February 11, 2015

Dear Partners,

I’m thrilled to report that we collectively ended the year fat and happy. My streak of poor
predictions remains intact as AVM Ranger gained 31.8% in 2014 versus 13.7% for the
S&P 500. And what really carries weight around here (if you look close you may see the
slightest puffing of chests): over 6.5 years we’ve compounded at 37.9% per annum vs.
9.9% for the S&P 500.

This 28% spread of relative outperformance is our main concern. Our scorecard is
relative to the S&P 500 for one simple reason: most funds fail to beat the S&P 500 over
time. If we can beat the S&P (after fees & taxes) then we feel we’ve added value to
limited partners (LPs). If we can’t, we’ll find a new field of employment (we all know
the world doesn’t need another fund padding pockets at investor's expense).

Also relevant to long time Arlington investors is our 15-year record. We’re happy that
our record has been rewarding (so far) to those trusting souls who invested with Arlington
at our grand opening; they have seen a 22% compounded annualized return over the past
15 years, outpacing the S&P by 18% per annum.

(I’ve chosen to report all figures gross of fees as some investors have adopted our fixed
2.4% fee, while others have chosen our 1-and-15 performance based structure.)

One important note before we move on: we’ve had an amazing run over the past 6.5
years. We haven’t suffered a down year, we’ve beat our benchmark 5 out of 6 years, with
one year being a dead-heat, and we’ve outperformed the S&P by a large margin.
Unfortunately, none of these accolades are likely to continue. Our level of
outperformance is certain to shrink, and the manner in which that occurs is likely to
include both down years and years of underperformance.

PORTFOLIO COMMENTARY

In reviewing the portfolio I try to dance a fine line, balancing pertinent information with
readability, while not spoiling current investment ideas we may be interested in buying
more of. I aim to provide a general sense of my thinking toward investing, including an
example or two that “shows our work” so to speak, balanced against not going
overboard with financial minutiae that bores some LPs and causes others to wish I’d stop
writing and get back to work.

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While last year’s letter rattled on about our sluggish investment behavior, this year we
saw a change of pace, with a handful of ideas. And while intuition suggests that ideas
drop as markets rise, our focus is on business values independent of market levels or
short-term noise.

A culture that insulates us from the noise is important in a world of 24-hour news cycles
and myopic measuring. Without it, the job would take on the feel of a financial track
meet, as frenetic managers line up each year waiting for the gun to go off. A friend’s
reply after asking about our year-end performance captures the culture: “enjoy next week,
it all resets on January 1st.”

This near-sighted focus by outsiders (perpetually ailing fund managers) seems tethered to
frequent reporting and portfolio transparency−two things we’ve long resisted. As any
Facebook user can attest, when people know they’re being watched they have a tendency
to alter behavior….

Our recent Berkshire Hathaway (BRK) experience reinforces our conviction. Three years
ago BRK represented a slam-dunk idea yet drew unease from outsiders that had read our
letters, causing many to leave us at the altar due to our unconventional stance and
commitment to our reasoning. Had increased reporting exposed us to additional angst,
we would’ve been distracted at best, and abandoned the idea at worst, which would have
been a huge mistake given the rarity of the opportunity.

Berkshire Hathaway (BRK)

We unloaded most of our BRK position in 2014. Our decision was driven by outside
opportunities and a diminishing gap between price and value. I’m happy to report that
over roughly 41 months of ownership, our unconventional BRK holding outpaced the
S&P in fine fashion, registering a gain of more than 170%. The premise of our BRK
thesis always rested upon minimal risk concurrent with a high probability of adequate
return, analogous to a 3-yr T-bill yielding 15%. Such an unusual opportunity (carrying
almost zero chance of major loss) and associated large position size should be considered
an anomaly rather than a regular occurrence.

Sony (SNE)

Sony is a new holding, initiated midway through the year. A staid culture, bloated cost
structure, and bureaucratic mismanagement have long been hallmarks of SNE, and good
reasons for avoiding it. However, new management, led by C-suite execs, Kazuo Hirai
and Kenichiro Yoshida, seem committed to accountability, return on capital, and a
willingness to make tough decisions.

