June 03, 2010
Magna International's proposal to eliminate the company's dual-class share structure is fundamentally unfair to the company's subordinate voting shareholders. It also raises a number of larger governance questions as to whether the board of directors has fulfilled its duty, as well as the purpose and benefits to shareholders of dual-class share structures. The Ontario Teachers' Pension Plan intends to vote against the proposed transaction for the reasons set out below.
There are three parts to Magna's proposed transaction:
- elimination of the dual-class share structure whereby the Stronach Trust will receive a US$300 million cash payment and 9 million Class A (single voting) shares, with a total financial value of US$863 million in exchange for 726,829 Class B (multiple voting) shares
- elimination of Mr. Stronach's consulting contract by the end of 2014
- establishment of a private joint venture, controlled by Mr. Stronach, for Magna's E-Car business
The Magna board is asking the Class A Shareholders to decide for themselves whether the proposed transaction is fair and reasonable. The Magna board will then be asking the Ontario Superior Court of Justice to determine that the Arrangement is fair and reasonable, something the Special Committee considered a "key procedural safeguard". Yet the board itself is unwilling to make that determination despite being in the best position to do so in terms of having access to management, independent valuation work and other material non-public information of the Company.
Teachers' has long supported the principle of one share, one vote. We have advocated against dual-class share structures for many years; however, we believe Magna's proposal is an unprecedented and excessive transfer of wealth from shareholders to the Stronach Trust, and we question the appropriateness of the significant payment to the Stronach Trust.
As a proponent of good governance and a major participant in capital markets, Teachers' will not support dual-class share collapses at any company that would transfer significant company and shareholder wealth to the controlling shareholder to eliminate multiple-voting shares. We believe premiums at the level proposed by Magna are excessive and unwarranted and are concerned that this transaction would set a bad precedent for future dual share collapses.
The questions we asked ourselves about the proposed transaction and our analysis follows.
Is it appropriate for the company to pay this premium to eliminate its multiple-voting shares?
It is rare for controlling shareholders to receive a premium over the value of the subordinate shares when companies eliminate multiple voting shares. In most relevant cases we could find (i.e., outside of takeover bid or acquisition situations), the multiple voting shares were exchanged for common shares on a one-for-one basis when the voting structure was collapsed.
What these examples appear to acknowledge is that the voting rights and economic rights, in the case of multiple-voting shares, are separate. Mr. Stronach and other proponents of dual-class share structures argue that multiple-voting shares are in the best interests of the company and all of its shareholders because they allow the vote holder (usually the company's founder and business leader) to make long-term strategic decisions aimed at creating extraordinary value for all shareowners. According to that argument, a dual-class share structure is simply a corporate governance framework, the benefits of which are meant to accrue to all shareholders. (Indeed, in the meeting circular, the company describes the Stronach family as having been the "custodian" of Magna's corporate culture through its control of the Class B shares.) It seems logical then, that any economic value to be derived from the structure belongs to the corporation and all of its shareholders.
Dual-class share structures are usually collapsed when a company's strategy has become established and has had time to play out, or as part of a succession planning process where the visionary founder no longer plans to be as involved with the day-to-day business. It stands to reason that there ought to be no payment to the holder of the multiple-voting shares simply because the time has come for the company's voting rights to be normalized. This transaction is not a takeover; it is simply a governance change. If the holder of the multiple-voting shares is truly the "custodian" of the company's best interests, it would surely put these interests ahead of its own.
In the precedent dual-class share elimination transactions we reviewed, the multiple-voting shareholders were rewarded the same way as all other shareholders – namely, through an increase in the value of common shares into which their multiple voting shares were converted (on a one-for-one basis).
It is noteworthy that in most of these examples, the controlling shareholders' multiple-voting shares represented a significant economic interest in the company (as distinct from the number of votes controlled). This is not the case at Magna. Mr. Stronach's Class B shares currently represent just 0.6% of the Class A and Class B shares combined.
The proposed US$863 million total payment for the Stronach family's 726,829 Class B shares amounts to US$1,187 per share. The proposal, as announced, represents a premium of approximately 1,800% over the pre-announcement trading price for the Class A shares on May 6, 2010. Our research found no precedent for anything close to such a premium.
Are the Class B shares worth US$863 million?
Magna's Class B shares have not traded publicly since 2007. One proxy for their value could be the price the company paid in 2007 to repurchase all Class B shares from holders other than Mr. Stronach in a complex deal involving Russian billionaire Oleg Deripaska.
