How Horsehead Holdings Made Me Look More Like a Horse’s Ass

Who are you?

I’m a startup guy, and a lifelong business nerd. I’ve been reading, listening, and talking about business and investing since I can remember. I read a lot and fancy myself a life-long learner. I have near-zero experience in finance or investing as a profession. And apparently, I’m a pretty shitty investor.

My motivation to invest well comes from two distinct areas: 1) My desire for financial independence, and 2) Buffett’s quote: “Being an investor makes me a better businessman, and being a businessman makes me a better investor.”

Where did the idea come from?

As an eager reader and student of business, I came across The Dhandho Investor, by Mohnish Pabrai. It was recommended to me by a “successful” professional money manager, and I’d seen it on various blogs and book lists.

I loved the book. It was written clearly and simply, and communicated powerful ideas. It made value investing seem so simple! Which I quickly and VERY erroneously equated to “easy.” Simple is not easy.

(As it turns out investing is not particularly simple either.)

One of Mohnish’s ideas in the book is to “be a cloner” which means to dig around in the paperwork that other fund managers are legally required to submit publicly to the SEC, find out what they are already invested in, and use those ideas as a starting point for your own research.

I did more and more research on Mohnish Pabrai and found all kinds of impressive things. Talks at Google, columns on Forbes, letters to his partnership — all of them reinforced my belief that this guy was an investor with a hot hand. (setup for the hot hand fallacy). Mohnish talked at length about his “Investing Checklist” which seemed like an intelligent approach. He made a show of emulating Buffett in a number of important (partnership structure) and irrelevant (bridge player) ways.

So I decided on my investment strategy: Check out what Mohnish Pabrai was buying, and buy that. Especially if it was cheaper than when he bought it. (My belief was that this might result in higher returns, as I’d get an even better price for the same company.) This was possible because of how few stocks were in Pabrai’s portfolio — rarely more than 10. And when his positions are so concentrated, I figured his assessment of the odds that they would go to Zero would be almost zero… (can you feel the foreshadowing?)

What a great strategy! I’m getting the same returns as all those suckers who are paying Pabrai management/performance fees, but I’m not paying a CENT! And if I’m buying positions after him that are cheaper, my returns may even be better.

What was the idea?

So, this specific stock for this story: Horsehead Holdings [$ZINC]

What did it do? Who fucking knows. Something about Zinc. Who cares.

Ok, I did a know *little* more than that, but not much. I knew that Pabrai had bought low and rode it up before, and that upon researching the management team and diving deeper into the business, made a significant increase in his position when the price went lower. When I looked, I believe it was 8–10% of his whole portfolio. (I saw that as a sign of reassurance.)

The company had contracts with manufacturing facilities to come and take away the scraps of Zinc from their production process. They would take that Zinc, refine it, and sell that as a product. So they provided a service with long-term contracts, where they got PAID to pick up the raw materials of their production. Pretty badass. There was a defensible ‘moat’ in the contracts with customers, and they were one of the few places to buy Zinc in America (True? idk. Maybe.)

They had also made some acquisitions recently of companies that were performing well and could be sold in a pinch.

Horsehead did have some debt, but they also had decent cashflow, and a number of sale-able assets (like the recent companies they had bought) that could be sold to keep the core Zinc business thriving if the going got tough.

What Happened?

This story hinges upon the Mooresboro plant (BUM-Bum-Buuummmmm…). Once Horsehead had locked up the customer contracts to be the exclusive picker-uppers of Zinc, the bottleneck became their processing facility, which was apparently old and inefficient.

So they decided to take on a HUGE Capex project to build a shiny new $500,000,000 facility for refining the Zinc in order to really fly and scale up the business. Great, ok. Sounds good guys. Let’s grow this thing.

As time went on, there were a few small problems with construction and beginning production at the Mooresboro plant. Then some medium problems.

While this was all happening, Horsehead was taking damage on another financial front — the commodity price for Zinc was falling. This affected the value of Horsehead’s assets, and lowers their margin. Overall, it had the effect of weakening the company at the time when it could least afford it.

And the price began to fall. Which was not what I was hoping for. However, I did the mental gymnastics to tell myself that this might actually be a great opportunity. If Mohnish Pabrai and Guy Spier thought it was a great investment at $10 and nothing huge had changed with the opportunity… maybe it’s an even BETTER investment at $4. Maybe I can buy another block at $4 and see it go to $20 and wouldn’t a 5x return be incredible?!? I dwelled on this, and started believing it because I WANTED to believe it. (And it kept me from confronting the fact that I’d torched 50% of my initial investment. Buying another block “validated” my initial hypothesis, which felt good.)

