The government of Ontario owns four government business enterprises (GBEs), as outlined in the box below, each of which returns significant revenues to the province. Government business enterprises are government organizations that:1
Government Business Enterprise Overview
Liquor Control Board of Ontario (LCBO)
The LCBO is a non-share, capital Crown corporation under the Liquor Control Act, reporting to the Ministry of Finance. The LCBO is responsible for regulating the importation, distribution and sale of alcohol in Ontario. The mission of the LCBO is to be a “socially responsible, performance-driven, innovative and profitable retailer.”2 The LCBO is governed by an 11-member board of directors, appointed by the lieutenant governor-in-council, on the recommendation of the Premier and Minister of Finance.
As at Mar. 31, 2011, the LCBO had 611 retail stores and 216 agency stores3 across Ontario.
Ontario Lottery and Gaming Corporation (OLG)
The OLG is a non-share capital Crown corporation established on Apr. 1, 2000, by the Ontario Lottery and Gaming Corporation Act. The OLG’s mandate is to enhance economic development in Ontario, generate revenues for the province, and promote responsible gaming. It is governed by a 12-member board that reports to the Minister of Finance.
The OLG is responsible for the sales of lottery products at approximately 10,000 retail locations, and 27 gaming sites that include 17 slot facilities at racetracks, five casinos and the Great Blue Heron Slot Machine Facility, and four resort casinos (including Caesars Windsor, Casino Rama, Casino Niagara and Niagara Fallsview Casino Resort), across Ontario. The OLG has operating agreements with the private sector for the four resort casinos and the Great Blue Heron Slot Machine Facility.
Ontario Power Generation (OPG)
OPG was incorporated under the Business Corporations Act on Dec. 1, 1998, and the province is OPG’s sole shareholder. OPG reports to the Minister of Energy. OPG assumed the generating assets of the former Ontario Hydro and is now the largest electricity producer in the province. OPG’s generating assets have a fleet capacity of almost 20,000 megawatts (MW), and include two nuclear generating stations (6,606 MW), five thermal generating stations (6,996 MW) and 65 hydroelectric generating stations (6,327 MW). In addition, OPG owns two other nuclear generating stations that are leased out on a long-term basis to Bruce Power LP. The corporation is governed by a 12-member board that reports to the Minister of Energy.
OPG’s large hydroelectric facilities, which include plants located near Niagara Falls and on the St. Lawrence River, as well as its nuclear facilities, are regulated by the Ontario Energy Board (OEB). OPG’s smaller hydroelectric facilities are unregulated and receive market prices for energy produced.
Hydro OneHydro One was incorporated under the Business Corporations Act on Dec. 1, 1998, and the province is Hydro One’s sole shareholder. Hydro One reports to the Minister of Energy. Hydro One assumed all of the transmission assets, as well as the distribution assets that were not transferred to municipalities from the former Ontario Hydro. Hydro One owns 97 per cent of transmission in Ontario, and has four subsidiaries that operate in electricity transmission, distribution and telecommunications. These four subsidiaries include:
The transmission and distribution businesses of Hydro One are rate-regulated by the OEB.
Ontario’s four GBEs play a critical role in the province’s fiscal condition. In 2010–11, the four combined to produce net income of $4.6 billion, with LCBO, OLG, OPG and Hydro One contributing $1.6 billion, $2.0 billion, $0.4 billion and $0.6 billion respectively. Since 2006, these four organizations have provided an average combined net income of $4.3 billion annually (see Chart 17.1).
The combined net assets of the four GBEs amounted to $17.6 billion at the end of last fiscal year, about 13 per cent of the government’s total assets. With $8.6 billion in net assets, OPG makes up the largest share of assets, followed by Hydro One ($6.2 billion), OLG ($2.4 billion) and LCBO ($0.4 billion).
The GBEs also contribute to the fiscal plan in other ways. The OLG is required under legislation to remit to the province a “win contribution” of 20 per cent of gaming revenue from the privately operated Resort Casinos and Great Blue Heron Slot Machine Facility. Ontario Power Generation and Hydro One provide the province with payments in lieu of taxes (PILs) that go towards paying down the stranded debt that remains from the restructuring of the former Ontario Hydro.
