Guelph Speaks brings you the second independent analysis of the alleged Guelph Hydro/Alectra merger agreement by Toronto Energy lawyer, Jay Shepherd. Mr. Shepherd’s expertise and experience presents an unbiased and revealing overview of the controversial merger between the two corporations.
On Monday, Guelph Speaks will present a timely review prior to Wednesday’s council meeting to approve or reject the merger agreement. It will be an overview of an agreement that has yet to be finalized according to Mayor Guthrie, the Chief Administrative officer, Derrick Thomson and Alectra.
Gerry Barker, December 9, 2017
Posted on December 9, 2017
by Jay Shepherd
Since my article on November 5th analysing aspects of the Guelph Hydro Alectra merger, a number of readers in Guelph have asked me to look at the transaction further, particularly in light of the lengthy report tabled December 1st to Guelph City Council.
The best way to do that is to look at the actual agreements. That way the information is clear and precise, and is not filtered by the perspectives of those providing the information.
I asked the Mayor, the CAO, Guelph Hydro and Alectra for the agreements, but was told by Guelph Hydro CEO Pankaj Sardana (who was apparently designated to respond on everyone’s behalf) that the agreements are not final, and so cannot be shared. I believe they have, however, been circulated to the Guelph Hydro and Alectra boards of directors, to City Council, and others, so they can’t be that confidential (40-60 people have probably seen them by now).
Further, under OEB rules they will have to be made public when OEB approval is sought, although of course by then they will be signed, and Guelph will be legally obligated to complete the deal. Public disclosure at that point doesn’t really help anyone.
It thus appears that the primary reason to withhold public disclosure now must be so that the public doesn’t have all of the details of the transaction.
That is unfortunate, but it is what it is. I will have to provide my commentary based on the report to City Council.
That report comes from a specific, pro-merger perspective. For example, the Guelph Hydro lawyers providing the legal analysis are the same firm that represented Alectra in their merger application before the Ontario Energy Board. While I’m sure they are trying to be objective (and they are a good firm that I know well), they have an obvious point of view. No matter how well they may eliminate their bias in fact, it is pretty difficult for them to remove the perception of non-objectivity.
The commentary below takes several of the claims in the report to City Council, fifteen in all, and assesses how they match up with the facts.
I repeat my earlier comment that I do not have an opinion on this transaction. This article is intended to provide information and analysis, but any interpretation that suggests I think the transaction is good, or not good, would be incorrect. I strongly believe that it is the residents of Guelph whose opinion matters. My opinion – even if I had one – does not.
Claim #1: A merger between Guelph Hydro and Alectra is better for Guelph residents in the long term than Guelph Hydro remaining a standalone utility.
This claim is likely to be correct.
However, it is also highly problematic, because this comparison asks the wrong question.
Guelph Hydro as a standalone utility is probably not a viable long-term option. As the electricity distribution sector expands and becomes more complex, smaller distributors will have a hard time keeping up. Further, they will have a hard time recruiting the best people, which will put them even more behind the curve. In these respects, the discussion of “Utility 2.0” in the report and attachments is largely accurate. We are entering a period of change.
Guelph Hydro is big enough to be a very good utility today. As expectations on, and challenges facing, distributors increase in the next decade or so, Guelph Hydro will probably be at a disadvantage unless it increases in size through merger or acquisition.
This means that comparing any merger proposal to the standalone option starts out stacked in favour of the merger. Size is going to matter. Standalone is effectively a straw man. It is not going to happen.
The fair comparison would be a merger with Alectra vs. a merger with Cambridge or Kitchener or Waterloo or Milton or Halton Hills or Oakville or Burlington, or even several of them. The problem is that the residents of Guelph don’t know whether those possibilities were considered and, if so, what stood in the way of reaching agreement on any of those potential merger directions.
Without that information, it is impossible to know whether the Alectra merger is better than other viable alternatives. The public doesn’t know what other alternatives were available, and/or considered. (It’s a secret. Largely for legitimate reasons, but it’s still a secret.)
