Memo

From:

Guy Spier

Re:

Horsehead Holding Writeup for Aquamarine Fund DDQ

Date

December 12th, 2016

As part of our management of the Aquamarine Fund, we keep an updated due-diligence

questionnaire (or DDQ). In it we seek to answer all the questions that a prospective investor in
Aquamarine Fund might forget to ask, or might want to ask but would feel uncomfortable asking.
One of the questions in the DDQ asks me to describe my most difficult investment experiences to
date.
I recently completed this writeup on Horsehead Holding which will be added to that section of the
DDQ. Please do feel free to get back to me with your feedback:

Horsehead Holding
By far and away, the most difficult experience that I have had in my investing career has been the
bankruptcy of Horsehead Holding.
Horsehead is a recycler of Zinc based with its headquarters in Pittsburgh, Pennsylvania. In 2011, I
started buying shares of Horsehead Holding for the fund. I believed that I had identified an unusual
emerging moat based on the companys dominant position in the recycling of electric arc furnace
dust (EAF dust). In the prior years, the company had tied up more than 80% of available capacity.
This positioned Horsehead to be the lowest cost and dominant supplier of zinc in the United States.
Around 2012, Horsehead took the decision to shut down its Monaca zinc recycling facility based
on the Waelz, a pyrolytic or burning process and started constructing a new state of the art
recycling facility in Mooresboro, NC which was based on an far cleaner electrolytic process. This
technology, provided by the Spanish engineering firm, Technicas Reunidas, had already been
successfully used in a number of plants around the world.
The original estimate for the cost of the plant was $375 million, to be funded by a combination of
debt, equity and cash from operations. Ultimately, the plant cost around $500 million. The cost overruns were funded by the issuance of debt and equity. I participated in one of those equity raises.

In the months after the plant opened, production did not ramp up as planned, although in its
communications with the public and the shareholders, the company made clear that these were
teething problems and that they had every confidence that production would soon ramp up. Then in
2015, the price of zinc began to slide as Horsehead continued to have problems at Mooresboro. The
management, however, continued to reassure the markets that the business plan was intact and that
they had sufficient cash to get through a temporary period of low zinc prices.
In early January of 2016, the company announced that it had tripped a technical default on its
revolving line of credit from Macquarie Bank, and later in the month it transpired that Macquarie had
frozen the companys bank accounts which had also triggered PNC Bank to do the same. These
inexplicable actions by Horseheads banks all but forced the company to file for chapter 11
protection from its creditors.
During that time, I was aware of offers on subsidiaries of Horsehead that would allow the company
to pay down debt and buy more time for a slimmed down Horsehead to get the Mooresboro plant up
and running profitably. I was also confident that the company could raise more equity. Indeed, the
company had approached me, and I had responded that although I did not have all the requisite
capital myself, I was ready to invest more provided it was alongside other investors as part of a
sum that ensured that the company could get through this period of tight liquidity.
Given these insights, I believed the companys public statements that it had sufficient liquidity to get
though its operational difficulties and the low zinc price.
But in the days that followed their bankruptcy filing, Horsehead shut down all communication with
the shareholders. As documents started to get filed on the docket, a very different picture started to
emerge regarding the intent of the bankruptcy in which the clear goal was to transfer ownership
and along with it, enormous value from the equity holders to the creditors.
At this point, many wise observers opined that my best bet was to take my losses and walk away.
Instead, I decided to fight.
My first port of call was the US Trustee and my petition requesting an equity committee filed along
with a valuation report by KPMG - which put the value of Horsehead in excess of $1.2 billion. This
was denied. My next step was to go pro-se (without legal representation) in front of the Judge to
request an equity committee. In my pro-se motion, I pointed out the many irregularities and unusual
circumstances that had taken place in this case. My motion was joined by more than 250 individual
shareholders who also wrote into the court, as well as by Phil Town who wrote his own pro-se
motion.
At the hearing on the equity committee, and against all odds, the judge awarded us an equity
committee, stating amongst other things that something did not smell right to the court.
I became the Chairman of the Equity committee, and, encouraged by the judges stance we went
about trying to discover what had happened to so precipitously yank the company into bankruptcy
in spite of the evident liquidity available.

