The appetite to buy Hydro One’s latest bought deal will likely spur other Canadian utility companies shopping for U.S. assets to consider a similar financing structure.Fred Lum/The Globe and Mail
Underwriters had little trouble selling Hydro One Ltd.'s $1.4-billion bought deal, which was announced last week with the utility's $4.4-billion acquisition of U.S.-based Avista Corp.
The entire allocation of convertible debentures was sold within a day, say sources familiar with the financing. Demand from retail investors was particularly strong out of the gate, which encouraged institutional buyers to jump in as well, a number of people said.
The appetite to buy Hydro One's latest bought deal will likely spur other Canadian utility companies shopping for U.S. assets to consider a similar financing structure, which was used previously by Fortis Inc. in 2013, Emera Inc. in 2015 and Algonquin Power & Utilities Corp. in 2016 to fund their own acquisitions.
In this Hydro One deal, the debentures were sold through instalment receipts paying an interest rate of 4 per cent a year.
Investors are initially only putting up one-third of the usual $1,000 commitment per debenture, but will get a quarterly payout as if they'd paid for the entire amount up front. That means the yield will initially be in the 12-per-cent range, which is something that appeals especially to yield-hungry retail investors. After the closing of the deal, expected in mid-2018, investors will have to put up the remainder. After the final payment is made, the debentures are then convertible into Hydro One's common shares at a price of $21.40 per share or they become debentures that pay no interest.
The structure works to fund deals with an extended review period because investors can make money while they wait – and these payments are tax deductible for the issuer. For investors, the wider the gap between when the first and second instalments have to be paid, the better. That means they can continue to earn an attractive return on the first instalment and invest the rest of the money elsewhere.
In the past, big Canadian investment banks have cornered the market on this kind of financing because they have vast retail distribution networks to sell into. But the downside is that not everyone can buy into this type of deal, including some Canadian funds or investors in the United States for regulatory reasons.
Hydro One announced the Avista transaction last Wednesday after markets closed. After opening on Thursday down 5 per cent, near the conversion price of $21.40, shares of Hydro One rallied sharply. Since then, the stock has traded sideways, closing on Monday down 0.3 per cent to $22.58.
The success of Hydro One's latest bought deal stands in sharp contrast to its previous stock sale two months ago. In May, the province of Ontario sold $2.8-billion in equity, but underwriters only managed to sell about 60 per cent of the stock at the original offer price. Later, investment banks repriced the deal at a lower rate, meaning the syndicate's profits were drastically reduced.
In a bought-deal financing, a syndicate of underwriters buys the entire block of stock from an issuer and then tries to flip the stock to investors. If demand is particularly strong, stock sales can be blown out in a matter of hours. But regardless of whether the shares are sold to third parties, the issuer gets its funds from the underwriters. For taking on such considerable risk, underwriters are generally richly rewarded for their efforts.
The current convertible debenture bought deal is co-led by RBC Dominion Securities, CIBC World Markets and BMO Nesbitt Burns. Bankers stand to make a fee of at least $49-million on the offering, which is being done at a 3.5-per-cent commission.