ZINC - Horsehead Holding Corp

[coc]

 

It's just a delusion when you are taking IV estimates on highly uncertain companies -- might as well go the technical analysis route.

 

You have a fighting chance of seeing a reasonably accurate glimpse of IV if you approach only the companies that have a high degree of certainty.  Compare that to Pabrai's approach chasing "high uncertainty" stocks -- it doesn't surprise me that he's got the IV so completely wrong when he's trying to value a highly uncertain situation.

 

I think this is the most accurate way to diagnose the problem. And because I think Mohnish is smart and a nice guy, I wish he would come to understand it better. I'd thought the 2008 losses would have done it, but then he piled into car companies, zinc, CHK...you lose as much as you make on these types of companies. Every home run is matched by a spate of losses. And that's how you get a situation where you invest in 10 situations that you think are offering 20-40% annual returns and your net record ends up at 10-11% per annum...the mistakes hurt.

[Picasso]

 

Sort of interesting comments here from Monish since he gets caught in so many value traps.

 

1) He doesn't believe in value traps

2) Doesn't believe in catalysts

3) Thinks a catalyst means there is no uncertainty

 

 

I'm curious what other people have to say about those premises to value investing.  Seems like a recipe for getting your ass kicked.

[AzCactus]

 

Sort of interesting comments here from Monish since he gets caught in so many value traps.

 

1) He doesn't believe in value traps

2) Doesn't believe in catalysts

3) Thinks a catalyst means there is no uncertainty

 

 

I'm curious what other people have to say about those premises to value investing.  Seems like a recipe for getting your ass kicked.

 

Find it funny how he found a way to answer the question and throw in his returns which I'm sure are no longer quite as high. 

[alwaysinvert]

 

Sort of interesting comments here from Monish since he gets caught in so many value traps.

 

1) He doesn't believe in value traps

2) Doesn't believe in catalysts

3) Thinks a catalyst means there is no uncertainty

 

 

I'm curious what other people have to say about those premises to value investing.  Seems like a recipe for getting your ass kicked.

 

Totally agree with him. Not that catalysts are completely impossible, just that they most often are bullshit rationalizations. Catalysts are for event-driven investments (i.e merger arbitrage etc), not for long-term holdings. If your reason for a long-term position is a catalyst playing out, I immediately think that is highly suspect. I can buy that there are fuzzy reasons why the market sells off a stock and you can pick it up on the cheap due to a longer time horizon or more tolerance for short-term pain. I can't as a rule buy that the stock will double in 12 months due to some future event which only you have predicted correctly. 

[Vish_ram]

The learning for all of us is to understand the range of possible outcomes and gauge their probabilities.

 

For zinc, it may have hundreds of outcomes based on permutations of variables like inflation, access to capital in times of need, commodity environment, macro (particularly china),... If 80% of these outcomes result in principal loss, then it may not be worth it.

 

If you look at many of Buffett's investments, the range of outcomes is much narrower. A high majority of those outcomes result in gains.

 

[walt373]

The learning for all of us is to understand the range of possible outcomes and gauge their probabilities.

 

For zinc, it may have hundreds of outcomes based on permutations of variables like inflation, access to capital in times of need, commodity environment, macro (particularly china),... If 80% of these outcomes result in principal loss, then it may not be worth it.

 

If you look at many of Buffett's investments, the range of outcomes is much narrower. A high majority of those outcomes result in gains.

 

For an investor who doesn't do macro work, is not involved in credit, and shies away from activism, he sure does buy a lot of cyclical, leveraged, poorly run companies. What outcome would you expect when someone brings a knife to a gun fight? I don't think the lesson is to avoid those variables. But you certainly should if you want to ignore them.

[bennycx]

The bashing going on here is just amazing. Just months ago people are discussing how this is a great investment and now everyone thinks management is bad. Are the people commenting now lurkers of the thread secretly thinking previously that Horsehead was a bad investment or are they investors who got just lost significant sums of money? Sometimes we do need people playing devil's advocate to prevent group think into an investment...

[indirect]

"Looks like Pabrai has bought and sold a dozen commodity companies last 10 years.