Very shortly into the case, yet more distressing information came to light namely that in the
months prior to bankruptcy the company had indeed received substantial and valuable cash offers
from potential buyers of subsidiaries of Horsehead that were more than the value of the outstanding
debt.
This only confirmed what many experts already knew: Horsehead had become the subject to a very
well-planned loan-to-own raid by a group of distressed debt funds lead by Greywolf. Their goal
was to transfer ownership in Horsehead into the hands of the debt-holders at the lowest possible cost,
and without regard to the rights of the equity holders. As I had stated in my pro-se motion, this move
circumvented the SEC rules of fair disclosure to public investors as well as the Chancery rules on
change of control and made a mockery of the bankruptcy rules.
For example, at the time that the company declared bankruptcy, I was surprised to discover that two
of the very self same funds that had been large shareholders had also become holders of the
companys bonds. For example, Greywolf had been, and continued to be the holder of more than
10% of the companys shares.
Moreover, at the time that I petitioned the US Trustee, it struck me as very odd that many of the
larger funds who had until only recently been listed as major shareholders were no longer
shareholders. By contrast, I received an overwhelming response to my internet posting from smaller
shareholders.
As I thought it through, it became clear to me that the only reasonable explanation to this was that
Greywolf and Hotchkis and Wiley had planned the bankruptcy many months prior and that they had
to have been in possession of insider information. Similarly, all those funds that had disappeared
prior to the bankruptcy filing would likely have gotten wind of what what going down as a result of
selective disclosure by the company.
Additionally, it is utterly inexplicable that a lender would behave the way it did towards Horsehead
shutting down liquidity and freezing bank accounts, given the collateral value that was clearly
available. No responsible lender would expect to have many customers after behaving in this way
towards one of its clients. The only reasonable explanation that I have for this inexplicable
behaviour is that Macquaries real client was not Horsehead, but the funds that sought to drag the
company into bankruptcy.
The appointment of the equity committee had raised my hopes and expectations that the judge had
seen this, and that he was not going to allow this to happen in his courtroom. But shortly after
awarding an equity committee, the judge denied us important discovery and even threatened to not
approve the equity committees professional expenses.
Subsequent to those decisions our only option as the equity committee was to do our best to find a
buyer or an alternate plan of reorganization. In this endeavour, the judge did offer us some help, but
without going so far as to order a market test, and without allowing an extension of the timetable for
the case. This meant that the final confirmation hearing was set for the end of August 2016.
That gave us 2 months to try to find an alternate deal for the company. In spite of receiving
substantial interest in the assets, we were greatly hindered by the orientation of the company and its
advisors who were in full co-operation with the creditors.

For example, we offered to put up new money and to co-invest alongside the creditors which was
rebuffed without a counter-offer. Also, significant was that we had little to no co-operation from the
companys investment bankers, Lazard who did their very best to slow down any interested party,
and to dissuade them from going through with their due-diligence. And there are other examples,
which, if disclosed here, would probably result in my violating the NDA which I signed.
Lastly, the confirmation hearing was perfectly timed for the creditors - at the end of August, 2016,
during the summer break which meant that many of the people who might have been interested and
willing to bid were away.
At the end of the day, although we came closer than anyone had expected, we were unable to provide
an alternative to the creditors plan of reorganization. At the trial, and in confirming their plan, the
judge took the time to state that this had been the most difficult decision of his ten-year career on the
bench.
A few things to keep in mind.

At the time of filing, Horsehead had $450 million in liabilities. At the final confirmation
hearing, the judge found the company to be worth $653 million. In other words, even with
the judges conservative valuation, the company filed for Chapter 11 protection with more
than $200 million of shareholder equity.

The company filed for bankruptcy having ignored offers for subsidiaries which were for more
than the value of all of its outstanding debt. If Horsehead had accepted one of those offers, it
would have been able to protect the shareholders.

Had the company had done a rights issue to the shareholders, and raised the requisite equity
capital, the company could have easily avoided bankruptcy.

At multiple points leading up to the bankruptcy filing, the company reassured the investors
that everything was fine.

Had the US Trustee appointed an equity committee earlier on we would have been able to
oppose the DIP order and buy more time.

Had the management of the company been more vehemently opposed to the creditors and
worked with the shareholders, the outcome would have been very different.

In other words and I cannot state this with enough emphasis, it is glaringly clear that
Horsehead had many other options to declaring bankruptcy and that at the time that it
declared, it was actually solvent. This could not have happened without some very significant
collusion.

Inexplicably, even having appointed an equity committee, the judge seemed to have changed
his mind part way through the case, and decided to go along with the creditors plan.

