Frank Stronach: Gambler

Canada’s auto-parts king is staking his empire on a struggling carmaker. Can this possibly end well?

The story goes like this: Frank Stronach is kicking back in his jet, restlessly waiting to depart one of the world’s playgrounds for the rich, after a party for captains of industry, nation builders and socialites. It’s the middle of the decade, during the thick of the Canadian billionaire’s quest to create a gaming and entertainment conglomerate by cobbling together some of the most prestigious horse tracks on the planet. The Austrian-born industrialist is eager to get back to business. He has something to prove to the investors at Magna International Inc., his global auto-parts company, who have bitterly protested the chairman’s unexpected gaming ambitions.

A horse track expert boards the plane, hoping to relax as much as anyone in Magna’s inner circle can when the boss is around. But Stronach has a task for him. He orders his man to grab another flight, to take another look at a racing operation that doesn’t seem to fit the business plan. “Frank,” replies the executive. “That track sits in an uncivilized jungle. The last time we looked at it, we had to go through three road blocks. Machine guns were pointed at our car. What makes you think things will improve?” Stronach smiles. “It’s getting safer all the time,” he says. “You used to complain about five armed barricades.”

These are the kinds of stories that inevitably emerge when Magna insiders get together to unwind and talk shop. This one might be apocryphal, but it’s the moral that really matters. Whenever Canada’s most flamboyant entrepreneur sets his mind on something to expand his business interests, he doesn’t worry too much about whether it makes sense to others. The risks that other people must take to fulfil his vision aren’t terribly important either. That point is particularly relevant today, because Stronach is now embarking on what is undoubtedly the biggest gamble in a long career of rolling the dice.

By now, we all know that the Magna Entertainment Corp. (MEC) horse-racing venture was a massive failure. It lost hundreds of millions of dollars, enraged shareholders and was ultimately forced to seek court protection from creditors earlier this year. But that didn’t quench Stronach’s thirst for the big score; it merely shifted his focus back to the automotive world. Indeed, just a few months after Magna’s founding chairman told shareholders at the company’s annual meeting that they “dodged a bullet” by losing the bidding war for Chrysler two years ago, Herculean efforts by Stronach and Siegfried Wolf, the company’s Austria-based co-CEO, have put Magna in control of General Motors’ troubled European division — Adam Opel.

On Sept. 10, just days after Stronach’s 77th birthday, competing bids for Opel were still on the table, put forth by China’s Beijing Automotive Industry Holding Corp. and RHJ International, a Brussels-based private-equity outfit. But the Canadian team managed to convince politicians in Britain, Germany and the United States, not to mention GM’s skittish board and wary European unions, to support a joint offer by Magna and Russian lender OAO Sberbank. Together, they bid $782 million for a 55% stake in Germany-based Opel, which includes GM’s British Vauxhall operations.

In Canada, where the acquisition is widely seen as the crowning achievement of Stronach’s storied career, Magna officials are playing down the significance of the move, in a bid to calm the nerves of analysts and customers. Magna has always been a respected supplier to many automakers, but now it appears the company will also be competing with some of its clients — a prospect that has some, most notably BMW, quietly grumbling about maybe taking their business elsewhere.

Don Walker, the company’s North America–based co-CEO, says Opel will not change anything, because it is a simple “equity investment” in a vehicle company that will never be run by Magna. “At some point,” he says, “we hope to realize a return on our investment.”

Walker points out that GM is still Opel’s largest single shareholder, with a 35% stake, and that Magna will only appoint three directors on a new 20-member board. “We do not control Opel,” Walker says emphatically.

That may well be technically true. The problem, of course, is that Stronach and Wolf already seem to be calling the shots, talking to unions about 10,000 proposed job cuts and installing the Magna culture. And they have gotten into the habit of referring to Opel in the first-person plural.

“We’ll do everything we can to avoid job losses,” Wolf told European reporters. “If we convince enough customers, we’ll be talking about more, not less employees.”