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SNE is a large company that generated $65+ billion in 2014 sales. This ample revenue
stream was produced by numerous businesses: Movies, Music, Games, Sensors,
Electronics, Phones, and even a financial arm. SNE’s unwieldy sprawl provides comfort
via diversity, and opportunity via refocusing resources.

In our view, SNE is heading in the right direction: focusing on businesses with solid
competitive positions and prospects for profitability, and shrinking or exiting divisions
that don’t. This is an uncommon approach−shrinking rarely brings out the champagne
bottles like chasing growth, yet in SNE’s case, it’s a blueprint for success.

We’re often drawn to opportunities like SNE: a simple idea, with a handful of sound
assets hidden under bloated costs and inefficiencies. When bloated costs and sound
assets clash with sharp management and a cheap stock price, opportunity lies in wait.

While Consoles and Sensors have been standout performers of late, we think SNE’s
Entertainment arm is a particular gem, littered with iconic assets that are both durable and
valuable (worth over half of SNE’s market cap in my opinion), and likely to grow in
value over time. Though profits can fluctuate from year to year (depending on financing
arrangements, box office success, syndications, etc.), the underlying assets are unique,
long-lived, and impossible to duplicate.

Investment success doesn’t require SNE to make cutting-edge breakthroughs to spur

growth, rather, simply aligning costs and a culture of accountability will create
substantial shareholder value. A 2014 Jefferies report highlighted some eye-opening facts
that show both the problem and the potential:

- SNE’s SG&A costs represent 33% of sales (dwarfing competitors) and represent
230% of 10-year cumulative operating profit.
- SNE’s SG&A spend was greater than its market cap.
- SNE’s R&D spend is on par with Apple, yet SNE fails to generate 50% of Apple’s
revenue.
- If SNE’s SG&A were inline with Samsung and Panasonic, operating profit would
increase to $7.5b vs. $1.3b today.

At this point, we feel that we’re past the cross-your-fingers stage. Management has taken
action on a number of fronts, having cut the dividend, exited the PC business, slashed
costs, and shrunk divisions, showing us that there’s mettle behind the message. Best of
all, if things go awry and the old status quo creeps back in, SNE’s bargain priced shares
should provide protection against major loss.

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Alleghany (Y)

Having long followed Y, we were giddy buyers as the share price dipped (ever so briefly)
midway through the year.

Started as a railroad rollup nearly 100 years ago, Alleghany ran highly leveraged into the
teeth of the Great Depression, requiring a rescue by JP Morgan. The founders died
penniless.

Today Y is predominantly in the insurance business, though it seems the scars of its
history have been imprinted on its culture. In fact, Y is commonly criticized for being
overly cautious and conservative; a catnip-like critique to fund managers attuned to Ben
Graham’s two rules of investing (rule #1, don’t lose money; rule #2, don’t forget rule #1).

The criticism seems to miss the long-term message of Y’s track record: a plodding
opportunistic history of financial acumen akin to the tortoise outpacing the hare.
Prudence litters the firm: premium volume to capital is sensible, loss reserving is
conservative, the investment approach makes sense, and smart incentives are in place.
We’re happy to be co-owners at current prices, accepting adequate prospective returns,
even if unspectacular.

Outerwall (OUTR)

Outerwall is a new addition to the portfolio though it shouldn’t be totally unknown to

long-time LPs with sharp memories (hint: we owned the predecessor 12 years ago).
Though largely considered a business headed for the history books, its core businesses
−today−are simple and profitable, and we think will linger much longer than the
consensus view.

OUTR’s main business, Redbox, is well known. The little red kiosks dispense DVDs
across the US, piggybacking on the footprints of retailers and embedding themselves
within their stores (or just outside of them). Redbox’s widespread convenience is married
to an unmatched low price, providing a compelling value proposition and a commanding
market position, which bearish investors liken to commanding the Titanic. In addition to
Redbox, OUTR also owns Coinstar, an automated coin kiosk that allows consumers to
trade coins for cash or gift certificates.