Lessons Learned
Horsehead has certainly been my most painful and expensive investing experience to date. But it has
also been an extraordinarily rich learning experience which could be the subject of a book or a
monograph. Here are some of the key lessons as it pertains to current and future investments.
1. Leverage
I already knew about the dangers of leverage especially in an operating business exposed to one
commodity and where the company is building a new plant. But in a classic case of the boiling frog
syndrome, the leverage slowly crept up during the time that I owned the shares. Such that had I run
my checklist during the year prior to the bankruptcy filing, I would likely not have invested on
account of the high leverage. But because the debt gradually increased, it did not set off the alarm
bells that it should have.
In order to protect against this boiling frog syndrome, and as a result of my experience in Horsehead,
I have implemented an in-flight checklist in which I periodically review changes in leverage in our
investments.
2. Management
My experience with Horsehead has caused me to re-evaluate my thinking on contact with
management teams. It now strikes me as asinine not to speak with management. The key to good
investing is not whether one speaks to management but when one does it. Armed with plenty of
insight into the company and its environment, I have no doubt that speaking to the management is
helpful. And in this case, would have helped to alert me to the changed management agenda of
helping the creditors swallow the company whole.
3. What does the market seem know that I dont know?
In the past, I have been unwilling to sell an investment merely because the stock price is going down.
In retrospect, it is always worth remembering and asking the question what does the market seem
know that I dont know. In the case of Horsehead it turns out that the market knew an enormous
amount more than I did namely that the company and its management had taken the decision to
collude with the creditors to take the whole enchilada.
I have added a question to my in-flight checklist to force me to explicitly contemplate this possibility
with future investments.

The Decision to Fight.

Friends, observers and investors questioned my decision to fight this. Some cited the power and the
resources of the creditor groups that we were opposing and the overwhelming odds against winning.
Others talked to me about the opportunity cost of the fight which could have been better spent
looking for investments for the fund.
For my own part, I have no doubt that fighting was the right thing to do, and, even knowing the
outcome, if I were given the choice again, I would have made the same decision.

I have two reasons.

1. Firstly, it was the morally right thing to do. Even though I was certainly not the largest
shareholder, I was publicly associated with the company. At the time of filing, I was perhaps
the only investor who had the wherewithal to stand up to what was happening. And even
though I had no contractual, fiduciary or other obligation to the other shareholders, I do
believe that I had a moral obligation.
2. Second, my reputation was at stake. Without wanting to be there, I found myself in a
situation where a creditor group intended to brazenly apply a loan-to-own strategy, riding
roughshod over the shareholder rights, and putting the judge in a position where he had to
accede to a fait-accompli. If I had allowed this to just happen without a fight, it would have
been sending a signal that I, and the fund that I manage are a push over. That our interests
could be safely ignored.
As it is, I have no doubt that the creditor group regret not talking to me prior to executing their plan,
and that in the event that similar circumstances recur, a creditor or other investor group would
certainly want to talk to me first.
Moreover, because I have demonstrated that I am willing to stand my ground, other investors and
management teams will be more interested to engage and listen.
Conclusion.
We all hope to get through our investing careers without an outright loss. That is no longer the case
for me. While I cannot change the past, I am determined to learn all of the lessons and to apply them
in my investing practise going forwards.

Horsehead Related Reading:

Motion requesting an Equity Committee: http://www.slideshare.net/secret/wJcjNjwrBXxP81
Joinders to the Motion: http://www.slideshare.net/secret/aQpfqLuaCxOHLY
Oral submission to the Judge: http://www.slideshare.net/aquamarine/horsehead-holdings-guyspier-submission-to-judge-sontchi
Equity Committee hearing - Transcript: http://www.slideshare.net/secret/gXbfNws9l4CVKe
Shareholders seek a voice in Horsehead Bankruptcy: http://www.postgazette.com/business/pittsburgh-company-news/2016/04/04/Shareholders-seek-a-voice-inHorsehead-bankruptcy/stories/201604030114
Horsehead shares soar as investors get role in bankruptcy case: http://www.reuters.com/article/ushorsehead-hldg-bankruptcy-shareholder-idUSKCN0XT1RY

How Bankrupt is Horsehead Holding? Its Investors Want to Know:

http://www.nytimes.com/2016/08/28/business/how-bankrupt-is-horsehead-holding-its-investorswant-to-know.html
Zinc Producers shares fall short in bankruptcy fight: http://www.reuters.com/article/horseheadhldg-bankruptcy-idUSL1N1BE1O8