Investment Mistakes(Thankfully by others)

Prabai's Mistake

Ok. Some might disagree that the outcome of Horsehead investment is still uncertain and should not be consider a mistake. However, falling from a price point of 9 bucks to 2 bucks would at least warrant a good re look. I will try to reverse engineer his investment idea at that point in time and what has changed.

Firstly, Prabai started out buying this coy as a net net during the 2008/10 period Nothing very wrong with that approach. Subsequently, the company move on to try and develop a new plant which will allow it to be the low cost producer, ( Steel coys paying them fee to provide them with waste product that can be use as valuable input for making Zinc). Buying Horsehead now while the plant is developing its moat is like getting in on the ground floor. (The numbers are not reflected in the financials). I can understand where is he coming from. Paying an attractive price with a huge potential upside.

What when wrong?

The plant failed to ramp up, encountering difficulties after difficulties, consuming loads of cash. With negative operating cashflow, the company is force to take on huge debt, taking on balance sheet risk and huge issuance of equity, diluting current shareholder interest. Adding on to it's woes, most of the debts are due in 2017, hence a potential liquidty crunch ahead if production still fails to ramp up by then,facing bankruptcy or another massive share issuance. Both does not bore well for the current shareholder. Lastly, falling zinc price is not going to help a Zinc producer very much. The movie is still currently being played out.

What can we learnt from this?

New plant production is never a dream fairytale, unlike the projection by managements, whose rosy production forecasts can only go one way, UP. Be wary when management says the problem is being resolved. Even when one problem seems to be resolved, another will surface to take it's place (There is never only one cockroach in the kitchen).

Secondly, beware of debt laden, high operating leverage companies operating in an economic sensitive industry. There is little room for errors.

Hence because of the above, there should be sufficient cashflow from other sources to cover the funding needs of the new plant. With a huge debt and negative cash flow, for Zinc, it seems to be a make or break situation.