A Valuation & Strategic Appraisal of Ontario Power Generation

Valuation of Crown Corporations, Crown Corporations, Ian Madsen

Ontario Power Generation (OPG) is Ontario’s largest electric power generating utility. In 2016, OPG supplied electricity to approximately 50 percent of local and provincial power utilities. OPG‘s wide provincial geographic scope and vast array of productive generating assets would make a lucrative divestment for Ontario taxpayers—either in its entirety as a whole or through separated parts. With having only one predominant customer, Hydro One, reconfiguring and, possibly, splitting up OPG would be an extremely complex process.

It is not clear that a break-up of OPG would be feasible, nor that, if it was broken up, that the total proceeds would exceed those from divesting OPG as a single unit. It is not apparent that a break-up of OPG, by region or nature of generation technology, would make the then-disparate multiple firms more competitive, efficient, innovative or market- and customer-responsive.

The recent intervention of the Ontario government into Hydro One’s corporate management compensation levels, and the subsequent resignation of its previously independent Board of Directors, may have made a partial or full divestment of OPG more appealing. Contrarily, has the political intervention reduced interest of prospective investors in OPG?

Using an intrinsic value method and discounting to the present value, the Province of Ontario’s interest in OPG’s projected future free cash flows, employing OPG’s net income as a proxy for free cash flow (which is currently, and perhaps foreseeably negative as the company is today), and taxed at statutory rates, is estimated to be from a minimum of $5.38B to a maximum of $37.69B—with a tighter, more plausible range of a median (midpoint of all the relevant values) of $9.42B to a mean (simple average of all the relevant values) of $12.13B.

Under the market-based valuation system, and using five viable, standard valuation metrics (such as trailing and forward Price/Earnings, Price/Sales, Price/ Book Value, Price/Operating Cash Flow), and employing comparisons with six Canadian and forty US publicly listed electric-dominated utilities with minor renewable energy generation capacities, the current value of OPG ranges from $7.34B to $26.02B—with a mean of $17.07B and median of $20.09B.

Only an intensive, meticulously minute appraisal of all of OPG’s assets, including assessing its physical assets and all its accounts (including ‘hidden’ assets and liabilities), would provide an accurate valuation of the company, albeit one still dependent on subjective reasoning and assumptions. Even then, that valuation would not necessarily indicate what magnitude of proceeds could or would be garnered in a divestment (by way of either a public share offering, a partial or total sale to one or more institutional or private investment fund companies, or a sale to a corporate acquirer).

OPG, as currently situated and operated, produces negative free cash flow and low returns on assets, equity and capital employed. This suggests a period of restructuring, reorientation and rationalization to improve OPG’s margins, before the company should issue any equity to the public (so that higher value can be realized in a subsequent sale).

Utilities usually pay a dividend to their investors. While OPG reports sufficient income to pay a dividend, its current low cash generation may not allow sustainable dividends. However, if OPG could present a credible and viable plan of redirection towards future commercial success and strong resilience to challenges, share flotation could be successful, with a possible dividend later.

As OPG’s debt level is relatively high with capital expenditure needs exceeding reported operating cash flow, much, if not all, of the proceeds of the first sale of treasury shares in a partial divestiture might or should be used to shore up OPG’s liquidity, and not flow to the Province of Ontario’s treasury.

Caveat: this appraisal document is in no way a prospectus, nor are the estimates, projections, observations, and analyses definitive or authoritative. Other analysts may have valid differences and ways of scrutinizing and valuing OPG.

Read the entire Valuation here.