Magna Head Turns Sights on Russia
Not many people remember the Torrero, but those who do will never forget it. It was a four-wheel-drive sports car, with a top speed of 240 km/h and buffalo-hide interior, and back in 1989 it was heralded as Magna International's bold step up into the business of designing and manufacturing cars, and beyond the less-glamorous world of stamping out bumpers and parts for America's big three automakers. Magna unveiled the Torrero prototype at the Detroit auto show, with plans to start producing it in 1992.
Suffice it to say everyone - analysts, investors and clients alike - was less than thrilled.
Around that same time, Magna's mercurial leader, Frank Stronach, was digging the company out from beneath more than $1 billion in debt. The stock was languishing, and Magna had embarked on a slash-and-burn campaign that would see dozens of plants shut down, executive dining rooms closed and corporate jets sold, in a valiant race to appease bankers and stave off bankruptcy. After sinking more than $8 million into development costs for the Torrero, the idea was quietly abandoned. But the whole sports car digression left anxious investors openly wondering - is Frank Stronach crazy?
Today, almost two decades later, puzzled observers are asking that question again. Or is it still? Stronach's sometimes-unfathomable schemes to diversify beyond auto parts are familiar ground for Magna investors, but the company's latest moves have focused even more attention on troubles that have been long obscured by robust growth in North America and Europe. For all Stronach's attempts to branch out, Magna now finds itself overwhelmingly dependant on three financially troubled Detroit automakers, virtually shut out of fast-growing markets in Asia, and with a stock price that is roughly where it was 10 years ago. This week, the company got even more bad news. BMW is pulling out of an agreement under which Magna built the X3 SUV in Austria. Analysts say that contract accounted for up to 11 per cent of Magna's profits last year, and its loss leaves the company even more reliant on its struggling American customers.
Last month, in a gambit to light a fire underneath his stalled empire, Stronach announced a widely panned, and ultimately failed, attempt to buy the Chrysler Group. But if acquiring a money-losing automaker that had already humbled the management gurus behind Mercedes Benz seemed like an ill-conceived gamble, that was nothing compared to his next big move.
Late last week, Stronach steered into an agreement to sell part of the company to Oleg Deripaska, a controversial Russian billionaire with close ties to the Kremlin who is barred from travelling to the United States. The move, which will see Deripaska sharing control of Magna, stunned shareholders and left analysts scrambling to explain what Stronach is up to. In hopes of breaking into the burgeoning auto markets of the former Soviet empire, Stronach has begun a long march into the heart of a region mired in corruption, where industry and commerce frequently serve political masters. Most shocking of all, Stronach has loosened his control over his empire, something he swore he would never do.
"Frank thinks very big and in ways that the rest of us just don't," says John Doddridge, who was CEO of Magna from 1992 to 1994, and who admits he struggles to see the logic in this move. "If I were there, I wouldn't touch a lot of these things. But some of the things I wouldn't touch, Frank has turned into home runs over the years."
Yes, Stronach has many home runs on his record. And many strikeouts, too. And as the 74-year-old embarks on what is arguably the biggest risk in Magna's history, the open question is this: is this the work of the maverick who defied conventional wisdom and launched a clever expansion into Europe 15 years ago? Or is it another doomed adventure by the impulsive gambler, who once spent $8 million building a car that never got off the drawing board?
Franz Strohsack has never been easily satisfied. Even his name seemed somehow too constrictive after the 22-year-old emigrated to Canada from his native Austria in 1954. As the well-worn story goes, he moved to Montreal with $200 in his pocket, collected golf balls at a driving range, then moved to Kitchener, Ont., where he washed dishes until landing a job at a local plant making aircraft parts. He adopted the name Frank Stronach, and in 1957 started his first toolmaking business. By 1977, sales had grown to $89.7 million, as major manufacturers outsourced fabrication and assembly work. By 1987, sales were more than a billion.
That might be enough to satisfy most people. Not Frank Stronach. Throughout the 1980s he indulged more and more of his interests beyond the dull business of twisting and cutting metal. He built a sprawling horse farm in Aurora, Ont., just north of Toronto, and became a renowned buyer and breeder of thoroughbred racehorses - a passion that would eventually come to occupy far more of Stronach's time and energy than the car business. Thus followed a string of failed ventures: an attempted acquisition of Canadair from the federal government in 1986; a short-lived business magazine called Vista, known more for its huge budget than its journalism; a clothing company; a disco; and a chi-chi restaurant named after his now-famous daughter Belinda. He even sought to reshape Canada, running for Parliament as a Liberal in 1988. Soundly trounced, he returned to the car business to find Magna teetering on the edge of disaster.
After a decade of rapid growth and even-faster spending to upgrade facilities and buy small competitors, the company was being crushed under a mountain of debt. The ensuing turnaround is now the stuff of business legend. Magna slashed costs and engaged in a delicate and protracted dance with bankers and bond holders to restructure the company's debts. It was in the midst of this turmoil that Magna finally, reluctantly, let the Torrero die. "They started flying so high and then they crashed and burned," says Doddridge, who was brought in with great fanfare to be Magna's CEO in the aftermath of the debt imbroglio. "They were lucky to survive bankruptcy and they knew it."
Stronach emerged from the ordeal vowing never to lose control of his company. But his propensity to run madly off in all directions endured. Some things worked, like a courageous and prescient expansion into Europe's beleaguered parts sector - which now contributes close to a third of Magna's annual revenue. Most though, like the racetracks, casinos and amusement parks, have done little but sap Magna's energies and money. Largely as a result, investors and Bay Street analysts have never really warmed to Stronach or learned to trust him. For decades a perpetual cloud has hung over the stock, depressing the share value, a phenomenon known among financiers as "the Frank Factor."
