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Passion saps profit

The Baltimore Sun

The Horse Wizard was a hybrid of a slot machine and a live race telecast, in which images of horses instead of cherries spun on the screen. Win, and listen to the sound effects of coins dropping.

It was Frank Stronach's pet project. To the founder of Magna Entertainment Corp., the Horse Wizard took the thinking out of betting, while offering the excitement and instant gratification of casino gambling to a new generation of patrons.

But if Stronach expected others around him to embrace his enthusiasm, he didn't hear it. "I remember sitting there, and he had some test ones, and I tried them and said, 'This is really bad, Frank,'" recalled Gino Roncelli, a former Magna director."'

Oh no, they're going to get used to this. This is going to be great,'" Roncelli remembered Stronach saying. "I said, 'Frank, this is a terrible loser.'"

Undeterred, Stronach authorized spending $15 million to $20 million to build and install Horse Wizards at Magna's major thoroughbred tracks. At Laurel Park, officials built a new room with flat-screen TVs, faux-velvet ropes and nightclub lighting to hold 36 of the slot-machine lookalikes.

But the device had little of the appeal of either slots or live wagering. The result: Virtually no one played. Less than a year after the VIP debut party in January 2005, Laurel shut the Horse Wizard lounge. The machines still sit in the roped-off room.

The Horse Wizard was, in microcosm, the story of Magna Entertainment under Stronach. Fueled by the auto-parts magnate's passion for horse racing, Magna's eight-year run as a public company has been marked by autocracy and misplaced risks that have disappointed even some of Stronach's allies in the fight to save horse racing, according to more than a dozen interviews with people in the industry and a review of thousands of pages of federal and state financial filings.

And his management acumen could have an even greater impact on the future of Maryland's racing industry, if voters pass a slots referendum in November.

Magna has lost more than $400 million since 2002 and survives on infusions from Stronach personally and his other businesses, filings with the Securities and Exchange Commission show.

It has had five CEOs in eight years - not including Stronach's three stints as interim CEO - and equally rapid turnover in track management. Most of Magna's tracks lose money - one exception being Baltimore's Pimlico Race Course, though its profit is entirely from the Preakness Stakes, the middle leg of racing's Triple Crown.

The company has yet to see payoff from hundreds of millions of dollars invested to develop casino complexes around its racetracks. On Dec. 28, Magna shares closed under $1 for the first time.

The November referendum could determine whether Magna can install slot machines at Laurel Park. Magna and Maryland horsemen contend that revenue from slots is, as Magna director Joseph A. De Francis put it, "absolutely essential to the viability and survival of the horse industry in Maryland."

But Magna has been unable to make money even with slots at its two U.S. racetracks that have them, financial filings show. Some Maryland political leaders have questioned whether Stronach's company is fit to hold a slots license if the referendum passes.

Nationally, the horse racing industry has seen a steady decline in live attendance, handle and race purses, and it is facing stiff competition from newer gambling attractions such as Indian casinos. Still, Magna's closest competitor, Churchill Downs Inc. of Louisville, Ky., made a profit of $29.8 million on revenues of $376.7 million in 2006, and all but one of its major tracks showed operating profits.

Stronach did not respond to repeated interview requests by phone, e-mail and letter. De Francis, who sold his family's remaining stake in Laurel and Pimlico to Magna in September and stepped down as a Magna executive, said the company has learned from its mistakes and would operate a profitable gambling business in Maryland.

John Franzone, chairman of the Maryland Racing Commission, says many of Magna's problems stem from poor management - a problem that he says goes to the top. "After so many managers [who have come and gone], you have to look in the mirror and say, 'Why did this keep happening?' " he says.

Entrepreneur

In 1957, three years after emigrating from Austria with only a few hundred dollars, Frank Stronach started a tool-and-die shop that, over the ensuing decades, grew into one of Canada's great entrepreneurial successes. His Aurora, Ontario-based Magna International is now a $24 billion global auto-parts empire.