 

Catastrophic losses

-------------------

Harvest natural, Cryptologic, Pinnacle airlines, Delta financial, Compucredit, ABX air, Horsehead,

 

Near deaths (80% or more down)

-----------------------------

ATSG, SGU, Universal alloy,

 

50% haircut

-----------

Cresud, Potash, Posco

-------------------------

 

Others

ICO got bought by Arch Coal, now bankrupt

 

 

It is strange to see a Buffett admirer get attracted to commodities, subprimes, airlines etc. Heads I win, tails LP's get hosed.'

 

Vish_Ram,

 

Are you sure he lost money on all the above mentioned stocks?

 

 

[matts]

The bashing going on here is just amazing. Just months ago people are discussing how this is a great investment and now everyone thinks management is bad. Are the people commenting now lurkers of the thread secretly thinking previously that Horsehead was a bad investment or are they investors who got just lost significant sums of money? Sometimes we do need people playing devil's advocate to prevent group think into an investment...

 

If you read the entire thread, there has been plenty of skeptical posts right from the beginning and all throughout.

 

 

[LC]

The bashing going on here is just amazing. Just months ago people are discussing how this is a great investment and now everyone thinks management is bad. Are the people commenting now lurkers of the thread secretly thinking previously that Horsehead was a bad investment or are they investors who got just lost significant sums of money? Sometimes we do need people playing devil's advocate to prevent group think into an investment...

 

Posters in this thread have been criticizing management for a long time. The issue as I see it is as follows: Horsehead has this decent technology and group of contracts to recycle EAF dust into zinc. It works, it helps steel producers, it's easier than mining for zinc, etc. Economically, it all sounds groovy. Management comes along and sucks. Absolutely sucks. 700MM of market cap down the drain trying to ramp up a plant.

 

So you have this dichotomy between a good business and shitty management who managed to royally fuck it all up.

[indirect]

lets invert and ask a question

 

If he lost money on all those stocks, then how can he have the record he has?

 

 

[LC]

i think what he misses is what buffett missed when he bought berkshire.

 

as a commodity producer, if you have a special technology that brings the marginal cost of production down, eventually all the other plays will figure a way to match your cost of production. the buffett analogy is "everyone in the stadium standing on their tippy-toes - no one sees any better". all of berkshires competitors bought the special mills to reduce their cost.

 

the takeaway is this: commodity production necessitates large capital investment. you need to build factories, hire union workers, etc. this large initial capital outlay is technically a sunk cost, but owners don't see it that way. so they spend the capital to "stand on their tippy-toes" with everyone else. so, try to compete against people with small "sunk costs". once you gain an advantage, they will usually back off and eat the small initial outlay, rather than continue competing with u.

[rishig]

One big lesson to learn from this blowup is the importance of a strong balance sheet in a business like this. You can have the "greatest" management team (whatever that means), but without a strong balance sheet, a commodity business can be taken out due to unforeseen factors.

 

I was at the Pabrai annual meeting (and I am grateful - the trip saved me from ZINC) in Southern California in 2015 and I asked the following question during the Q/A:

 

RishiG: "I would like to hear your thoughts Bob (CFO) on Horsehead’s balance sheet and its ability to withstand the time it takes for the plant to ramp up. Also could you give some comments on non-core assets’ ability to provide liquidity."

BobScherich (CFO): "Horsehead is going through a very challenging transformation and we’re de-risking the business significantly. The balance sheet is on the forefront of our minds, especially debt that we have tried to use primarily for the investment in the plant. We need to refinance within the next couple years. We have concentrated investors in these notes and they are very supportive. There is a lot of interest and they like the underlying assets that are there so we have lots of opportunities in front of us. We are concerned today with the commodity prices. For anything associated with energy or any commodity, pricing is going down significantly. We are highly dependent on the price of zinc and have hedged very effectively through the end of this year so we don’t have concerns near term. But commodity prices can be very unpredictable and Buffett said it best back in 2009: periods of irrationality can outlast liquidity. My primary job is to maintain liquidity. It is something that we give constant attention to. We can’t predict what will happen with commodity prices but we will continue to take actions to make sure we maintain liquidity"

RishiG: "Could the non-core assets be part of providing liquidity if needed in the future?

