Wednesday, January 4, 2012

There He Goes Again: Stronach's $10 a Share Scheme

Frank (center) and friends

As readers of this blog know, I have no love for Frank Stronach, or for what he's done to racing. I've discussed some of his more egregious conduct here, here, here and here, just for starters.

Stronach is already the highest-paid executive in his adopted country of Canada, where he emigrated from his native Osterreich. Now Frank has come up with yet another approach to separating racing fans and would-be thoroughbred owners from their money. On December 28, 2011, companies controlled by Stronach filed six registration statements with the US Securities and Exchange Commission; each registration was for a separate corporation, each named for successful Stronach horses: Awesome Again, Red Bullet, Ghostzapper, Macho Uno, Perfect Sting and Ginger Punch. Each of the corporations proposes to sell $4,050,000 worth of $10 shares to the public. The balance of each corporation's total capitalization of $4,500,000 will be held by another Stronach entity called Golden Pegasus, giving Frank effective control of each company.

Each of the corporations will own 20 brand-new two-year-olds, which were purchased at auction last year by yet another Stronach company. The new corporations will have racing rights to the horses only for their two-year-old seasons and for their three-year-old year up until November, 2013, when the horses will be sold and the proceeds, if any, distributed to the shareholders. That's a very strange provision, since it puts enormous pressure on the trainers to produce early results, possibly at the expense of a horse's longer-term career. Also, a significant portion of good horses' earning come in their fourth and subsequent years, so shareholders won't get the full benefit of those earnings.

[All six registration statements are substantially the same, except for the identity of the horses. The one that I've reviewed thoroughly, and that I discuss in detail in this post, is for the Awesome Again Racing Corp. and is on file here.]

Frank's last ride in the market

Announcement of the Stronach offerings has drawn a bit of press interest, and was welcomed by industry chronicler Ray Paulick on his web site, which also quotes West Point Thoroughbreds chief Terry Finley as saying that Stronach's plan is good for racing. There's been a vigorous debate in the comments section of the Paulick piece.

I've read all the comments, and I've applied my law-trained eye to the SEC registration statement. Alas, there's only one conclusion I can draw: this is just one more Stronach scheme to separate those in the racing industry from their money and add that money to Frank's own obscene hoard.

Before turning to the specifics revealed by the SEC filings, a bit of disclosure. I'm racing manager of Castle Village Farm, a modest thoroughbred partnership operation based in New York. We communicate regularly with our partners by email, we host them at the barn and the training track every week, they're all welcome in the paddock and the winners circle on race days, we provide detailed monthly financial reports on our modest expenses, and we don't mark the horses up much when we buy them for resale to the partners. In other words, we, and some other small partnership operations, offer a real racetrack experience, at an affordable price, for someone who might want to get in the game with only $1,000 or so. But if heavy advertising and misguided press enthusiasm steer prospective owners to bottomless pits like Stronach's corporations, that'll deprive those of us who do offer real ownership experience the chance to introduce new partners to the game in a way that will encourage them to stay involved. Enough said.

Now for the details of the Stronach offering.

Each of the six new corporations is offering $4,050,000 at $10 a share, with a total target investment for each of $4,050,000. The offering is initially open for only 90 days from December 28, 2011, but each corporation has the option of extending the offering for another 90 days, into late June, 2012. If the target investment isn't subscribed by then, so the SEC filing states, all money will be returned to the prospective investors.

Each corporation owns 20 new two-year-olds, purchased last year at an average of $60,000 or so each. If the full amount of $4,500,000 is subscribed (including Stronach's own 10%), the $1.2 million or so in purchase prices will be paid back to a Stronach corporation.

The horses are currently in training at Stronach's Adena Springs complex in Florida. As of December 23, 2011, each new corporation is paying a Stronach entity some $150 a day for training and routine vet costs (there's a $100,000 reserve for "emergency" vet bills). That sounds way too high for training-center costs; $60-75 a day would be much more reasonable, even including routine vet work and farriers. Even when the horses move to trainers' barns at various racetracks, that sounds high, at least compared to what I know to be the actual trainer and vet charges in New York, which must be the most expensive locale in the US to train at. That $150 a day will be charged every day except when horses are on injury layups; then the charge drops to $60 a day, somewhat closer to reality. Although the SEC registration statement says that Golden Pegasus, the Stronach entity that collects the $150 a day, will return any profit above 10% to the shareholders, Golden Pegasus itself will be paying training bills to Adena Springs, another Stronach entity. That's called transfer pricing, hiding the profit in deals between various corporate subsidiaries. Shareholders shouldn't expect to see much in the way of a profit rebate from Golden Pegasus.