As he built one of Canada's largest fortunes, Stronach also became one of the top breeders and owners in thoroughbred racing. He has won almost every major award in the business and has amassed countless wins in big races, including four Breeders' Cup races and the 2000 Preakness with Red Bullet.

But he wanted to own more than horses.

"It was his hobby. He has millions and millions of dollars' worth of horses. It's like having an NFL team with no league to play in," said Wayne Lilley, a Canadian journalist who wrote a biography of Stronach.

As Stronach told California racing officials last year, he brought one of his fillies to the Santa Anita Park near Los Angeles in the mid-1980s, won a few races and fell in love with the place. So when the track went up for sale in 1998, he bought it.

A year later, he picked up a string of other racing properties: Gulfstream Park, near Fort Lauderdale, Fla.; Remington Park in Oklahoma; Thistledown in Ohio; Golden Gate Fields in Northern California.

Magna International, which Stronach controls through a super-voting class of stock, paid for the shopping spree - angering public shareholders who wanted new investment to go into the auto-parts business. Under increasing pressure, Stronach spun off Magna Entertainment as a separate company in 2000.

Stronach wanted to transform Magna's major racetracks into Las Vegas-style entertainment centers with shops, restaurants and other attractions. He shelled out millions to refurbish tracks, lobby for slots and create new wagering technology such as the Horse Wizard - the latter by buying into AmTote International Inc., the Hunt Valley-based company that pioneered electronic bet processing systems.

Both Magna and its primary competition, Churchill Downs, the company built around the track that hosts the Kentucky Derby, saw their futures in track consolidation and creating simulcast networks that would create year-round wagering by transmitting live race signals to tracks and other sites.

In 2002, when the Maryland Jockey Club looked to sell Laurel Park and Pimlico, Magna outbid Churchill Downs for a controlling stake. By the next year, Magna owned 14 tracks, almost double Churchill Downs' holdings.

But as timing would have it, revenue from simulcasting peaked around the same time. Live attendance continued to fall. Competition from other forms of gambling grew.

"Everyplace they turned, they bought at the top of the market," said Timothy Capps, a former Maryland Jockey Club official who is now executive-in-residence at the University of Louisville's Equine Industry Program. "Within two to three years, the tracks weren't worth as much as [when] they bought them."

Still, Stronach continued to come up with big plans.

Austria and California

One of the costliest involved a $105 million venue 22 miles outside Vienna in Stronach's native Austria. It featured live thoroughbred and harness racing, restaurants, live concerts and shows, and slot machines.

The facility opened in April 2004, luring top-tier entertainers including Jon Bon Jovi. But few Austrian and European racing fans ventured into the countryside to find it. In its first full year of business, the racing-casino operation - or racino - reported a loss of $15 million before taxes, interest and depreciation, SEC documents show. And because of continuing losses, the company took a nearly $60 million write-down of its assets in the fourth quarter of 2006. Magna ended racing there in November.

"Frank Stronach is from Austria, and it's hard to close down something your ego is tied up with," Roncelli said.

In 2001, Magna spent $6.6 million to buy a 260-acre site in Dixon, Calif., near Sacramento, and spent millions more on environmental studies and other regulatory work toward a plan to develop a horse racing, retail and entertainment complex. But after Dixon's City Council approved it, a citizens group launched an effort to stop it, collecting enough signatures to force a special election.

Magna contributed $545,664 to a pro-racetrack group for lobbying efforts leading up to the vote, according to campaign finance statements filed with the state. But even some local racing stakeholders opposed the project, with the state fair racing association noting increasing competition, said Drew J. Couto, president of the Thoroughbred Owners of California and a former Stronach employee.

Last April, voters effectively killed the project. The property is now for sale.

Magna also abandoned plans to develop a racetrack entertainment venue near Detroit, partly because of the state's ban on slots. In an odd twist, the lead director on Magna's board, Jerry Campbell, then decided to pursue the project himself at a nearby site. Campbell, who remains on the board, did not return calls seeking comment.

