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A Time-Tested Way to Lose Money

(Business Wire) — NEW YORK — November 17, 2017

Real Industry, Inc. (NASDAQ: RELY) (“Real Industry” or the “Company”) today announced that it has initiated restructuring efforts through the filing of a petition for voluntary Chapter 11 reorganization in the U.S. Bankruptcy Court for the District of Delaware.

This comes to our attention, again, as RELY was a former holding (including its predecessor form). Like with a highway accident, we just have to slow down and take a look. This is also a nice example of the “sell discipline” that few ask about—most just question the things that we haven’t sold. (If you’ve thought, from time to time, that what we have done is dumb, then you haven’t looked at all the dumb things we haven’t done! But we digress.)

While the whole RELY story is a fascinating one, our point to be considered here is the fallacy of the “smart guy” theory. It is frightening how many times I have been told to look at a stock because X-guy owns a lot, and in the past X-guy has done Y and Z, and ergo that is all you need to know here. Several iterations of a mistake later, you realize the fool’s chain of thought—that everyone down the chain thought the guy before him had done the work, and therefore you can just suspend full concentration. Voila, you own a mess.

Backtracking, RELY was originally a result of a California Savings and Loan bankruptcy that an enterprising, youngish investment banker-type nearly killed himself arranging into a new public company with a small set of assets and north of a $1 billion tax loss carryforward (an asset which has a lot of value in a world of 39.6% corporate tax rates). Unfortunately, said CEO did not have or control much capital, and thus he arranged a diverse set of financiers who were granted Board representation while he himself owned only 5% of the company. Off they went to look for deals to utilize the tax shield. This is where we stepped in—seeing a pile of cash, free optionality, and an orphaned and overlooked security that happened to be headquartered here in L.A.

But execution in the deal business is a funny thing, particularly in regard to timing, and after 18 months, the bickering set in. Lo and behold, other people thought this was a good idea too, and decided to throw the CEO out through a proxy action, and execute the deal themselves. The resourceful CEO saved himself by turning to a Sam Zell entity, who bought 10% of the equity and joined the Board. Sam Zell (as some know) is a multi-billionaire, who among other things, has had huge wins in turning corporate shells with huge tax assets into massive value. Who wouldn’t be happy with that backing? But further lo and behold, another year goes by, and yet another group thinks this whole thing is a great idea and actually convinces the former savior Zell group to throw the CEO out and do it themselves…and that they do.

So, on paper, you have a stock selling for its cash, you have a world famous investor owning 10% at a cost higher than yours, and now they are putting in their guy to execute a plan they have done successfully in the past. What could go wrong?

Well, a large and crappy deal using a high amount of leverage in a cyclical industry, for one. And a CEO with what was simply a really questionable plan. After announcing the long awaited “move,” the stock had its double, was touted in Barron’s, and the “well, Zell owns 10%” story was in full bloom.

We let them have every share we owned. Besides not liking the deal, we didn’t quite see the point of that much leverage eating up the tax shield advantage, we didn’t like the CEO’s “ambitions,” and Sam Zell owning 10% of a $700mm company is really not a lot of HIS money at risk, when you think about it. So, ask yourself—how much time is really spent by “X-guy” when it’s probably less than 1% of his net worth? And if a REALLY good batting average in investing is 60%, who says this is the one? It is a classic behavioral finance flaw—we grossly overweight the happy story and underweight the litany of prior failures and attempts.

Stay tuned. This will come out of bankruptcy at some point. With some guy or some group that has the fulcrum security to control it…and an even bigger tax loss carryforward. And a story.

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