The major black eye impacting 2015 (though the decision was made in late 2014) was our investment in OUTR. This was a mistake I should have avoided. My assumptions appear faulty, and I clearly underestimated the effects of substitutes on consumer behavior.
Further, I should have insisted upon first-class stewardship before considering an investment given the challenges at Redbox. With scarce reinvestment options and a declining business, capital allocation (important in any business) takes on critical importance. The conditions prevailing at OUTR demand thoughtful capital allocation, not a blind devotion to venture-like investments in kiosk businesses and systematic share buybacks without reference to value or opportunity costs.
In hindsight, I should have recognized the folly of investing alongside executives with poor incentives (no skin in the game), and a destructive record of capital allocation. I naively thought our overtures would nudge management and the board in the right direction and produce smart results … Lesson learned.
The critical variables at OUTR rest upon Redbox’s future decline rate (and associated level of cash flows) and the efficacy of future capital allocation. Given the many variables at play, it’s hard to know if Redbox’s recently reported decline rate will continue apace, accelerate, or perhaps snap back slightly (given better content buying and a stronger release slate) and moderate in the years ahead. Equally important is our unease with the current management and board of directors.
As of this writing there’s hopeful news: Glenn Welling at Engaged Capital (an “activist” hedge fund) has taken a large stake and is advocating urgent change. Engaged Capital’s top priorities are to redirect capital allocation and sell the company. In the near term we plan on working with interested parties to support rational behavior and value creation.
Unfortunately, even under new leadership OUTR will likely remain a candidate for my “wall of shame,” serving as a reminder to avoid similar mistakes in the future. If we were to sell out of our remaining position today–around $34 per share–OUTR would end up costing us roughly 4.5% of capital, one of the worst losses in our 16-year history.
The above commentary has been excerpted from the annual letter of Arlington Value Capital.
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