There are still many questions to be answered before the deal is finally done. The European Commission has been asked to scrutinize the proposed sale for excessive favouritism to Germany, which is providing more than $6 billion in loans, hoping to protect local plants. Proposed job cuts could also threaten union support for the sale. Opel currently has 25,000 workers in Germany, 5,500 at Vauxhall operations in the United Kingdom and more than 20,000 spread across Europe.

Completed or not, the gambit has already put Stronach’s $24-billion auto-parts operation at odds with its customers. Indeed, when Magna bid for Chrysler, Stronach could at least claim he was out to aid a troubled client. But Opel attracted other suitors. At one time, Italy’s Fiat, which is run by Sergio Marchionne, another Canadian empire builder, was seriously interested — and he wanted to buy GM’s European business as part of the strategy he developed earlier this year as Fiat was taking control of Chrysler, which is still a major Magna customer.

Shawn Morgan, a Chrysler spokeswoman, declined to comment on the company’s relationship with Magna. But Volkswagen, a long-standing customer, has said it is watching the Canadian supplier’s move toward direct competition with some concern. And bidding for Opel clearly threatens Magna’s existing vehicle-assembly operations in Graz, Austria, where it currently builds cars on contract for European customers, including BMW. That operation alone generated about 20% of company revenue last year. “Magna has always been a strong supplier for us,” Friedrich Eichiner, BMW’s chief financial officer told the press during the recent Frankfurt auto show. “But Magna will now become a competitor. This is a new situation, which we will have to assess.”

Walker insists Magna’s existing clients should never worry about working with the Canadian supplier because firewalls are always in place to protect sensitive technology. But not everybody is buying that, and bond-rating service DBRS says only that the flight risk of Magna’s customer base “is difficult to quantify at this point in time.”

Even if Stronach’s existing customers turn a blind eye to the competitive question, there are other major obstacles to success. As Opel negotiator John Smith recently pointed out, GM will appoint a new sales-and-marketing executive for the company because neither Magna nor Sberbank have “ever sold a vehicle” or “done a car from scratch.” And the Canadian outfit is jumping into a raging battle for market share at a time when every car company on the planet is scrambling to figure out where oil prices and consumer tastes will go. Even mighty Toyota is feeling financial pain thanks to the worst industry downturn since the Great Depression.

To be sure, Opel has some things going for it. It sold about 1.5 million vehicles in Europe last year, with the Astra, the first model built on GM’s new small-car platform, accounting for 30% of total sales. It is a leader in the development of environmentally friendly cars, and in eastern Europe, sales grew 41% in a year — almost four times more than the industry itself.

Still, Opel’s operations are heavily based in high-wage countries, and they haven’t merely fallen on hard times due to the financial crisis. The company has suffered massive losses over the past decade, including more than US$4.5 billion in the past two years. Any attempt to move production to lower-cost Russia will probably prove difficult, especially given the support that has been handed to the company by European governments. And the deal with GM cuts Opel off from selling into at least three key markets: South Korea, China and the U.S.

None of this is likely to dampen Stronach’s relentless drive, however. He is a capitalist version of Plato’s philosopher king, attempting to grow his empire while spreading the Magna culture of generous employee incentives — a culture that comes with its own constitution. “You grow or you die,” he said after the Opel deal was announced. And when Magna’s bullheaded chairman starts talking about a need to protect his legacy by expanding into new lines of business, history says get ready for a bumpy ride.

Investing with Frank Stronach means resigning yourself to certain flights of fancy.

MEC was neither his first nor his last side adventure in gonzo capitalism. Before chasing his horse-racing vision, Magna’s chairman scared investors with a series of unexpected moves for an auto parts company in the late ’80s. There were ski condos and a glossy business magazine called Vista. Magna opened a restaurant named after Stronach’s daughter, Belinda. It developed tennis gear. There was even an airline concept. Commonly dismissed as “Frank’s follies,” these ventures, along with an uncontrolled expansion of Magna’s core business while Stronach was trying to land a seat in Parliament, created a near-fatal debt crisis for the company. At one point in 1990, the value of its shares had fallen more than 80% to $2.75.

