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Rise of the base metal magicians

Scott McCulloch is Editor of Families in Business magazine.

It's been 10 years since the late Leonard Schnitzer took Schnitzer Steel Industries public and while his family may by weary of increasing media scrutiny it seems a small price to pay for the scrap metal concern's stunning financial success

Some might say the Schnitzer family are the descendents of alchemists. After all, who else could extract US$496 million a year from scrap metal? The way the Schnitzers have wangled it, your old car could end up in a Chinese office building. Not bad for a company whose origins lie in the dreams of a Russian immigrant.

Today Schnitzer Steel Industries and its joint ventures operate 26 metal collection and processing facilities, and control strategic deep-water terminals for shipping its oxidised booty. The company is also a manufacturer of finished steel products and controls a US chain of self-service car components stores operating under the name Pick-N-Pull.

As a former first world war conscript into the Russian army it's a far cry from what Sam Schnitzer envisioned when he founded Alaska Junk back in 1908. Yet the enterprise blossomed and Sam hit the acquisition trail snapping up sawmills, logging camps and shipyards. His son Morris formed Schnitzer Steel Products on his own in 1936. After the second world war the patriarch turned Alaska Junk over to Morris and his brothers Gilbert, Manuel, Harold and Leonard.

Although a fraternal desire to modify the company took hold (the brothers changed the company's name to Alaska Steel) the Schnitzer appetite for acquisition was unwavering and in 1956 they picked up Woodbury, a local steel distributor. By 1963 the Schnitzers had formed Lasco shipping. Morris's Schnitzer Steel Products returned to family control and in 1978 Alaska Steel and Woodbury quietly morphed into Metra Steel.

Sam Schnitzer's five sons diversified the business into the steel, real estate and shipping empire it is today. But all the while, one son, long-time chairman and CEO Leonard Schnitzer, insisted company officials stick to their core business. Under his guidance, the company snapped up companies that both supplied and used scrap, including Cascade Rolling Steel Mills.

Leonard, who took the company public in 1993, died last June. Even after he retired as CEO in 2002, Schnitzer Steel Industries executives still sought him out for advice in company decisions. "[Our vision] doesn't differ at all," says Robert Philip, Leonard's son-in-law and CEO. "The reason that the company went public in 1993 was for us to allow the business to grow using equity as opposed to debt. So we really didn't change our focus at all. In fact as we matured as a public company, we've grown our business through acquisition in the scrap business – on the west coast and the east coast – and most recently we announced the acquisition of the 50% ownership of the auto parts business (Pick-N-Pull) that we didn't own."

Why is scrap so sexy? In a word: China. Local infrastructure campaigns have mushroomed as a result of the country's inclusion in the World Trade Organisation and its need to prepare for the Olympics. China is willing to pay to supply its hungry mills with raw building materials. The Three Gorges Dam, new roads and underground railways, as well as projects in inland cities are fuelling demand. Growth has also emerged from technological change – mainly the shift to electrical arc furnaces, which use scrap.

Philip, meanwhile, is adamant that the company will follow the pattern established by his father-in-law Leonard and his brothers. The firm is investing in new equipment. A new mega shredder – a monster contraption that hammers old cars into grimy metal chunks – has been commissioned for the company's California facility in Oakland. Three other mega shredders are under construction for joint ventures in New Jersey, Boston and Los Angeles. "Those are significant investments," he says.

What of returns? If last year's results are indicative of earnings to come then the case for Schnitzer Steel as scrap metal merchants turned alchemists will almost certainly galvanise. The firm's profits and share price have soared over the past year. The company reported net income of $16.87 million on revenue of $153.6 million for fourth quarter ended 30 August compared with income of $2.2 million on sales of $100.09 million in the corresponding 2002 period.

It wasn't always so. In 1993, after two years of financial losses, the usually private Schnitzers took their steel operation public in a floatation that raised $48.5 million and enabled the family to pay down a large chunk of company debt.

The transition, says Philip, tested the family's mettle. "It was definitely an emotional change for the company to become public after it had been private for almost 100 years," he says. "I think the family felt that as the enterprise evolved, becoming a public company was the best way at the time to allow the type of growth that would allow the next generation to successfully maintain the enterprise."

The move ushered in a fresh era of expansion, one that would see a scrap metal empire emerge on both coasts and deliver handsome results. Since 1993 Schnitzer Steel has posted a profit each year, nimbly navigating the Asian economic crisis, recession and an onslaught of international competition. The company has also cultivated a loyal workforce, employing 1,475 across the US, including nearly 200 in its hometown of Portland and 435 at its operations in nearby McMinnville where it can churn out 700,000 tons of hot rolled steel.