 

BobScherich (CFO): "They could, but the non-core businesses that we have generate cash very effectively. We have a lot of alternatives and we will focus on that."

 

After these two questions, Mohnish jumped in and asked a very important question:

 

Mohnish: "You have this new plant and when it’s fully ramped up there is $90 to $110 million in additional EBIT coming out of the new plant. At current zinc prices at what percent capacity does the plant break even?"

 

BobScherich (CFO): "The zinc price has moved down about 25% in the last 2 or 3 months. For cash flow breakeven we need to be close to 75% capacity at the current zinc price. Right now, we are hedged well above the current zinc price which is why we have a concern. We need to get the production levels up by the time we hit the unhedged portion."

 

Mohnish: "At what percent capacity of the plant do you break even company-wide?"

Bob: "At the current zinc price probably in the 60% to 70%. With our old asset that we shut down, we would have been in a much different, unfavorable position."

OK, so the highlighted sections had enough information for me to stay out of ZINC. Here is why:

- ZINC was hedged until end of the year

- For cash-flow break even they needed to be at 75% capacity.

- At end of the year, they may be nowhere close to that and their hedges will expire.

- So, now they start burning cash, and where will the liquidity come from?

- Will they sell their non-core assets. No? That is the only thing that generates cash to pay interest

- So, where will the liquidity come from? Either a highly dilutive share offering or some kind of restructuring

- What if zinc (commodity) prices fall further? Well, in that case, the cash raised can also disappear quickly.

 

Main problem is they didn't have any cash generating business (see the comment on selling the old asset and being in unfavorable position) and no place where liquidity can come from.

 

A sane management team could have done one or more of the following:

- not sold the old asset until capacity was at cash flow breakeven

- hedged zinc to a few years out until the plant came up

- raised a lot of liquidity by selling shares when the capital markets were open to them.

 

As investors, the mistake was one of focusing on income statement instead of balance sheet. Sure, when the plant is up, it will generate hundreds of millons, but who will own this asset if there is a liquidity crunch (the debt holders?). Where will the liquidity come from - is the main question an investor should have been asking.

[Txvestor]

Rishig,

 

Your analysis on this one has been spot on. And to your credit i beleive you posted the same reasoning much earlier. I definitely agree that my analysis focussed too much on the story of how things go when the plant is fully operational and not enough on how we get there.

I also perhaps gave too much weight to Pabrai when he added shares less than 6 mths ago.

These are indeed painful lessons on loss of capital, and why Buffett puts avoidance of loss of capital right up there on the list of important aspects of investing.

On that note, i also want to point out a flaw in Pabrai's apporach. When you take up such concentrated positions, you really can't afford to have ANY investment go to zero. And Pabrai has had many more than one as pointed out earlier in the thread. Lets take this mental exercise of concentrated investing to the extreme for illustrative purpose and say you are 100% invested in your best idea. You get it right 5-6 times consecutively and over a 10 yr period accomplish a 3200% return. Your record would be spectacular and outstanding. Then lets say you went per your usual customary practice, 100% into Zinc. You'd be wiped out, and your 11yr record would be negative. In other words concentrated investing has a way of wiping out many good decisions with just one bad decision. Hence my argument that if you are going to preach/practice concentrated investing, you can't have ANY errors. Or atleast so few while not 100% concentrated that you can have a tremendous run. Pabrai has said numerous times in the past that you'd do well to get 2/3 decisions right. That does not translate to a superconcenrated portfolio with 40% investment in one stock. I think this goes beyond accepting volatility for longer term returns.

If one looks at Buffets early record, he sized positions in a way that allowed him to just 'stay in the game in case of an error' but beyond that it was all concentration and the error rate was astonishingly low. In fact some observers were commenting around the time of his Tesco blunder that he was making more errors now than early on when he knew every shred of company detail, but arguably he's much more diversified as well. The number of billion dollar errors he makes is nowadays astonishing but when you manage 500+B of capital, its a rounding error.