Magna’s founder rallied the company, swearing never to over-leverage operations again. The company’s shares, which currently trade around $44 on the TSX, soared 35-fold in the mid-’90s, outpacing Microsoft. But investors paid a steep price again a decade ago, when Magna started buying racetracks. Indeed, after spending US$126 million on California’s Santa Anita Park, home to the legendary Seabiscuit, the auto parts outfit lost about a third of its market cap.

But Magna has survived and thrived under its unpredictable leader — subject of a classic rags-to-riches story. First child and only son in a family of five, Franz Strohsack was born in Weiz on Sept. 6, 1932. A natural athlete, he may have had a shot at professional soccer in Switzerland. But his mother pushed him along another path when she sent him to learn the tool-and-die trade at age 14. In 1954, fuelled by desire to make his mark on the business world, he moved to Canada (the first target country to approve a visa) armed with eight years of experience, a new name and about $200.

Stronach started off washing dishes and working odd jobs. By 1957, he had his own machine shop in a Toronto garage, where he worked hard and slept on a cot. The business grew. Employees liked his willingness to share profits; customers were attracted to his motto: “Better product for a better price.” In 1960, Stronach landed his first auto-parts contract, which, ironically, was to produce sun-visor brackets for GM. In 1969, he merged with Magna Electronics Corp., a public industrial components manufacturer. He took control, changed the name, and focused the business on auto parts.

From there, Magna has grown into the most diversified automotive supplier on the planet, with more than 70,000 employees and close to 300 facilities. Anyone who attends his shareholder meetings has heard Stronach, who typically takes home more than $30 million in annual pay, frequently attack the institutional investors who dare question his approach. He’s also fond of talking about his corporate constitution, the “Magna Carta,” which limits senior managers to salaries below industry average and awards bonuses only if profits are generated for all stakeholders. If the company is operating in the black, the constitution says 10% of pre-tax profit must be set aside for employees; 6% goes to senior management, which is why the chairman’s pay has skyrocketed along with Magna’s earnings over the years; a minimum of 7% goes to research and development; and 2% must be given to charities or go toward social programs that support “the basic fabric of society.”

In 1984, when Stronach unveiled his constitution to take a stand against executives who “stuff their pockets with all the gold they can find,” he was considered God’s gift to corporate governance. But because Stronach controls Magna through multiple-voting shares (not to mention his my-way-or-the-highway management style), he has become a target of shareholder activists. “If we didn’t deploy an index strategy, we would not invest in Magna at all,” says Wayne Kozun, senior vice-president of public equities with Ontario Teachers’ Pension Plan.

But Magna’s founder doesn’t care what critics think. As he explains, Magna is a public company, but there’s “only one cook in the kitchen.” At the company shareholder meeting in 2005, he told investors: “If I didn’t like a restaurant, I wouldn’t eat there.”

And while many see his various digressions as pure ego, there is a more fundamental priority at work. Namely, the desire to diversify and make Magna less reliant on the whims of big automakers. “Magna is more than a business,” he explained to this magazine in 2005. “It’s a creation. I want Magna to be well and strong a hundred years from now.”

That’s a laudable goal. The question is whether buying into a massive, money-losing auto company is the way to do it.

As far as veteran auto-sector analyst Dennis DesRosiers is concerned, buying control of Opel “stinks” as a strategy for any auto parts company, especially Magna. He says Stronach should be focused on using the firm’s strong balance sheet to buy up struggling automotive suppliers.

After all, Magna hasn’t been immune to the global recession. It suspended its dividend for the first time in 18 years after a US$200-million loss in the first quarter of this year, and has been forced to shutter some plants and lay off employees. In the second quarter, when vehicle production declined 49% in North America and 28% in Europe, Magna lost US$205 million. Sales plunged 45% to US$3.7 billion, down from US$6.7 billion for the same period in 2008. But Stronach’s operation is non-unionized, so it doesn’t face the labour-cost issues that have helped push GM, Chrysler and Magna’s major U.S. competitors into bankruptcy court. And despite losses in the first half of 2009, Magna still has a strong balance sheet, with an enviable US$1.7 billion in cash on hand.