Then there were some big problems at the plant.

ZINC had taken on debt and spent a shitload of money on this plant, and it wasn’t producing. It needed more invested to become operational and actually make money. And when you’ve spent hundreds of millions of dollars on a thing that isn’t making you any money you are in trouble.

One thing they had to do was write the asset down on their balance sheet. Previously, their $900,000,000 of “Plant property and equipment” made me be like “well the Market cap is $500,000,000, and there is not more than $400,000,000 in debt so how could we possibly fuck this up.”

Well, that fucking lying balance sheet. All the sudden they were like “oops nah that big ass factory is NOT worth $500,000,000 — it’s actually more like zero.” So that’s where your problems really get started.

The stock price kept falling and I realized this might be a real shitshow.

And those problems get considerably worse when they miss a payment of their debt. That’s around when Mohnish sold out. He saw where this was heading. I did not. Because I am an idiot. Or naïve. Maybe both.

The value of the stock was now down around $1. The company was going to declare bankruptcy. At this point, I was holding on because… I don’t know why. I just was. Because I didn’t have the balls to rip the bandaid off, maybe. Or because I believed in a fairy-tale ending.

And there was just a glimmer of hope that there could be a resurrection. An equity committee was forming, and was taking the company to court for unfair treatment of shareholders. An auditing firm was brought in and valued Horsehead at $1 Billion. Things were looking up.

There was a court case. Shareholders lost.

The price is currently $0.018 trading on OTC. That’s a zero.

NOT a fairy-tale ending.

Why did that happen?

Let’s talk about incentives.

Let’s say you run a company. It’s worth $1,000,000. You own 5% of this company, your stake is worth $50,000.

This company is struggling, and is heading toward bankruptcy. There are things you could do to avoid this, but it would be hard work. You would have to fire people, sell off assets, spin off companies, raise outside capital, etc. And it might not work.

And someone approaches you with a proposition: Let your company go into bankruptcy. Let us buy it for $100,000. We will then give you 15% of the company, and we’ll take this thing right back to $1,000,000 over the next few years. Maybe even more! You’ll have triple the money, the easy way!

How do you think that plays out…

This is a very tough situation. As much as I’d love to make the executives the scapegoats here and blame them, I think they were backed into this corner.

Previously, while raising funds to get the Mooresboro plant running, my understanding is that they took some money on very onerous terms from Greywolf Capital. There were clauses in their agreement that they could not shop their assets for sale, and that Greywolf got control of the company.

I objectively realize that this was a pretty badass maneuver by Greywolf, and I recognize that they got a great deal. But as the individual investor who got fucked on this, it sucks to get kicked in the teeth.

And I’m sure Horsehead executives had the best of intentions when they set off on the Mooresboro misadventure. They didn’t expect the project to go over budget. They didn’t expect the commodity price of zinc to drop. They didn’t expect to have Greywolf acquire their debt and control what assets they could sell.

They weren’t prepared for an confluence of negative events while they made this dangerous transition.

To be fair, all of this happened after the core thesis proved wrong. There was a lot of buried risk in the fact that the company had taken on too much debt, was vulnerable to fluctuations in Zinc commodity prices, and the execution just wasn’t there. There were overlapping risks that increased the uncertainty that I didn’t see and did not respect enough to scare me away.

What did you learn?

I learned that as an investor in the public markets you are powerless. Pow. er. less. That you have one lever in front of you, and all it does is buy or sell. Everything else is wishful thinking.

I learned that you are completely at the mercy of other’s decisions. The executives you rely on can be affected on levels that are not available to you. The old adage “If you’re not sure who the sucker at the table is, it’s you.” about sums up my feelings of this experience.

I learned to choose very carefully which companies invest in (if any) because if a devout respect for the shareholder isn’t in their scripture, you’re the sucker at the table. Berkshire doesn’t treat it’s shareholders like suckers.

I learned that many businesses we invest in have many machinations below the surface that are very difficult to find, let alone understand. I massively underestimated the amount of work it takes to grok a company and the forces that determine it’s fate.

I learned that I misunderstood the level of risk involved in this company, and the layers of risk that overlapped. Worse, I did not update my understanding of the risks as the situation changed. Instead I clung to my original optimistic assessment.

I learned I belong in index funds.

If you have a story of losing money and getting your ass kicked — write it up and share it with us! I’ll publish stories of all kinds contributed from readers as posts.(Anonymously if you prefer).

You are welcome to write it yourself. If it’s easier for you, I’m happy to hear the story over the phone and turn it into a post for you.

Email me about your stories: Eric@iamaterribleinvestor.com

I look forward to learning with you.