Tuesday, December 06, 2005

Magna International (MGA)

This morning, KeyBanc Capital Markets (formerly McDonald Securities) initiated coverage of Magna International with a buy.

I couldn't agree more. This truly is a magnificent business, which I could like a lot better were it structured in a more shareholder friendly conformation. From a governance standpoint, the business is ruled by the supreme master and potentate Frank Stronach.

A benevolent emperor, Stronach has ruled Magna under his "Fair Enterprise" philosophy which provides a percentage of profits to employees, management, and shareholders. Through a family trust, as well as through his right to direct the voting of the Magna Deferred Profit Sharing Plan, Frank, his wife, and son control 55.4% of the total vote carried by the Class A and B shares...essentially, as minority shareholders, we have no say. "Fair Enterprise" is especially fair to Frank and not necessarily magnanimous to the rest of us. In order to make ends meet, Frank in FY 2004 supplemented his modest $200,000 salary with a bonus of $1,500,000 PLUS $38.6 million in consulting fees to the eponymous Stronach & Co as well as Stronach Consulting Corp. Terms and conditions of this consulting gig have never been disclosed to shareholders.

Now don't get me wrong. Strong suppliers will get even stronger in this backdrop of bankruptcies and disruptions for Detroit and its suppliers. Magna is an exceptional company with average content per North American vehicle of over $750 and a very diverse product offering. Magna, in fact, is one of few suppliers that can outsource not only parts but also complete assembly. In short, Detroit (and all other auto manufacturing centers) need Magna. The restructuring of GM and F will depend on continued outsourcing benefits and consequently greater reliance on companies like Magna. It is much easier for assemblers to go this route rather than to eke out concessions from the UAW.

Magna has expanded its North American production base to incorporate production worldwide. Magna has quadrupled its production in China in the last five years with 20 locations in place. The company has 9 locations in Eastern Europe.

The company has generated free cash flow since 2000 and CFFO has exceeded net income from 2000-2004. Year to date, the company has generated a modicum of FCF. Return on invested capital is about 9% for the last full fiscal year, and has shown improvement in the last few years.

I like the strategic position as well as the current valuation of the stock. It is a shame that one of the best positioned companies in auto parts with the safest capital structure is relegated to the lowest valuation by these easily rectified corporate governance issues.

It is what it is.


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