As to Pabrai's record, I think those making the point that his record since 2004 is unimpressive have a valid argument. Thats a long stretch and spans both bull and bear markets. Like I said, if you started out with a spectacular record(which he no doubt has), then provided you don't make massive errors, you will remain an outlier for years even decades to come even as you underperform and can use that early boost to market yourself by averaging out over time, yet anyone joining late will get very sub par returns.

I still like Pabrai, he's a very humble and generous person, and unfortunately for him( and fair to his LPs) this error will make sure he works free for them for some time to come! I have certainly learnt many things from him, but I've got to say I don't think all his own investing principles are consistently applied to his investments. He obviously got it terribly wrong on this one amd I would definitely be interested in knowing his thinking on this all of last year and in August when he added to an already massive position.

 

[Max Alpha]

It would be easy to drop the boot in for entering into ZINC but everyone makes mistakes, the real issue here I think is one of position sizing.

 

There is something to be said about position sizing when dealing with a stock which faces relatively binary outcomes. When you are talking about a business which is a highly leveraged price taker it is important to acknowledge that it can always go to zero.

 

Ideally a value investor increases position sizing as the gap between market value and intrinsic value increases from a share price decline. In this case uncertainty was rapidly increasing as it became apparent there was a real risk that they couldn’t ramp up the plant. The gap between market value and intrinsic value was actually decreasing rapidly (if it ever existed), in spite of enormous share price declines.

 

Although the value framework would have suggested not playing in this space at all, I think it particularly struggles with managing exit strategies. In this case the declining prices represented the greatly reduced likelihood of that binary homerun, not a business on sale. A situation like this needed to be priced as an option and weighted accordingly.

 

ZINC is also a useful warning for those trying to use SoTP type valuations to justify a floor price in a distressed environment (…particularly relevant to those of us who have dabbled in mining services in recent times). Unless that balance sheet item is Cash, there is virtually no way an outsider without industry specific expertise can reasonably value those parts with public information, it could be 10% of the listed book value, or it could be 80%.

 

[SnarkyPuppy]

The concept that they all got together and decided the CFO should buy some shares in an attempt to prop up share price and use the ATM is pretty funny (I doubt he was buying thinking it was a good investment)

[mrvlad0]

...ouch Mohnish

 

Horsehead Holding Corp. to Temporarily Idle Mooresboro Facility

http://yhoo.it/1JyNMsh

 

 

[tylerdurden]

I don't know whether they had any reasonable chance of doing so but they should have sold Zochem/Inmetco. When you make a huge survival bet on a single plant, you should do everything in your power to buy more time. I don't care whether they were paying interest payments etc. if they were sold they could have had another shot at ramping that plant and/or seeing higher zinc prices. Without those asset sales bankruptcy was guaranteed...

[randomep]

It would be easy to drop the boot in for entering into ZINC but everyone makes mistakes, the real issue here I think is one of position sizing.

 

 

I have a big problem with your conclusion max alpha. This is basically Pabrai's analysis of what went wrong. So effectively you two are saying that if Pabrai encounters a similar investment to ZINC, Pinnacle, Lear etc he will take it, only this time with a smaller bet. So in your eyes there is nothing wrong with his process of choosing these high risk bets. I don't know if his long term investors agree after two blowup years: 2008 and 2015.

 

So if he follows through he will buy 5 of these type of stocks to get the same type of portfolio exposure?  I wonder how he can possibly study 5 complex investments at one time w/o someone helping him read filings and do research.

 

Or maybe he will just make a 4% bet at a time, kind of like buying a lottery ticket in addition to his core portfolio?

 

 

[Max Alpha]

It would be easy to drop the boot in for entering into ZINC but everyone makes mistakes, the real issue here I think is one of position sizing.

 

 

I have a big problem with your conclusion max alpha. This is basically Pabrai's analysis of what went wrong. So effectively you two are saying that if Pabrai encounters a similar investment to ZINC, Pinnacle, Lear etc he will take it, only this time with a smaller bet. So in your eyes there is nothing wrong with his process of choosing these high risk bets. I don't know if his long term investors agree after two blowup years: 2008 and 2015.