“This is a company with unprecedented opportunity in its core business of producing automotive components and systems,” DesRosiers says. But instead of feasting on industry road kill, Stronach is directing “huge management and financial resources” to “get into the business of producing mass-market vehicles,” a business the company “knows nothing about.” Furthermore, if the deal is completed, Sberbank is expected to transfer its stake to Oleg Deripaska, a Russian oligarch with auto interests, who is expected to open the door to a rapid Magna expansion into Russia, where Ikea recently suspended operations due to the “unpredictable character” of law and order.Those concerns aren’t exactly new. In 2007, Stronach cut a deal to share control of Magna with Deripaska, who invested US$1.5 billion in the Canadian firm at the time. The Russian’s direct involvement with Magna ended late last year, when a liquidity crisis in his other operations forced him to sell his equity stake in the company. But according to Magna spokeswoman Tracy Fuerst, the “working relationship” with Deripaska’s GAZ auto-making group has remained strong.

Nevertheless, Carlos Gomes, an auto-sector analyst with Scotia Capital, argues that Magna’s renewed focus on Russia — which sits between Syria and Kenya on the 2008 Corruption Perceptions Index — could prove to be riskier than the deal’s supporters expect. According to Gomes, Russia has a low vehicle-penetration rate, about 180 vehicles per 1,000 people, compared with roughly 560 vehicles in western Europe, so the potential is enormous as long as Russia’s energy-dependent economy recovers. Still, he thinks it “has the weakest outlook among the BRIC nations [Brazil, Russia, India, China] because of declining population,” and there are no guarantees that Magna would be able to make Opel into a major player there.

Fadi Chamoun, a Toronto-based analyst with UBS Investment Research, says the Opel deal could be positive for Magna if it is simply “a tactical move aimed at providing a step up in terms of market share for Magna, with an intended exit strategy.” But so far, the company appears to be “embarking on a high-risk strategy, which has the potential to impact fundamental aspects of the company’s shareholders’ value creation profile,” he says.

And that gets at the basic disagreement about what the Opel deal represents. Is it simply an equity investment in a company with potential to tap into a new growth market? Or is it a profound change of direction? Michael Willemse, an analyst with CIBC World Markets, sees little risk to Magna’s shareholders because he can’t imagine Magna’s co-CEOs being willing “to inject a material amount [of capital] above the original investment,” which would be inconsistent with “Magna’s desire to maintain a strong balance sheet.”

But it is always what the king of Magna wants that counts. And Stronach, who is already calling Opel the “Magna car company,” has been known to have plans his court doesn’t know about. On more than one occasion, Magna’s chairman has discussed plans to place Opel assembly plants in Canada, despite the fact that the deal with GM denies access to the U.S. market — where the vast majority of Canadian-made cars are sold. According to one Bay Street source, who asked not to be named, Magna executives have been quietly informing analysts that “there are no plans to build Opels in Canada.”

Stronach likes to joke that the only big dream in his life was to own his own bike so he didn’t have to share one with his sister, so maybe he really isn’t interested in spending too much time, energy and money on saving Opel, especially with Russian and American cooks crowding the company kitchen. But with MEC essentially dead in the water, Magna’s chairman certainly appears to be aggressively targeting the customers of his auto parts clients to fill his kingdom’s coffers. And if the Opel deal is really about empire, then even Willemse admits the so-called Frank factor could eventually force Magna to throw a lot of good money after bad — exactly what happened with the failed horse-racing venture.

This time, though, there is a big difference. When Stronach was building MEC, he was handcuffed by the Magna Carta, which limited his ability to spend Magna’s money on “non-automotive ventures.” This time, Magna’s expected investment in Opel is less than $400 million — and easily manageable given the company’s cash stockpile. But since Opel is clearly an automotive business, Stronach is free to make whatever moves he sees fit, even grand long shots that could agitate existing customers and scare off investors. This time, there is no limit on how much the King can roll the dice with other people’s money. And as everyone knows, the King likes to gamble.