The only comparison given is to an option that is not viable. Take this deal, or die. That is not really useful.
Claim #2: “Guelph Hydro will pay the City a special dividend of $18.5 million immediately prior to closing, without adversely affecting its regular annual dividend.”
The implication is that this is a benefit from the transaction. It is not.
The “special dividend” has to be paid to adjust the debt equity ratio of Guelph Hydro to roughly 60/40, the standard for Ontario distributors. Guelph Hydro is currently managed conservatively, and so is underleveraged. It doesn’t need a merger to pay $18.5 million out to the City, thus increasing Guelph Hydro debt and decreasing equity. It could do that today. The effect would in all respects be exactly the same.
It is called a dividend only because that is the legal form that is used to effect the change. It is not like a normal annual share of profits. It is a catch up of prior year profits that have been left in the company and accumulated as equity. It is not coming from Alectra. It is coming from Guelph Hydro’ cash on hand, which at the end of 2016 was $22 million.
Where the analysis by the advisors says “Guelph is better off financially under a merger with Alectra than on a standalone basis with ~$29 in additional cash through closing adjustments and dividends”, that is just bad math. The $18.5 million dividend is not an improvement in the City’s financial position, and the $10.1 million in extra future dividends (see below) is speculative at best.
The City is not better off initially under this transaction. That is just not correct.
Claim #3: “Dividends are projected to exceed dividends under the “maintain full ownership” option by $10.1 million.”
It is not possible to confirm this.
Past dividends by Guelph Hydro to the City have been $3 million per year, and there is no reason to think that would end. Based on current estimates of Alectra combined income, a 4.63% ownership by Guelph, and 60% payout, dividends look to be about $2.2 million per year to Guelph in the short run.
Without the backup calculations for the $10.1 million figure, it is not really possible to get to anything like that on the basis of public information.
Claim #4: “GMHI will receive one permanent seat on Alectra’s board, and will have the right to appoint an independent director.”
This is correct, but it is important to understand what it means. It is one, not two.
Guelph will appoint one member on the 13-member Alectra board. It cannot be a councillor or the Mayor. It must be an independent, and it is one person.
Further, it is important to note that the Alectra board doesn’t have the same close oversight of management as is currently the case with the Guelph Hydro board. For example, Alectra is right now before the Ontario Energy Board seeking a 2018 rate increase of 1.3% to 4.2%, depending on rate class. That request was not approved by the Alectra board. That decision – what rates to request – has been delegated to Alectra management.
There is no information on whether the executive management team of Alectra will include anyone from Guelph. I suspect it will not.
Claim #5: “There are important restrictions on transferring shares, and therefore indirectly on privatization, in the USA.”
Assuming the new USA (unanimous shareholders’ agreement) is substantially the same as the existing one, this statement is correct. Any significant minority of shareholders can block or slow down any process of privatization of Alectra. (Some of the details of this agreement remain confidential, even today, but for good reasons.)
It is also true that some of the municipalities that own shares of Alectra are currently opposed to selling shares to the private sector. Alectra has a small percentage of shares already held by an investment bank, for the OMERS pension plan, and some shareholders don’t want that non-municipal ownership increased.
There will, however, be strong pressure to privatize or partially privatize in order to monetize the value of the shares of Alectra. At some point, high priced offers will be made by companies like Enbridge, and EPCOR, and others. It is not reasonable to expect that Alectra – or any other distributor, merged or standalone – will remain municipally-controlled forever.
Claim #6: “Rate increases are projected to be more moderate than they would be under the “maintain full ownership” scenario.”
This is probably not true.
As I have noted in my previous article, Guelph Hydro has a better record of controlling rate increases than Alectra does, and that goes back many years.
That is likely to continue into the future. In their merger application, Alectra filed a forecast showing expected rate increases over the ten year “sitout” period of an average 1.74% per year (Exhibit JTC1.3 in that proceeding, for those keeping score). That included a first year increase of 2.79%.