The magnitude of the GBE’s fiscal impact compels us to investigate means of generating further value from them. In doing so, we look at two distinct approaches: partial or full divestiture of the business; and improving business efficiencies while retaining full government ownership.
Given their relatively stable net income and strong value, the GBEs may be attractive to potential private-sector investors. However, because these assets contribute substantial, ongoing and growing revenues to the province, any potential divestiture would need to carefully assess the value of any upfront, one-time gains against loss of future revenues.
To compare one-time benefits and ongoing losses, we consider how proceeds from a potential sale could be deployed. A full divestiture of any or all of the GBEs would result in a lump-sum payment to the province at the expense of future revenue streams. If proceeds of a sale were used to pay down provincial debt, Ontario could save on interest costs of up to four per cent, based on recent bond yields. By comparison, GBEs provide a return on assets (ROA) of at least eight per cent. Any full divestiture would have to overcome this spread to provide a fiscal benefit to Ontario.
A second divestiture model is to sell a minority stake in any or all of the GBEs and shift the management role to a private partner. A partial sale, in the range of 10 to 20 per cent, would provide the government with an upfront payment to reduce provincial debt load as well as ongoing interests in the GBEs through its remaining stake. Notionally, such an arrangement would allow the businesses to act in a more commercial manner, thus increasing the value of the province’s remaining interest. To make economical sense for Ontario, the partnership would need to raise the overall returns of the GBEs so that the net income or dividends flowing to the province, combined with upfront payments, would ultimately provide more value relative to the status quo. In such a model, further clarity would be needed on the application of federal income tax rules for new limited partnership models.
In addition to either model, transactions or partnerships could be contemplated to achieve wider policy objectives and/or structural reform goals. Regardless of the rationale, a transaction or new partnership model should meet key principles that include:
As a condition of any sale, the province would certainly have to consider the sensitive nature of the lines of business in which the GBEs operate. To ensure that these businesses continued to operate in a manner consistent with other legitimate policy goals, such as social responsibility, the government might wish to attach certain conditions or employ careful regulatory constraints as part of any divestiture. Such conditions would, we expect, be incorporated in the market’s valuation of the business.
Current circumstances do not appear to offer a convincing value proposition for the province; even so, the province should not ignore the option of selling its GBEs. Indeed, the opposite applies. Ontario must be prepared and willing to entertain new approaches that generate better value out of the GBEs. However, we caution that any action must not be driven by ideology. Before any sale is executed, there must be overwhelmingly clear evidence that Ontario would benefit from such an arrangement in the long run.
Recommendation 17-1: Do not partially or fully divest any or all of the province’s government business enterprises — Ontario Lottery and Gaming Corporation, Liquor Control Board of Ontario, Ontario Power Generation and Hydro One — unless the net, long-term benefit to Ontario is considerable and can be clearly demonstrated through comprehensive analysis.
A second option is to retain full government ownership of the GBEs but improve their performance. As described above, the GBEs make significant contributions to the province’s fiscal plan. However, the GBEs may not be achieving their full potential because of operational inefficiencies and because they are at times required to act in ways that are counter to their direct commercial interest. In this light, there are opportunities to enhance the GBEs’ value and the contributions they make by focusing on efficiency opportunities and allowing them to operate more commercially and focus on their core businesses.
Augmenting asset efficiency and allowing GBEs to operate in a more commercial manner would contribute to the province’s fiscal position. For example, removing implicit subsidies and other price-distorting effects would increase transparency for suppliers and customers alike.
There may be opportunities to improve LCBO returns, through increased efficiencies and new business opportunities. The Auditor General of Ontario’s 2011 Annual Report noted that the LCBO could more effectively use its purchasing power and improve the current markup structure used to determine retail prices.4
The LCBO has other obligations that reduce profitability. For example, it provides discounted shipping as well as premium shelf space to support and promote Ontario producers. These may not represent profit-maximizing strategies, and their policy merits should be balanced against reduced profitability.
With respect to new business lines, the LCBO may be able to grow its bottom line through a more aggressive store-expansion program while continuing to promote socially responsible consumption.