It's a good time for the scrap metal industry. So good in fact that over a 2-week period in July large shareholders and board members dumped 300,000 shares. That in itself is not remarkable. The value is – some $12.5 million, according to US Security and Exchange Commission filings. And why not? In the four quarters to August 2003 Schnitzer's income statements never looked so robust. The firm's share price more than doubled over 2003 and by early December trade volumes were routinely cracking the one million mark. On 1 December alone a record 3.7 million shares changed hands.

Media speculation has been rife with reports suggesting the sell-off of shares by insiders – heirs, board members and executives – was triggered by estate tax issues stemming from last year's deaths of Leonard Schnitzer and his brother Manuel. One reason why the family business went public was the offer of a liquidity option for members of the next generation, according to Philip. With business booming and Schnitzer Steel's share price keenly in tune with the company's robust balance sheet, 2003 was as good as time as ever. "I think the sell-off was more driven by the family wanting to have some liquidity as opposed to them having estate tax issues, " reasons Philip, who himself pocketed $419,365 after unloading 10,000 shares in November.

"The stock's good and people are selling," Carol Lewis, a Schnitzer board member and granddaughter of Sam Schnitzer, told The Oregonian in July. Good? It's gold dust. Company revenue soared by 34% to $496.8 million in fiscal 2003. Many analysts are expecting a repeat performance in 2004 with some predicting revenue to approach $664 million. For its part, Schnitzer Steel is predicting a quarterly operating profit modestly above last year's first-quarter level of $5.2 million.

The recent growth comes after a long, rocky road for the US scrap industry. Demand in Asia all but collapsed following the 1996-97 financial crisis. That, and a flood of scrap steel seeping out of the former Soviet republics between 1999 and 2001, led to heavy casualties in the industry.

Schnitzer Steel took it on the chin. Despite dented profits in the mid- to late 1990s, the company marched onwards and upwards. But successful public companies eventually draw attention, something the Schnitzers – one of Oregon's best known and most philanthropic families – may have grown weary of.

One powerful investor, Cascade Investment, recently angered Schnitzer officers by likening its imbalance of shareholder voting power to that of cable TV service provider Adelphia Communi­cations, where insider dealings lead to heavy losses for investors. "I think that they have a corporate philosophy that they are trying to portray in the US and unfortunately we were their poster child to pick on," explains Philip. "I think they are very serious about governance and what we take serious offence to is lining our company up with the likes of Adelphi."

Cascade Investment's actions are seen as part of a wider strategy to make corporate boards more accountable, a trend in the aftermath of scandals at Enron and WorldCom. The bee in Cascade Investment's bonnet is over the composition and potency of Schnitzer Steel's board – a factor it believes fundamental to the company's success.

The firm believes Schnitzer family members have too much control over the company. Most of Schnitzer Steel's directors are family members, and while the family owns around one-third of the company's stock, members control more than four-fifth of the votes – a result of a dual-class stock structure set-up when the company went public. Cascade Investment also notes that seven of Schnitzer Steel's 10 board members are either direct heirs to the Schnitzer fortune or have married into the family.

But the fact the company is public, Philip points out, has not altered the way it's run. "Our family business has been governed the same way since 1908 and that is with the tenets of fairness, honesty and valuing the human aspect of our employees." The third generation is managing Schnitzer Steel but few family members are actually involved in operations, he hastens to add. "I think Cascade Investment overlooked the fact that there are only two family members on the board that are actually actively involved in the business. That is why we take offence to Cascade's allegations that the family members are only looking after themselves, which is not accurate."

The Nasdaq stock market's new corporate governance rules, approved last November by the SEC, require member companies to have a majority of independent directors on their boards. However, the rules exempt 'controlled companies' such as Schnitzer Steel, where votes are controlled by one person or group, as long as those companies disclose their voting imbalances.

These days board composition is hotly debated and experts familiar with corporate governance tend to view insider-dominated boards in one of two ways – cast under an optimistic light or in the glare of a cynical beam.

For Larry Dann, a University of Oregon professor who has researched corporate governance, the glass is decidedly half-empty because when a family controls so many votes there's scope for self-dealing. Perhaps. Ralph Shaw, who runs a Portland venture capital firm and is one of Schnitzer Steel's independent board members, says the company's board members ask as difficult questions as any other member. This is because they are heavily geared towards the company's success. Philip agrees. "I think that there's no question that companies that have board members aligned with shareholders are going to do better than board members that don't have the same interests as shareholders," he says. "Certainly our board is completely committed to do what's necessary to improve the value for shareholders and we've proven this."

In the interim, Schnitzer Steel will carry on doing what it does best: turning junk into useful material at a profit. The eastern European market holds promise because of favourable trade conditions. Meanwhile, demand from Turkey, one of the largest makers of reinforcing bar, is strong and China's appetite for scrap is voracious. Philip is optimistic. "I have just come back from China and I have never been so bullish about our industry as I am today. There's a very exciting period ahead for Schnitzer Steel shareholders."

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