McGuinty’s Super Privatization

The front page of today’s Toronto Star reports, “The Ontario government is looking at creating a publicly held $60 billion ‘super corporation’ of assets such as the Liquor Control Board of Ontario and Hydro One and then selling a minority share to private investors.” It would also include the province’s other major Crown corporations: Ontario Power Generation and Ontario Lottery and Gaming.

More than a month ago, my pre-budget testimony at Queen’s Park noted, “Another 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.”

Apparently, I was correct to suggest that the McGuinty government was contemplating selling all of Ontario’s 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. Although 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 “super corporation” 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 government’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 “super corporation” 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: the government gets cash today and retains control of its house, but loses some of the ownership. Would that 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-corporation profits are worth $72 billion of up-front cash. However, The Star reports that the super corporation “could be worth between $50 billion and $60 billion.”

If the government sold one-third of the shares based on a $50-billion valuation, it would shrink the current year’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, partially privatizing public enterprises seems politically clever, but financially stupid. The Star quotes a Liberal insider almost admitting as much: “It 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 doesn’t react positively to it.” Indeed, there are a couple of reasons why the market might even value the “super corporation” below $50 billion.

First, the stock market generally discounts conglomerates relative to pure plays. On New Year’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, “There would be foreign ownership limits, no single shareholder would be able to own more than 5 per cent.” 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, it is possible that retaining control and majority ownership would allow the Ontario government to classify the new entity as a provincial Crown corporation exempt from federal tax.

One comment

  • 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.

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