Recommendation 17-2: While continuing to promote socially responsible consumption, undertake initiatives to enhance the Liquor Control Board of Ontario’s profits, including:
The OLG provides significant net income to the province, but operational efficiencies could be explored to improve the company’s margins while continuing to respect social responsibility and meet its conduct and management requirement for the operation of all lottery schemes. For example, a number of questionable business practices should, at a minimum, be reviewed from a value-for-money perspective.
Finally, OLG should continue to seek new and innovative ways to deliver gaming in Ontario to increase its revenues. These include expanding existing business lines, creating new business lines (as it is doing for Internet gambling), and leveraging further private-sector involvement. In all such ventures, the OLG must remain mindful of its mandate to promote responsible gaming.
Recommendation 17-3: Improve the Ontario Lottery and Gaming Corporation’s efficiency through, at a minimum, the following measures:
Recommendation 17-4: Re-evaluate, on a value-for-money basis, the practice of providing a portion of net slot revenues to the horse racing and breeding industry and municipalities in order to substantially reduce and better target that support.
Recommendation 17-5: Consider directing the Ontario Lottery and Gaming Corporation to expand its existing business lines, develop new gaming opportunities and make effective use of private-sector involvement.
In an effort to reduce short-term cost increases to consumers, the government has occasionally intervened in both OPG’s and Hydro One’s regulatory rate filings. The result of such action can effectively decouple electricity rates from costs, providing an implicit subsidy to ratepayers. It may also put at risk the net incomes of both companies to the potential fiscal detriment of the province. While stable, effective regulation is required for both companies given their dominant positions in their respective sectors, intervention that impedes on standard business practices without a clear, legitimate policy objective should be avoided.
Aside from reducing this form of government intervention, there are operational efficiencies that Hydro One could explore to improve its net income. On the revenue side, Hydro One has immediate opportunities to increase its top line. Hydro One could consider strategic partnerships, such as the recently created joint venture between Hydro One, a private partner and six First Nations, to compete to build a new transmission line in northwestern Ontario. Continuing to focus on these sorts of opportunities would increase revenues and allow it to share financial and construction costs with a private-sector partner, while affording development opportunities to local communities.
In Chapter 12, Infrastructure, Real Estate and Electricity, we recommend that Ontario should seek to capitalize on its strengths in the energy sector through developing and expanding export opportunities for its goods and services. A great deal of expertise lies within OPG and Hydro One; leveraging these firms’ human capital in a strategic fashion could be beneficial to taxpayers and rate payers alike in the long term.
Recommendation 17-6: The government should avoid intervening in Ontario Power Generation or Hydro One’s rate filings for the purpose of delaying short-term price increases; too often this leads to greater costs down the road. When regulations or directives are required that impinge on normal utility business practices, the policy objectives being sought must be transparent.
Recommendation 17-7: The government should seek and achieve efficiencies within the operations of Ontario Power Generation and Hydro One through means such as strategic partnerships.
The GBEs should examine their operations to find efficiencies. Benchmarking exercises and operational reviews should support these activities. Opportunities to increase revenues, augment efficiency and improve margins should also be fully explored.
Recommendation 17-8: Each government business enterprise must continue to build on its industry’s best practices to improve its operational efficiency. Each should revisit memorandums of understanding and other agreements to ensure that they reflect commercial mandates. And each should undergo peer ranking and benchmarking on the basis of financial and other metrics both to better understand the organization’s relative performance and find efficiencies.
1. Downloaded from http://www.fin.gov.on.ca/en/budget/paccts/2011/11_cfs.html#notes.
2. Downloaded from http://www.lcbo.com/aboutlcbo/index.shtml.
3. Agency stores are authorized outlets in existing private-sector stores, such as grocery stores, that sell beer and alcohol in communities that the LCBO has determined cannot support a regular LCBO store.
4. Ontario Auditor General, “Auditor’s 2011 Report: LCBO New Product Procurement,” 2011, pp. 186–201.
5. The gaming floor space and total complex space at Fallsview are twice and nine times, respectively, as large as those at Casino Niagara. downloaded from http://www.fallsmanagement.com/The_Casinos/index.html
6. Ontario Lottery and Gaming, “2009–10 Annual Report,” 2010.
7. Ontario Auditor General, “Auditor’s 2010 Report: Casino Gaming Regulation,” 2010, pp. 46–63