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Directors ‘very concerned’ about Stronach premium, Harris tells OSC

Date: Friday, June 25, 2010
Author: Investment Executive

Former Ontario premier Mike Harris, the lead director of Magna International Inc., says a special committee of directors was “very, very concerned” about the premium being offered to Frank Stronach in return for giving up his voting control of the company, a regulatory hearing was told Wednesday.

The Ontario Securities Commisssion and shareholders opposed to the deal are asking that a vote scheduled for Monday be cancelled until Magna provides more information on the deal.

The special committee set up to analyze the offer was worried about the optics of offering Stronach close to $1 billion -- US$300 million in cash and more than C$560 million worth of common shares -- to give up his special class of voting shares, Harris testified.

He said the committee was also worried that by issuing nine million additional common shares to Stronach, it would dilute the existing share base by an unprecedented amount -- about 7.5%.

“In that the dilution was conspicuously in excess of any precedents we’d seen, yes, we were very concerned,” Harris told an independent panel of the Ontario Securities Commission, which is examining whether the proposal should be allowed to go to a shareholder vote.

As lead director, Harris holds a key position that gives him responsibilities when dealing with matters that may be a conflict of interest between the company and Stronach, the board’s chairman.

Harris said he met with Stronach and his daughter, former Liberal cabinet minister Belinda Stronach, to raise the possibility of a smaller payout.

“I agreed that any deduction in the payment to the Stronach Trust would be good,” Harris said.

But “Ms. Stronach and Mr. Stronach indicated, ‘That’s the price, that’s the number, if it doesn’t go ahead we’re comfortable with the status quo.”’

With the status quo, the Stronach Trust indirectly owns all the 726,829 outstanding class B shares. Each of the super-voting shares has 300 votes, giving the family-controlled trust about 66% of the voting rights at Canada’s largest auto parts company, which was founded by Frank Stronach.

An independent panel of three commissioners will rule this week on whether the premium being paid to Stronach -- approximately 1,800% of the value of the common shares -- should prevent the deal from going ahead.

The regulator’s enforcement staff has called the proposal “contrary to the public interest and harmful to the integrity of the Ontario capital markets.” In addition, OSC staff and some shareholders who are against the plan have complained that no opinion on the fairness of the deal has been issued, Magna’s board hasn’t recommended which way shareholders should vote and there simply isn’t enough information for the average retail investor to make an informed decision.

But Magna said 54% of its shareholders had already approved the transaction as of Wednesday morning.

Magna’s chief financial officer, Vince Galifi, said Wednesday the payout to Stronach was conceived as a 50-50 split between the chairman and the company’s common shareholders.

The company’s senior management estimated Magna would gain $1.5 billion in enterprise value by eliminating the special voting shares, Galifi said. Enterprise value is a measure of a company’s value, often used as an alternative to traditional stock market capitalization. The measure is calculated as market cap plus debt, minority interest and preferred shares minus total cash and cash equivalents.

“Our objective was to keep Mr. Stronach interested in the process and move it to the next level. To do that we had to come up with something that would work so Mr. Stronach wouldn’t turn us away, but would also unlock value for our class A shareholders,” Galifi said.

Magna’s share price rose more than 14% between May 6, when the deal was made public, and the OSC’s announcement that it would intervene last week. However, OSC lawyer Sasha Angus questioned how much of that rise can be attributed to the proposal and how much should be attributed to the fact that Magna announced very positive quarterly results -- 132% above analysts’ estimates -- and reinstated its dividend at the same time.

Angus also pointed out that Magna’s share price would have to rise beyond a certain point to offset the dilution that will result from issuing nine million shares to Stronach. If this doesn’t happen, Magna’s common shareholders won’t get anything out of the deal.

Meanwhile, the payment to Stronach doesn’t depend on a higher share price. In fact, any increase in the stock is an added bonus to Stronach, Angus said.

James Douglas, a lawyer for a group of shareholders who are opposed to the transaction, facetiously referred to this as “the Frank factor.”

Allowing the deal to go forward “really says to Mr. Stronach and others similarly situated that the bigger the Frank factor you can create, the bigger the payday at the end of the road,” Douglas said.

If the proposal is approved, it will also create a new joint venture with the Stronach group, to be 73% owned by Magna and run by Frank Stronach, that would develop electric vehicles and their components. If this joint venture is converted into a corporation, it would have a dual-class share structure similar to Magna’s, giving Stronach 20 votes for every one vote held by a common shareholder.

The OSC will hear from several shareholders both for and against the proposal at this week’s hearing before it issues its decision.

Shares in Magna (TSX:MG.A) added $1.72 or nearly 2.5% to $72.44 in Wednesday trading on the Toronto Stock Exchange.