"Acquisition is the fun part," said Frank Trigeiro, who served as chief financial officer of the Maryland Jockey Club in the 1980s and 1990s. "You fly around and buy the racetracks ... then comes the reality of running the places. They were terrible managers. Absolutely horrible."

And then there was Stronach's costliest gamble: a nearly $180 million effort to redevelop Gulfstream Park.

Plans called for razing and rebuilding the track's grandstand and clubhouse and installing 1,200 slot machines, plus development of adjacent retail space and condominiums.

'Misguided ideas'

As was often the case with major proposals, Stronach pushed through the plans with little analysis or discussion, according to Roncelli, the former director.

"I think Gulfstream was already being torn down before the board said, 'Let's do it,' believe it or not," Roncelli recalled. "What are you going to do at that point? There's a wrecking ball tearing the building down. Are you going to say no at that point? There wasn't much discussion on that issue. I had plenty of conversations about what I thought about it."

Roncelli still laments the product, which opened in January 2006 with a grandstand that had just 900 seats, compared with 14,500 previously. "The new Gulfstream is a monument to misguided ideas about what a racetrack should be," wrote Andrew Beyer, longtime racing columnist for the Washington Post.

Magna financed the redevelopment with more than $160 million in loans from its parent, MI Developments - one of several moves that sparked a lawsuit from one of MID's largest shareholders, Greenlight Capital Inc. The New York investment firm alleged in court papers that MID was acting as Magna Entertainment's "banker of last resort" because the racing company was so mismanaged it couldn't borrow money elsewhere.

Ontario's Superior Court of Justice rejected the case in 2006; Greenlight is appealing.

Gulfstream has kept losing money since the renovation, largely because it has taken in by far the least slots revenue among the three South Florida facilities allowed to operate the gambling machines. In the three months that ended in September, the Hallandale Beach track generated $74 per machine a day, while Mardi Gras Racetrack & Gaming Center and Isle Casino & Racing took in $167 and $214, respectively.

Company officials have conceded that Magna failed to mount a major marketing campaign until at least six months after the casino opened. Nearby construction of retail shops blocked part of Gulfstream's parking lot and led some people to think the facility was closed, said David Roberts, director of Florida's Division of Pari-Mutuel Wagering.

Also, according to documents filed with the division, the slots operation gave away $1.3 million in revenue during the three months that ended in September in the form of "promotional credits" distributed to gamblers. That amount far exceeded the credits given out by Gulfstream's two nearby slots competitors.

Why that level of free gambling was distributed is not clear.

The Florida Department of Law Enforcement is investigating Gulfstream's racino operation, spokeswoman Paige Patterson-Hughes confirmed. The South Florida Sun-Sentinel has reported that the investigation centers on possible theft by employees in the slot machine area.

Gulfstream has shown signs of improvement since Magna hired a new vice president of gambling operations, Steve Calabro. The facility has slashed the number of machines to 516 from its peak of about 1,200, added video poker machines, changed the mix of slot offerings and increased marketing.

In November, which starts Florida's peak tourist season, Gulfstream took in $153 per machine a day on 592 machines. That rose to $183 per machine in December. Promotional credits have fallen sharply.

"Improving [Gulfstream's] performance I would say is one of the top, if not the top priority, of the company," De Francis said.

Last week, Stronach appointed a chief operating officer - Ron Charles, a Magna director and head of its California track operations.

While acknowledging Gulfstream's lack of casino management experience, Sen. Steven A. Geller, a Florida legislator representing Hallandale Beach and a gambling law expert, said the state's high tax rate on slots - 50 percent - is the main culprit for its lackluster performance. (Maryland would tax slots revenue at 67 percent if the referendum passes.)

"There's nothing wrong with Gulfstream that a normal tax rate would not cure," he said.

But Magna has also struggled with slots at Remington Park in Oklahoma, which opened its casino operation in November 2005. Remington lost $400,100 in 2006 on revenues of $78 million - nearly 71 percent of which came from gambling, according to filings with Oklahoma racing regulators. Remington's slots generated on average $236 per machine a day in 2006, but Calabro said the racetrack's poor performance dragged down a profitable casino operation.