A few years ago, when Stronach floated the idea of launching Magna Air - an airborne luxury hotel for business travellers - analysts and investors nearly fainted, and that idea too was eventually dropped. But at Magna's annual meeting in 1998, Stronach lectured the naysayers: "It's not good to have all your eggs in one basket, no matter how good the basket." The trouble was, while Stronach was musing about the airline business and building roller coasters next to racetracks, the global AUTOMOTIVE INDUSTRY was being turned on its head. Magna's failure to adapt is what brings us to the problems it faces today.
Japanese automakers haven't just put a dent in the fortunes of Magna's key customers, Ford, GM and Chrysler; they've chained them up to a tow truck and hauled them off to the wrecking yard. Toyota, Honda, Mazda and Nissan have pummelled the Big Three over the past decade, dislodging them from their dominant position in the industry. Rather than Magna riding the wave and reducing its reliance on these fading titans, the opposite has actually happened. U.S. automakers accounted for 63 per cent of Magna's sales last year, up from 61.5 per cent in 2004. Add in Magna's only major European client, BMW, and that figure rises to 81 per cent. Camrys and Accords are flying off the lots, but Magna gets very little of that business.
Not that Magna hasn't tried. The company has opened up more than two dozen plants and offices across Asia, but Magna's sales to all countries outside of North America and Europe accounted for just $269 million last year, a tiny sliver of the company's total revenue of $24.2 billion. Rather than reaching out to Magna, the Japanese automakers have simply brought their own suppliers with them to North America. American rivals like Delphi and Johnson Controls, meanwhile, have spent billions building facilities in places like India, China, Japan and Singapore.
Maybe that's why Magna has changed its tune so dramatically in the last week. After repeatedly telling shareholders the Far East holds the key to Magna's future, executives have started to downplay the region's importance. "China is already confronted with overcapacity," Siegfried Wolf, Magna's co-CEO, told bewildered shareholders last week, adding, "our culture is closer to Russia than to that of China or India."
Magna is now singing the praises of Russia's potential. The company says last year auto sales grew 20 per cent to more than two million vehicles, and is expected to continue to rise as many Russians buy their first cars. The deal, which saw Deripaska pony up $1.5 billion in exchange for voting control equal to that of Stronach's, also offers a low cost base from which to produce parts.
Yet for all the warm smiles and handshakes, the idea of Magna plunging headlong into a country where so many other Westerners have gotten burned is worrisome. "For Western businesses, there's no rule of law in Russia," says David Satter, author of Darkness at Dawn: the Rise of the Russian Criminal State, and a fellow at the Hoover Institution at Stanford University. "The government doesn't take contractual obligations seriously, the courts are controlled, the criminal element is integrated with government and bribery is almost universal. All of that makes for dicey conditions for a company."
The abrupt shift is all the more startling because of the man with whom Stronach has thrown in his lot. Deripaska isn't just any old Russian oligarch. As owner of the world's second-largest aluminum company and automaker GAZ, plus a collection of other former Soviet enterprises, the 39-year-old oligarch is said to be Russia's richest man. His wife is the step-granddaughter of former president Boris Yeltsin, and Deripaska has nurtured a strong relationship with Russia's iron-fisted President Vladimir Putin, who is not above tossing the odd businessman into a Siberian gulag when it pleases him.
As with most of the super-rich oligarchs who came to control Russia's economy after the collapse of Communism, messy questions continue to dog Deripaska. Just how did he cobble together his fortune out of the ruins of the Soviet state? It's a part of Deripaska's bio that is continually glossed over. For the Federal Bureau of Investigation, though, the gap was a red flag. After he visited the U.S. in 2005, the agency had Deripaska's visa revoked, according to reports, because he failed to satisfactorily answer investigators' questions about his past.
When it came time last week for Magna to introduce its Russian saviour, executives dismissed such concerns as "personal" matters. Stronach said he'd personally sought assurances from Putin that all was well with his new partner. That move drew the ire of the lawyer representing Mikhail Khodorkovsky, the energy oligarch now serving eight years in prison after running afoul of Putin. Canadian corporations shouldn't be "kissing the ring" of an autocrat, he said. But Stronach, who stands to pocket an immediate $150 million when the deal closes, remains steadfast, and outwardly respectful of Russia's repressive political culture. "You cannot have total freedom overnight," he told shareholders. "You'd have chaos."
But whether Stronach can peacefully co-exist with his powerful new partner remains to be seen. They may be decades apart in age, but both men have ferocious egos and a belief that any strategy is a good strategy - as long as it's their strategy. Stronach has blasted corporate governance activists in the past, telling disgruntled shareholders they can go ahead and sell their shares. Deripaska and the six directors he'll have on Magna's board won't be so easy to push away. Back in the early 1990s, when Deripaska was mysteriously accumulating a 20 per cent stake in a Siberian aluminium factory, he faced a backlash from the facility's Communist-era management. "I was expecting they would treat me as a shareholder," the oligarch told a reporter recently. "But they said, 'No, you have the shares, but we run our business. And it's separate.' " In an industry where corporate rivalries were often settled through violence and brutality, Deripaska came out on top, without ever running afoul of Russia's legal system. This is the partner Stronach has chosen for his great Eastern expansion. So, is it Magna's long-awaited breakthrough, or a game of Russian roulette?
Doddridge, like so many others, is respectful but wary. "I don't know what the hell he's doing with this deal," he says. "I can see some of Frank's counterintuitive brilliance in some of this stuff. But anybody who takes risks of this size is really rolling the dice. It only takes one big wrong move to do you in."
Maclean's May 28, 2007