Alectra’s actual application for their first year rate increase is now in, and it is very close to that, an average of 2.84% for the three general service classes (residential, small business, and commercial/industrial). Some of this is based on a predetermined formula which they can’t change, and the rest is extra money they have requested for additional spending they want approved. These new rates are not yet approved, but Alectra is pressing hard.
(I have excluded Horizon, because they are required to reduce their rates in 2018 due to an agreement reached with customers in 2014).
Guelph Hydro has also applied for 2018 rates, using the same formula. Their average distribution rate increase will be 0.23%. The reason is that, while they used the same formula as Alectra, they didn’t ask for any extra money. Guelph Hydro has historically been able to live within its regular budget, without extras, and still make a good profit.
Alectra has made clear that they expect to seek extra money for additional spending each and every year during their ten year sitout period. In total, they forecast that they will want approval for $500 million or so of incremental capital spending during that period, although that will change as circumstances dictate.
They don’t actually need the money, because they will have more than enough from the savings arising out of their merger. Under the rules, though, they can keep the merger savings, and ask for extra rate increases to spend more as well. There is no reason to think their tactics will change after bringing Guelph into the fold.
The graph at page 25 of the advisors’ report, which shows lower distribution revenue per customer under the merger scenario, appears to be based on inappropriate assumptions. The basis of those assumptions has not been made public. Where in that report at page 28 the advisors say Guelph customers can expect “Rate Increases Below Inflation”, that statement is inconsistent with the evidence of Alectra in their own merger application.
It is therefore more likely that rate increases will be higher under a merged utility than under a standalone utility, but it is really difficult to forecast the amounts with any level of accuracy.
Claim #7: “A Southwest Operations Centre will be preserved at the location of Guelph Hydro’s current offices with a minimum commitment of 10 years.”
This is almost certainly true.
The standard approach to mergers in Ontario, which Alectra uses well, is to promise a strong presence in the acquired area for a period of time. This reduces the feeling that the local community will be served by outsiders. This approach has been central to every past merger application I’ve seen.
On the other hand, in the longer term it will not make sense to keep a major operations centre in every Alectra community. Some will have to eventually lose their local operations for Alectra to operate efficiently. Ask the City of Markham, one of the original merger partners that formed Powerstream, how many Alectra employees are still based there.
Claim #8: “Guelph Hydro employs about 130 people. About 70 of those existing positions have been identified as needing to remain in Guelph. About half of the remaining positions would be offered relocation opportunities starting in 2019, with the majority of moves happening between 2020 and 2022. The other positions are expected to be addressed through attrition, voluntary retirement, or voluntary separation wherever possible.”
These ratios are consistent with Alectra’s past approach, and so are likely to be correct.
Of the current 130 employees, 70 (mostly tool in hand employees) will remain in Guelph, which minimizes travel time to job sites. 30 others will be offered jobs within Alectra, but only if they are willing to work in Hamilton or Mississauga or Vaughan. The other 30 will be without a job.
Claim #9: “Alectra will establish the GRE&T Centre in Guelph as a platform for supporting transformation in the electricity industry by accelerating integrated energy solutions. The GRE&T Centre will have eight to ten new full-time positions, with $5 million of capital spending in the first three to five years of the merger, and $3 million in annual operating spending within two years of the merger.”
This is true, but it may look better than it actually is.
First, it is a relatively small commitment, $3 million a year for a utility with +$600 million in annual revenue, i.e. under ½ of 1%.
Second, and perhaps more important, the former Powerstream Head Office was, in the Alectra merger, renamed the “Sustainability and Innovation Office”. This large (92,000 square feet) office building near Highway 400 in Vaughan, which can house 270 people, will clearly be the centre for most sustainability and innovation activities. Decision-making, of course, will be centralized in the Alectra Corporate Office in Mississauga, which is also a large (79,000 square feet) office building that can house 200 people or more.