 

So if he follows through he will buy 5 of these type of stocks to get the same type of portfolio exposure?  I wonder how he can possibly study 5 complex investments at one time w/o someone helping him read filings and do research.

 

Or maybe he will just make a 4% bet at a time, kind of like buying a lottery ticket in addition to his core portfolio?

 

I'm not condoning the investment, it looked like a poor investment and I have said as much previously and attempted to convince people so in this thread. I haven't looked into his other investments so I can't speak to that.

 

It just sounds like a lot of people are crying foul because they blindly followed him into a company throwing the kitchen sink at a single project in the commodity space. If the plant ended up working at slightly less than nameplate capacity like the vast majority of processing plants do everyone around here would have been singing his praises and talking about how clever he was and following him headlong into the next bet.

 

Instead it was a low probability engineering disaster and the plant achieved a small fraction of nameplate capacity and somehow the company had no recompense, an uncommon although not unheard of scenario.

 

Investing in stable companies with a conservative balance sheet isn't the only way to make money.

 

My point is you can't size a position with an option-like payoff profile like it is an investment in Google. It is better approached with options because if the coin lands on tails you lose 100% whether you bought a 10% equity stake or used non-recourse leverage, yet the upside is comparable.

 

He talks about chasing investments set to double every three years. You are going to encounter a few land mines with a goal set like this.

 

I didn't agree with the investment hypothesis, but I can appreciate how the risk/return profile might have appeared relatively attractive before evidence of the serious nature of the problems facing the plant came to light.

 

If your investment stands to make 200% on heads and lose 100% on tails, you better be able to flip it a few times before anyone gets upset. I think the biggest sin here is one of position sizing. He struck tails though, so it is clouded with hindsight bias.

 

[alertmeipp]

So anywhere in the capital structure worth looking into?

 

[str8shot]

It would be easy to drop the boot in for entering into ZINC but everyone makes mistakes, the real issue here I think is one of position sizing.

 

 

I have a big problem with your conclusion max alpha. This is basically Pabrai's analysis of what went wrong. So effectively you two are saying that if Pabrai encounters a similar investment to ZINC, Pinnacle, Lear etc he will take it, only this time with a smaller bet. So in your eyes there is nothing wrong with his process of choosing these high risk bets. I don't know if his long term investors agree after two blowup years: 2008 and 2015.

 

So if he follows through he will buy 5 of these type of stocks to get the same type of portfolio exposure?  I wonder how he can possibly study 5 complex investments at one time w/o someone helping him read filings and do research.

 

Or maybe he will just make a 4% bet at a time, kind of like buying a lottery ticket in addition to his core portfolio?

 

I'm not condoning the investment, it looked like a poor investment and I have said as much previously and attempted to convince people so in this thread. I haven't looked into his other investments so I can't speak to that.

 

It just sounds like a lot of people are crying foul because they blindly followed him into a company throwing the kitchen sink at a single project in the commodity space. If the plant ended up working at slightly less than nameplate capacity like the vast majority of processing plants do everyone around here would have been singing his praises and talking about how clever he was and following him headlong into the next bet.

 

Instead it was a low probability engineering disaster and the plant achieved a small fraction of nameplate capacity and somehow the company had no recompense, an uncommon although not unheard of scenario.

 

Investing in stable companies with a conservative balance sheet isn't the only way to make money.

 

My point is you can't size a position with an option-like payoff profile like it is an investment in Google. It is better approached with options because if the coin lands on tails you lose 100% whether you bought a 10% equity stake or used non-recourse leverage, yet the upside is comparable.

 

He talks about chasing investments set to double every three years. You are going to encounter a few land mines with a goal set like this.

 

I didn't agree with the investment hypothesis, but I can appreciate how the risk/return profile might have appeared relatively attractive before evidence of the serious nature of the problems facing the plant came to light.

 

If your investment stands to make 200% on heads and lose 100% on tails, you better be able to flip it a few times before anyone gets upset. I think the biggest sin here is one of position sizing. He struck tails though, so it is clouded with hindsight bias.