OUTR’s businesses have qualities that appeal to us: dense networks and low servicing
costs; low cap-ex requirements; little sales and marketing needs; fast cash conversion
cycles with minimal receivables; healthy cash flows; and dominant market positions built
upon unmatched value and convenience.

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The main risk to Redbox is obvious: consumers abandoning DVDs in favor of video-on-
demand (VOD) and streaming. In our view this is unlikely. Streaming shows little direct
threat, and the higher price of VOD (~$5) versus Redbox (~$1.5) has stifled VOD’s
traction. For the gap to shrink, studios would need to suffer lower profits or master
release-window alchemy with proper pricing. To date, and despite constant tinkering,
studios have been unable to crack the code. We believe the price gap will persist given
the supply chain structure and the makeup of studio profits (DVD’s account for roughly
70% of post box-office profits).

Critical to our thesis is OUTR’s cheap price and management’s intention to curtail
spending (some risk here), maximize free cash flow (FCF), and return cash to
shareholders. Over the last two years OUTR has shrunk the share count by 38%,
financed by debt and cash flow. Going forward, OUTR seems intent to continue the
trend. To show the potential, let’s look at the figures and make some rough assumptions
(for illustration we’ll assume 100% of FCF goes to share buybacks).

Shares outstanding: 18.6 million

Share price: $62
Market cap: $1.15b
Net Debt: $730m
Enterprise Value: $1.88b
Redbox adjusted FCF: $275m
Coinstar adjusted FCF: $75m
Venture Cap Ex: $50m (a reduction from current levels)
Total FCF: $300m

Even assuming FCF declines 12% per annum at Redbox, OUTR would be able to retire
68% of the shares outstanding in 3 years time; if the trend continued, the share count
would shrink 95% by late 2019, leaving owners with $170 in FCF per share. This
theoretical exercise isn’t a prediction, yet it shows the potential under a shrinking, yet
durable OUTR that’s capable of servicing its debt. Alternatively, if OUTR were to
choose dividends instead, investors would receive a current 25% yield.

Investors worried about longer-term risk should hope for a steep and sustained drop in
OUTR’s share price: if OUTR dropped 50% to $31 per share, and stayed there,
management could theoretically buy back 90% of the shares in 2 years’ time. This would
accelerate returns and reduce risk.

Our OUTR investment hinges on an unduly cheap stock price as an avenue to channel
cash flows. While this proposition is far from ideal on the hierarchy of investment
opportunities, and caps potential upside, at a low enough price OUTR offers a simple and
safe proposition to create value via share buybacks.

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Though OUTR is the investment I wrestle with most, we gain a measure of security from
Coinstar’s steady profits and I think the risk is worth taking at the current price.

Cimpress (CMPR)

Cimpress isn’t a new holding; rather it’s the new corporate name of the old Vistaprint.
CMPR’s multi-year repositioning is starting to resonate with consumers−and pay off for
investors−manifest by a growing base of loyal customers and increasing average order
values. Meanwhile, growing asset efficiency (a powerful long-running trend) is
combining with rising margins to generate high returns on capital and rapid earnings
growth.

Further, CMPR continues to widen its moat via advertising to win mindshare and
investments that increase quality and lower costs. CMPR’s dominant competitive
position, outstanding economics, and first-rate management team give us confidence in
its future.

XPO Logistics (XPO)

Though XPO holds massive growth potential, we became increasingly uncomfortable

with management’s aggressive stance of acquisitive growth. XPO induced further unease
when management expressed 2017 guidance−a dangerous move in our opinion−and we
sold our shares. Through a handful of name changes and three management teams our
XPO investment proved rewarding over our 7-year holding period, compounding at 28%.

CLOSING

Investment is most intelligent when it’s most businesslike ~ Benjamin Graham

2014 marked the 15-year anniversary of Arlington Value, and what a 15-year period it
was! One dot-com bubble of historical proportions, two bear markets, and an economic
wild-fire that brought bankruptcies and bail-outs aplenty. Through it all, Arlington
adhered to Ben Graham’s dictum above, applying a simple businesslike approach that, for
the most part, kept us fully invested through thick and thin. Underpinning our process
during this period was a mentality of buying businesses, not renting stocks.