Roncelli, Magna's former independent director, describes Stronach as well-intentioned but misguided at times when it comes to managing his passion.

The owner of a California plastics machining company and longtime horse owner, Roncelli said he's not disgruntled but speaking out with "some hope that he does turn this thing around."

High turnover

"We started with a great board with some high-end people," said Roncelli, who joined the board in 2000 and left six years later. "One by one, they saw it wasn't going the way it should be and decisions were made without them. One by one, they left."

Top executives left with equal regularity. The most recently departed CEO, Michael Neuman, lasted four months.

Neuman resigned in June, shortly after the California Horse Racing Board received Neuman's letter saying that the company had no plans to rebuild Santa Anita's barn area. The disrepair of the barns had long been a hot button issue, and infuriated board members asked that Neuman appear at their next meeting.

Stronach showed up instead. He told members that he was "very upset" that Neuman had written the letter, according to a transcript of the June 19 meeting, and said that Neuman was "very much reprimanded." Neuman's resignation was announced three days later. He could not be reached for comment.

The November firing of Lou Raffetto, president and chief operating officer of the Maryland Jockey Club, drew anger from all sides. The change came two months after Magna bought the De Francis family's remaining interest in Pimlico and Laurel.

"I think it's one of the worst decisions the company has made," said De Francis, who had hired Raffetto to run the day-to-day operations of the Jockey Club in 2001. "I was very surprised when the decision came down, and as I said, I disagreed with it strongly."

Franzone, the Maryland Racing Commission chairman, credits Stronach for investing in the sport and in Maryland's racetracks as well as trying new things, such as the Horse Wizard despite its failure.

But he said Raffetto's firing was disturbing because he had developed a positive working relationship with both legislators and horsemen.

Raffetto declined to comment for this article.

"All I've seen from Frank's generals is dysfunction. I haven't met one yet that has impressed me. I've seen millions of them come down here and say they're going to do this and that, and they don't do it. And Frank ends up firing the guy. That's the No. 1 problem that I see in Magna," Franzone said.

Says Roncelli, "I believe Frank's heart is in the right place. Carrying it out, he didn't have the right people who could stand up to him."

Sammy Gordon, president of the Florida Horsemen's Benevolent and Protective Association, said Gulfstream's management has an excellent relationship with horsemen and responded to fans' complaints about the refurbished facility by adding more outdoor seating and bringing back box seats.

"A lot of people criticize Frank Stronach, but look at what he has done," he said. "Nobody has put into this industry what this man has."

De Francis said Magna's business philosophy is still sound: To produce top horse racing content and distribute it globally through multiple formats, including television and the Internet.

"I think the fundamental problem that MEC has run into is that they don't, right now, have in their ranks the necessary depth of executive talent to be able to make that vision a reality. And Frank can't do it all by himself," he said.

Survival in doubt

Magna's auditors have warned that they have "substantial doubt" about the company's survival. It is trying to save itself by raising up to $700 million to eliminate its debt by the end of this year. It is selling unprofitable tracks and excess real estate, including a parcel adjacent to Laurel, and looking for gambling and racing partners.

Some analysts question whether Magna can meet such an ambitious goal, particularly in a slumping real estate market. If it is successful, the empire that Stronach built in the past eight years would be reduced to almost half its size.

Stronach told Barron's in 2000 that his racing company might one day be a bigger success than his auto-parts conglomerate. That vision has yet to become reality. But there are no signs that Stronach is giving up on his passion.

Nor is he short on ideas.

The Horse Wizard room might be closed at Laurel. But another of Stronach's inspirations is available there: a beverage called Frank's Energy Drink. Its Web site and ads feature photos of ample-bosomed young women in lederhosen promoting Stronach's "authentic Austrian energy."

The drink's vitamin-packed formula, according to the promotional materials, "keeps you yodeling all night long."

hanah.cho@baltsun.com

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