Initial expenses of the stock offering are estimated at about $200,000; naturally, one has to engage a big national law firm to do stuff like this. In Frank's case, that firm is Akerman Senterfitt, a politically-connected Florida-based operation. So, six times $200,000 equals well over a million. Not a bad few days' work for the lawyers and accountants.

Overall, the SEC filings estimate that $1.2 million of the $4.05 million initial capital in each corporation will be used to pay for the horses, $1.8 million will go for the (inflated) training and vet costs, and $1.1 million for "administrative and legal" expenses. Good deal, apparently for the lawyers, since administrative expenses are minimal. The corporations' only employees are longtime Stronach horseman Jack Brothers, CEO of each of the six corporations, and CFO Lyle Strachan. Brothers is supposed to get $25,000 a year from each corporation, for a total of $150,000, and Strachan $16,667, for a total of $100,000. Mysteriously, the registration statements report that the corporations have begun charging $1,150 a day -- an annual total of $420,000 for each corporation. Care to explain the discrepancy, Frank?

Brothers, Strachan and others in the deal are already on a Stronach payroll, somewhere in the labyrinth of interlocking companies that Stronach controls. In addition, the horses assigned to the corporations were initially chosen by a "selection team" that included Adena Springs' house vet, Dr. Peter Kazakevicius, as well as two principals in the Kentucky-based Hidden Brook Farm. Interestingly, Jack Brothers and others associated with the new Stronach venture are also listed on Hidden Brook's web site. Conflict of interest anyone? And each corporation's Board of Directors is composed -- surprise! --almost entirely of veteran Stronach employees and cronies

The offering statements also say that the horses will race primarily at Stronach-owned tracks -- Santa Anita, Gulfstream and Maryland -- assuming that Stronach hasn't destroyed Maryland racing before the horses reach the starting gate. Is that the best way to maximize shareholder value, when the most prestigious, value-enhancing races are in New York and Kentucky?

As it must, the SEC registration statement cites a long list of risk factors. It starts off the list with the following instructive statement, which is actually a pretty good model for any racing partnership to adopt:

"Investing in thoroughbred racehorses is a speculative activity, and the most frequent financial outcome from ownership of a thoroughbred racehorse or an equity interest in a thoughbred racehorse is the partial or total loss of invested capital."

That's certainly true. On average, a racehorse in the US earns about half as much as its annual training, vet and other maintenance costs. And well over 90% of all racehorses lose money for their owners, even before taking into account the amount the owner paid to acquire the horse. The last time I looked, some two years ago, a horse racing in New York had to earn about $50,000 to break even. And that's without the high fees, administrative charges and other burdens that Stronach proposes to impose on his investors. Just the administrative costs alone would raise that number to something like $75,000 -- before taking into account the amounts paid initially for the horses. And since the investor gets only the horse's (usually abbreviated) two-year-old season and perhaps 80% of its three-year-old year, I'd be astonished if more than two or three at most of the 20 horses in each corporation end up paying their way.

Nothing in the offering document offers investors much of a racetrack experience, either. And Stronach has a track record here. Comments from embittered veterans of his previous partnership vehicle, Adena Springs Joint Ventures, complained in their comments on the Paulick Report that they had virtually no hands-on involvement with their horses. That stands in sharp contrast to the situation with most successful racing partnerships, that offer their partners much more of an up close and personal experience, including barn visits, hospitality at the track, regular updates on their horses, etc. So let's see: a near-guaranteed loss of money, plus no direct involvement with your horse: sure sounds like a winning formula to me. But presumably the shareholders can get win photos, if they pay for them.

Supporters of the Stronach proposal have compared it to racing clubs in Japan, which are structured along similar, if not quite so rapacious, lines, or to the fan ownership of shares in the effectively not-for-profit Green Bay Packers. But there are key differences. Japanese purses are far higher than in the US, costs are lower, and a greater percentage of horses actually pay for themselves. And the Packers are the kind of community institution that inspires fan loyalty; can anyone say that about Frank Stronach and a group of 20 anonymous horses?

Speaking of those horses, I had a quick look through the list of yearlings attached to the Awesome Again Racing Corp. offering statement. Looks like the list is heavy with precociousness and speed orientation, which at least is consistent with the emphasis on racing at two and three. And not too many of Stronach's own sires are represented. Of the 20 horses, whose purchase price averaged just over $60,000, three were bought for more than $100,000 each, and a majority cost less than $50,000. That's not generally regarded as the most likely point in the market to find a big horse.

Lots more detail available in the SEC files, but that's enough to scare me off. And I'm even one of the few who made a profit vis-a-vis Stronach; I got in and out of his now-worthless Magna Entertainment Corp. stock a few years ago with a profit of all of $100. Thanks for small favors, Frank, but, as George Bush once lamentably tried to say, fool me once, shame on you; fool me twice, shame on me.

Does the Queen want to buy a few shares?