Archive for December, 2012

An Open Letter to Tim Hudak about the LCBO

December 4, 2012


So today, you resurrected the old idea of selling the LCBO.  Timmy, it would be nice if you checked the facts and figures before spewing your dogma.

But first, Timmy, ask yourself why your predecessors failed to do this, if it was such a great idea.  Here’s a clue:  It wasn’t a good idea!

Let me explain this to you.  The dividend that the LCBO pays to the Ontario Government is a Growing Annuity.  Since 2001-02 that dividend has had a compound average growth of almost exactly 6%, and that record of growth actually goes back many years, as I did a similar analysis years ago when Mikey Harris’s Common Sense Revolution didn’t.  Can we value this growing annuity?  The formula for the present value of a growing annuity is PV=PMT0(1+g)/(k-g), where PMT0 is this year’s payment, g is the growth rate and k is the discount rate.  As of yesterday, the yield of Ontario Government 25-year bonds was 3.44%.  Hudak, we have a problem!  The discount rate, the yield on long-term government bonds, is less than the growth rate, so the formula doesn’t work.  What does that mean?  The cash flows being generated by the LCBO are growing faster than the interest cost on the debt.

Let try some different assumptions.  Let’s assume that the current interest rates are depressed from normal levels, so let’s just assume 8%.  Furthermore, let’s also assume that the growth rate of the dividend from the LCBO falls back to 5%.  Now we can try to use the formula.  The most recent dividend from the LCBO, in 2010-11 was $1.55 billion, so we would estimate that for 2011-12, that will grow to 1.625 Billion.  Using the formula, PV = 1.625(1.05)/(8%-5%) = $56.875 Billion.  Do you really think that you can get $57 Billion for the LCBO?  I will bet you my house and pension fund that you would not be able to sell it for even half of that!  If sold off to create a competitive marketplace, no rational investor will imagine that the monopoly profits the LCBO is able to earn will continue.

And don’t forget, that if the prices do come down due to a competitive marketplace, then the government’s share of HST revenue will shrink as well.

Before you accuse me of being some left wing rabble-rouser, like your acolyte Bobby Ford, check your facts.  I am a fiscal conservative and former PC party member that has not been able to bring myself to vote for the mindless intransigence of the party since the Harris days.