In that transaction, the Class B shares were valued at $114 each, representing a 30% premium over the trading value of the Class A shares at the time. (Teachers' was a vocal critic of the 2007 transaction as one that was too rich and unfair to the Class A shareholders.) A 30% premium over the pre-announcement trading price of the Class A shares on May 6, 2010, (approximately $64) would be roughly $83 per Class B share, or $63 million in total, far below the proposed payment of US$863 million.
A better proxy may be the historical relative market prices of the Magna Class A and B shares from 2001 until 2007 (when the Class B shares ceased trading publicly). It is interesting to note that the average price premium from 2001 to 2007 of the Class Bs over the Class As was just 4.2%. This can be taken as a clear signal from the market that the value of the Class B shares during that period was effectively the same as the Class A shares. We ask ourselves, what has changed since 2007 to justify such a massive premium?
With these comparisons in mind, it is difficult to understand the basis for the US$863 million payment Magna proposes for Mr. Stronach. We found nothing in the management information circular in the way of a detailed rationale for the proposed payment. We consider this to be especially important given the current value of Magna's Class A shares (which the Class B shares used to track closely) and the precedent transactions where no premium was paid to holders of multiple voting shares when dual class share structures were eliminated.
Have the Magna directors fulfilled their duties?
Directors are required to make decisions in the best interests of the Corporation. The directors of Magna appear not to have made a decision whether the arrangement is in the best interests of the Corporation. Instead they have passed the buck to the Class A Shareholders and the Court. The Ontario Securities Commission and the Autorité des marchés financiers have stated that, in related party transactions, directors should disclose their reasonable belief as to the desirability or fairness of the proposed transaction and make useful recommendations regarding the transaction. The Magna Special Committee and the Board have not done this. Yet they expect the Class A shareholders to make a decision as to whether this transaction is in their best interests.
Shouldn't the proposal have included a fairness opinion?
Whether or not technically required, a fairness opinion detailing the basis for this transaction would have helped shareholders make an informed voting decision, particularly given that:
- Mr. Stronach and the Stronach Trust are related parties to Magna;
- the proposed level of compensation to collapse a company's share structure is unprecedented; and
- the Special Committee did not make any recommendation with respect to the Proposal, including as to the fairness of the Arrangement to Magna, its Shareholders or other stakeholders or as to how Shareholders should vote their Class A Subordinate Voting Shares (page12, information circular).
Magna will be asking the Ontario Superior Court of Justice to determine that the Arrangement is fair and reasonable, something the Special Committee considered a "key procedural safeguard". Without a fairness opinion or a determination from the Special Committee, how the Court can make that determination? Yet the fact that a Court will make that determination is one of the considerations that shareholders are advised to take into account in determining how to vote.
The fact that CIBC, the independent financial advisor to the Special Committee, had in the terms of its engagement that it would not provide a fairness opinion is, in our view, highly unusual and very telling. This is especially so given its advice to the Special Committee that the US$863 million purchase price for the Class B shares would result in significantly more dilution to the Class A shareholders than under other historical transactions.
Shareholders should also have received a fairness opinion on the value of the assets to be contributed by Magna to the proposed E-Car joint venture (discussed below). No fairness opinion was sought or obtained by the Special Committee according to the information circular. The circular does refer to the valuation work conducted by PwC for the Special Committee, which we believe should have been reproduced to allow shareholders to review and understand the basis for the value of Magna's asset contribution to the joint venture.
Of particular concern is the fact that fairness opinions often rely, in part, on precedent transactions. Given our view that this transaction is unprecedented, highly excessive, and unfair to Class A shareholders we are concerned that, if approved, it will serve as a future precedent supporting fairness opinions for other companies wishing to eliminate multiple-voting shares with a significant payment to the controlling shareholder.
What are the details of the E-Car joint venture?
The information disclosed about the E-Car (Electric Car) joint venture also raises concerns. The information circular noted that the Stronach group would invest $80 million and have effective control of the joint venture with a 27% interest. Magna would invest $220 million for a 73% interest. In addition to the obvious question as to why a minority shareholder should have effective control, other questions include:
What is the value of the other Magna assets being contributed to the joint venture (i.e., R&D effort, non-cash assets)?
The assets to be transferred are listed in the transaction filings but the basis for their fair value has not been provided to shareholders. The circular refers to a formal valuation performed by PwC, an independent financial adviser for the Special Committee. Including the valuation work in the information circular would have provided greater transparency on this issue. The information circular also refers to the five-year business plan relating to the E-Car business, which has never been disclosed to shareholders. As a result, shareholder have no basis for understanding what these assets could be worth.