There is little doubt that some initiatives will be carried out in Guelph, if for no other reason than Alectra promised that. If Guelph thinks that it will be the centre of a major hub of innovation and other green activity, that may be wishful thinking. The GRE&T Centre (“great”, get it?) has a very pretty (green) business plan, but its substance may be substantially less than the hype suggests.
Claim #10: “Alectra will meet or exceed service standards and reliability for electricity distribution customers in Guelph Hydro’s current service territory.”
This is also true.
As noted in my previous article, both Alectra and Guelph Hydro are well run utilities. On both reliability and customer service, Guelph has generally been better, but both are good. For example, Guelph currently gets about 200 phone calls on the average day, and about 5 of those have to make a second or third call to get their problem resolved. At the Alectra service levels, about 35 would have to make that second or third call.
Claim #11: Guelph customers will share in the $32.3 million OM&A and capital savings from the merger, as well as in the $426 million in savings from the original Alectra merger. (See Att-2, page 5).
This does not appear to be true.
Under the rules of the Ontario Energy Board, all savings for the “sitout” period go only to the shareholders. That includes the savings for the original Alectra sitout period. None of these savings go to the customers. There does not appear to be any basis for saying that they will, and the report is almost certainly wrong on this point.
Claim #12: From 2026-2041, customers will receive $73.7 million in savings from the merger. (See Att-2, p. 5).
This may or may not be true.
First, it is too far in the future to project, and second, the basis of the calculation has not been made public.
In the past, the customers of the Powerstream merger partners do not appear to have benefitted from the mergers, since their average rate increases were higher than those of Guelph, which did not have any mergers. Horizon customers, on the other hand, did apparently benefit from the merger between Hamilton and St. Catharines.
Thus, the jury is out on this one.
Claim #13: GMHI will benefit from greater growth in the value of its investment due to the scale of Alectra and its focus leading industry change.
There is no reason to believe this is true.
It is true that, compared to standalone, growth in value is likely to be better with a merged entity. There is no evidence to suggest that merger with Alectra, as opposed to merger with someone else, will produce better growth in value. Generally speaking, growth in value of a wires company is driven by demographics. Some of Alectra has reached lower rates of customer and business growth, while Guelph and other municipalities that are not part of Alectra can look forward to quite high future growth. Which will grow more: Hamilton and Mississauga, or Guelph and Milton?
Whether Alectra is “leading industry change” is a matter of opinion. Alectra is certainly active in the corridors of power, and has some influence. Many others in the Guelph-centred region are also active and influential. It would not be fair to say Alectra is the “leader”. It might be fairer to say they are an important player.
Claim #14: “All customers of a consolidated utility are expected to benefit from lower distribution rates than what they would have to pay as customers of their respective utilities.”
This is probably not true.
As I demonstrated in my previous piece, at the time rates are harmonized, the Guelph small business and commercial/industrial customers are likely to experience high rate increases, since their rates are quite low right now. Where Alectra says that it will not harmonize rates if this is the impact, that is not consistent with their past history.
Because we can’t see the agreements, we don’t know if the City of Guelph has any veto over large increases to customers in Guelph.
Claim #15: Guelph customers will experience a lengthy list of customer service and other improvements, shown at page 29-30 of Att-2, the advisors report.
This seems to be somewhat oversold.
When you go down the list of supposed benefits from the merged utility, it would appear that virtually all of them are already in place at Guelph Hydro. It is not clear where actual improvements are being proposed. Are there any?
As is so often the case when companies that have a business goal are trying to get the public onside, a picture is painted that is the prettiest version of the transaction. Claims are made, rosy forecasts are delivered as if factual, small things are treated as big, and any details that could undermine the narrative are either not made public, or glossed over.
That appears to be the case here. This may be a good deal. There are arguments on both sides. However, it is important that those assessing the situation start with the actual facts, not hopes and dreams and maybes.
Or sales pitches.
- Jay Shepherd, December 9, 2017
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