A businesslike approach toward investing is rare among managers beholden to quarterly

measurements and hot money. The pervading culture affords little room to act on long-
term thinking and intrinsic value. Pundits and pros alike seem convinced that buried
treasure lies in forecasting near-term earnings and projecting P/E multiples as a proxy for

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 value. In our opinion, this approach is long on speculation and short on wisdom. We
think short-term earnings should be treated like appetizers at dinner: avoid overindulging
or you’llasmiss
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tomorrow. However, the stark reality is that most problems - and solutions
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Don’t get the wrong idea: our motivations are self-serving, driven by a mixture of
valor. But in part, this attitude is deep-rooted in the culture of Arlington; we think vigilance towards risk
personal and professional considerations. We think prioritizing returns will prove both
is the plow-horse to harvesting solid investment returns.
financially rewarding and emotionally satisfying, whereas being exposed to monthly
measurements,
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buoyant economic conditions. Crucial to adopting this favorable approach is maintaining a long-term
focus and making sure future partners share our long-term perspective. Like-minded business partners
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that breeds patience and prudence to stick to Graham’s businesslike approach.
Although we have learned much over the past decade, our underlying principles have not deviated since
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I will
risk and folly. We are certain to make mistakes in the future, but the guiding principles won’t change,
be candid with our assessment of size and prospects going forward, and will remain
functioning as a stable beacon in times of distress. Without a clear focus and sound philosophy, price
invested right alongside you.
fluctuations become the bugle that stampedes the cavalry.

Before
Our wrapping
first decade up, Benisdeserves
of operation satisfying special mention our
beyond appeasing for competitive
doing a tremendous amount
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work behind the scenes. Arlington reminds me of a pro cycling team: our success
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wouldn’t
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makeyourmy job easier. I get far more
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credit than I deserve, and returns would suffer without Ben’s efforts.
I enjoy the investment process as much today as I did when I started AVM ten years ago, and don’t
Both Ben
consider andwork
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all. I feeland grateful
fortunate and for your
agree withinvestment and trust,
president Reagan when and are“Hard
he said, energized
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never killed
to keep anyone,it.but why risk it.” I look forward to reporting to you again next year. As always,
earning
don’t hesitate to call or email with questions or comments.

Sincerely,
Sincerely,

Allan Mecham
Allan Mecham

4
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The information contained herein is a reflection of the opinions of Arlington Value Capital (Arlington) as of
the date of publication, and is subject to change without notice at any time subsequent to the date of issue.
Arlington does not represent that any opinion or projection will be realized. All the information provided is
for informational purposes only and should not be considered as investment advice or a recommendation to
purchase or sell any specific security. While it is believed that the information presented herein is reliable,
no representation or warranty is made concerning the accuracy of any data presented. This communication
is confidential and may not be reproduced without Arlington’s prior written consent.

This letter discusses only certain specific investments or holdings during the time period covered. For a full
list of the securities investments and holdings in Arlington’s investment vehicles, see Arlington’s Schedule
13F filings made with the SEC (available at www.sec.gov).

Indices are provided as market indicators only. It should not be assumed that holdings, volatility or
management style of any Arlington investment vehicle will, or is intended to, resemble that of the mentioned
indices. The comparison of this performance data to a single market index or other index is imperfect
because the former may contain options and other derivative securities, may include margin trading and
other leverage, and may not be as diversified as the S&P 500 Index or other indices. Index returns supplied
by various sources are believed to be accurate and reliable.

Past performance is not indicative of future performance. Inherent in any investment is the possibility of
loss.

This performance reporting is not an offer to sell or a solicitation of an offer to buy an interest in any
Arlington investment vehicle. Such an offer may only be made after you receive the investment vehicle's
Confidential Offering Memorandum and have had the opportunity to review its contents. This reporting
does not include certain information that should be considered relevant to an investment in Arlington’s
investment vehicles, including, but not limited to, significant risk factors and complex tax considerations.
For more information, please refer to the appropriate Memorandum and read it carefully before you invest.