allowÂ the Ontario governmentÂ to classify the new entity as a provincial Crown corporation exempt from federal tax.
Very good post and commentary, Erin.
This type of “super-privatization” may seem like a short-term “win-win” politically, but it is likely to be a long-term loser financially for the Ontario public. I’d like to think there is a way to structure this so it makes sense financially over the longer term, but I don’t see it.
Erin has pointed out what the valuation would have to be in order to be competitive with raising capital through bonds. Ontario can now borrow at a rate of 3% short term, 4% medium term and less than 5% long-term, so his valuation is probably on the low side.
If control continues to be held by the Ontario government, then there will be continuing tension about management and financial decisions, as shareholders will want higher profits and dividend payments, and these of course often conflict with other social or environmental objectives. For a future politician, this would not be an enviable position to be in. In contrast, with bonds, it is very clear and inarguable what the obligations and coupon rate are.
The reality is that the only people for whom this scheme would be an unqualified win is the Bay Street and the financial industry, including Goldman Sachs and CIBC World Markets, for whom the Ontario government paid $200,000 for this advice.
For instance, the investment fees associated with public offerings often run to 5% or more. Let’s say the Ontario government drove a hard bargain and kept fees at 2% or less. On the sale of $20 billion share of this super-corporation, 1% in fees still amounts to up to $200 million in risk-free revenue for the financial industry.
With such juicy revenues, you can bet that the government would have to agree to a consortium, so all the major players get a piece of this enormous pie. Down the road, the financial industry also has a new product to flog and generate annual management fees from; something that pays much more than selling or managing bonds.
You can see why the street is salivating over this and who is really driving it. It may make the public books look good temporarily, but what it will really end up being is another stimulus plan for Bay Street–and I don’t think we need more of that.