 

many good points made. the key learning for me, as someone who only a year ago elected to clone a few of Mohnish's picks (after reading Spier's book and then Dhando Investing by MP), is that at least two of the three (horsehead, posco, gm warrants) have not met the "heads I win, tails I don't lose much" philosophy he has espoused.

 

I was willing to clone a few of his picks and take concentrated positions under the premise that he adhered to that philosophy. He talked about low risk but high uncertainty ("heads I win, tails I don't lose much") - which supposedly translates to low downside risk (which must be based on a high level of certainty that there is minimal downside) and potentially large upside (which has greater uncertainty).

 

Take Posco. I bought Posco around $70 in late 2014. Pabrai had bought a large position in Posco ($50-80M range) in 2014, sold nearly all of it soon after (I learned when I saw his quarterly filing 45 days post quarter), then he jumped back in in 2015 at around $55. I presume he did this for tax loss selling purposes in 2014. I was growing less comfortable with Posco and when I read that Munger sold out in late 2014 - he said it's sustainable advantage had eroded and it had become just another commodity player -  I dumped it at $55. The stock is now at $35. Time will tell but it doesn't seem to fit the low downside risk model.

 

Horsehead clearly didn't fit the low downside risk model. When he bought 2m additional shares for Dhando in July 2015, objectively (in retrospect) there was very high risk because the plant had yet to exceed even 25% capacity, they had continually missed target dates, and it was very possible that the company was at risk of filing if the ramp-up didn't achieve 75% within the following 12 months. But there was another lurking risk that would condense that runway to get to 75% capacity - which was if commodity prices tanked. Not easy to forsee but something that must be accounted for in calculating the risk of a commodity producer trying to get a new plant online. I failed to take these risks adequately into account, and instead took a cue from the July 2015 "doubling down" by Pabrai. And the rest is history. Pabrai clearly didn't properly calibrate the downside risk when he "doubled down" in July 2015, despite having been an investor in the company for 6 plus years that owned 14% of the equity. Yes we all make mistakes - but that was a deadly miscalculation of risk.

[arcube]

Yes we all make mistakes - but that was a deadly miscalculation of risk.

 

Indeed. Well said.

[investor-man]

Yes we all make mistakes - but that was a deadly miscalculation of risk.

 

Indeed. Well said.

 

Come on man. Deadly? Didn't he about double his money in Fiat last year? It probably offset his losses here completely. The potshots people are taking is appalling. I guess I'm contributing to it by responding, so I'll stop, but come one man... deadly?

[Picasso]

I mean the guy did just blow 10% of his fund on a super speculative situation.  He's probably going to get some redemptions which puts pressure on the rest of his holdings because he's going to end up with bigger and bigger stakes in FCAU or GM.  Does he really want 75% of his fund in auto stocks facing tech threats near the end of the cycle?  How will his investors feel about that?  I bet you a lot of his investors gave the bulk of their net worth because his minimum is so high and he is honest and trustworthy.  Not a good position to put those investors in.

 

I'd consider this fairly deadly to his fund.  If you've never managed OPM or ran a fund and had a fairly well known position blow up, you don't know what it's like to be under that kind of pressure.  He's better off losing 10% across a few bets that no one knows than 10% on a single prominent investment where you bring in the CFO to an investor meeting.

 

Also consider that Pabrai has likely not made or even lost money for investors on a net basis, despite saying he generated 20%+ returns for a long time.  Here's a nice list of guys who actually create net value for investors:

 

http://www.bloomberg.com/news/articles/2016-01-26/bridgewater-s-dalio-trumps-soros-as-most-profitable-hedge-fund

 

Anyway don't really care to crap on the guy, just wish he would stop with all these talks like he knows everything and then name drop his old returns while telling people not to speak his recent returns into the public domain.  It strikes me as someone who needs to tone it back a few notches and maybe that's why the "anonymous finance" world is so quick to criticize Pabrai.  Investing isn't easy and I'm kind of sick of him acting like it's really easy.  Doesn't Munger have a quote about investing not being easy?  That's a rhetorical question....