We note that an article published in The Globe and Mail ("Magna bets on Battery-Powered Future") reported that the company is looking to invest between US$400 – US$600 million to build two battery manufacturing plants to take advantage of the boom in hybrid and electric vehicle development. Does it plan to contribute this investment to the E-Car Joint Venture with the Stronach Trust? If so, will the Stronachs be investing their 27% pro rata share alongside Magna? Or will Magna hold this outside the joint venture? Magna has not answered these and other questions conclusively.
How will shareholders participate in the value generated by the private joint venture?
Magna stipulates that if the joint venture is converted into a corporation, it would be controlled by Mr. Stronach because his units would convert into multiple-voting shares. So while Magna argues that eliminating Magna's multiple-voting shares would unlock shareholder value, it is also stipulating that the E-Car business, as a corporation, would have a dual-class share structure. This is important if recent reports are correct that an IPO for the joint venture is now being considered ("Magna May Seek Partner Or IPO Of Planned Electric Cars Unit JV", Dow Jones International News). Which governance structure does Magna really believe is in shareholders' interests and how do these facts provide any assurance that Class A shareholders will participate in the value generated by the joint venture? Is it foreseeable that an excessive payment will be required in the future, at the expense of subordinate voting shareholders, to collapse the dual-class share structure of the E-Car joint venture?
What will the compensation and consulting arrangements with Mr. Stronach be for the joint venture?
Will there be consulting agreements like the ones Magna is proposing to eliminate in 2014? Will there be similar agreements at the joint venture level for certain members of Mr. Stronach's family? The company's information states that the management committee of the joint venture may choose profit-sharing as a means of compensating employees and managers (including for Mr. Stronach) as contemplated by the Partnership Constitution which is essentially the same as Magnas' on such matters.
What other business interests unrelated to the E-Car venture will the Partnership engage in?
The company's information states that under the Partnership Constitution, the joint venture will not be prohibited from investing up to 20% of the partners' equity in investments unrelated to the joint venture's business. Will this involve horse racing tracks? Real estate investments? What is the justification for this? How will it be in the interests of Class A shareholders to allow this to happen?
Is this joint venture the best way to enter the electric car market?
Magna describes itself as having a unique entrepreneurial corporate culture. Since the price to shareholders of this joint venture proposal is so high, we ask ourselves are there no other managers at Magna capable of providing a "focused and strong hand" to guide the E-Car business through its formative stages?
Why would the consulting agreements continue through 2014?
Mr. Stronach currently receives 3% of Magna's pre-tax profits in consulting fees, an amount that would be reduced in stages to 2% by 2014 and eliminated at the end of that year, according to the proposal.
Historically, this contract has paid Mr. Stronach compensation upwards of $30 million annually, although he was paid nothing in 2009 when there were no company profits. Co-CEOs Don Walker and Siegfried Wolf noted that the proposed transaction "has the potential to unlock significant shareholder value for Magna shareholders." However, continuing to compensate family members and executives from the company's pre-tax profit significantly reduces returns for shareholders and raises questions about the company's ability to maximize shareholder value in its dealings with related parties.
As the consulting agreements would otherwise expire at the end of 2010, we looked to the information circular to explain the rationale for the continuation of the consulting agreements through 2014.That rationale seemed to be only that the Amended Consulting Agreements provide "certainty" regarding the future consulting arrangements with Mr. Stronach and a "transitional period" during which Magna will continue to benefit from Mr. Stronach's advice.
We note that the amendments to the consulting agreements provide certainty to Mr. Stronach in so far as, upon a change of control, he will be paid either an accelerated lump-sum amount (based on a discount rate which is not specified in the circular), or the continuation of fees until 2014, in either case based on the company's "estimated profits" for each year through 2014. We ask ourselves why these amendments were considered necessary, especially given the size of the proposed consideration to be paid to the Stronach family to repurchase the Class B shares.
How well have shareholders' interests been served by this proposal?
Beyond the terms of the proposal and the questions they raise, the larger issue is whether this transaction is in the best interests of Magna shareholders.
The company noted in its press release that the elimination of the dual-class share structure aims to reduce the stock's trading discount to the level of its industry peers by creating a fairer structure for shareholders. While the share price has lifted in the short term, the future impact and long-term implications of this transaction remain unclear, partly due to the many unanswered questions this proposal raises. Mr Stronach is quoted as saying that the proposed changes could actually give him more influence at Magna than he has right now. If this is true, we question what is really changing at Magna as a result of this proposal.
For these many reasons, and after reviewing the information circular, we believe the transaction is excessive, unprecedented and unfair to shareholders. While Teachers' is supportive of eliminating dual-class share structures, we intend to vote against the proposed transaction. We encourage the company to develop a proposal that is fair to all shareholders.
Director, Communications and Media Relations
Ontario Teachers' Pension Plan