Inside the Deripaska-Magna Divorce

stronach110308.jpg Canadian Business has a great article examining Oleg Deripaska’s surrender of his stake in the auto parts manufacturer Magna after losing nearly $600 million on the gamble. Questions are raised about lax corporate governance standards and other hidden features of the transaction. Did the Canadian owner Frank Stronach (photo) hide his arrangement with Deripaska over management fees from shareholders?

Although that assessment was endorsed by many investment analysts who watch Magna closely, Peter Sklar, who follows the company for BMO Capital Markets in Toronto, noted that Magna shareholders might question why Stronach would change his ownership interest and grant joint control to a total outsider “just to entrench a partner for the Russian market, one of the smaller of the global automotive markets.”As Sklar noted when Magna first proposed to offer Deripaska joint control, the Canadian company was already working with another Russian carmaker, AvtoVaz, with which it had seen no need to forge new ownership relationships. More than a few questions remain unresolved about Deripaska’s past business practices, which could worry shareholders, Sklar noted. But then, “there is a common view that Magna has been lacking in its corporate governance standards,” Sklar also added. Concerning a side element to Magna’s deal with Deripaska through which Stronach was personally paid US$150 million to grant the Russian equal access to his management fees — which for many years have amounted to 3% of Magna’s pretax profit, or about US$30 million a year — Sklar raised the question “of whether there are other more significant motivations underlying the transaction” than the stated intention of taking Magna into Russia under Deripaska’s well-connected guidance. To be blunt, suggested Sklar, Stronach may have been “motivated to monetize as much of this fee stream as possible due to concerns about the sustainability of the fees.”Other analysts tracking Magna agree that Stronach’s US$150-million fee amounted to a substantial inducement to do a deal that seemed otherwise inexplicable. “Magna’s objectives could have been accomplished without selling a portion of the company’s equity,” noted UBS Investment research analyst Fadi Chamoun last year. And the side deal for Stronach’s fees was far from benign, he warned. “These fees would have returned to Magna shareholders once Frank stopped providing consulting services to Magna,” Chamoun said. As it was, the deal with Deripaska perpetuated “a highly controversial management fee structure” — one that risked becoming permanent.Seen in this light, Sklar now thinks the failure of the deal — despite the substantial further hit it caused Magna’s share price, and even though the Canadian company will now operate in Russia without the protection that Deripaska’s ownership stake guaranteed — “will be positively perceived by Magna investors.”