RPN Explains Support For PICO Board. Century Ups Debt Issuance

There has been lively commentary on the RPN Comment Board the last week. We have also received several private emails of an emotional nature. These communications disagree with our support of the PICO Holdings‘ Board, encourage us to adopt a more confrontational posture with the PICO Board and find fault with the PICO Board’s governance and financial management.

In today’s post and our next post, we address the legitimate and appropriate concerns of our readers and we articulate our support the PICO Board, comprised of Daniel Silvers, Andrew Cates, Eric Speron, Max Webb and Greg Bylinsky.

We divide our explanation into two parts. In today’s post, we discuss the historical aspects of our analysis.  In our next post, we’ll expand on current PICO corporate governance and return of capital.

We’re sharing our opinion. Opinions are not facts. In that sense, this debate is a new phenomenon for PICO owners.  We are debating among ourselves the conduct and intentions of the PICO Board. Having this discussion is a quality problem!  A year ago, shareholders were abused and deceived by a corrupt and incompetent Legacy Board. At RPN, we are grateful that this situation is now past.

Given that we all express opinion, it will be a harvest season or two before the truth emerges. Both the supporters and the detractors of the PICO Board are reflecting on their own past business experience combined with their assimilation of the PICO facts up to this point, and arriving at a synthesis for a judgement going forward. By definition, we are all speculating.

With these posts, we are not engaging in argument with our fellow shareowners. Our loyalty to shareowner value is unquestioned. Our readers’ loyalty to shareowner value is equally certain. We all want the best economic outcome for PICO owners.

Put more simply, we ain’t sayin’ we are right and anyone else is wrong. We are elaborating on how we see the current PICO situation. We always leave the door open to being wrong – that’s what keeps us right more often than not.

History

A common and pertinent question in the capitalist environment is: “What have you done for me lately?”

This question is a fixed aspect of capitalism. We don’t dispute this mentality; economics is constantly changing, and inordinate loyalty for past achievements often produces losses. However, we feel a historical review is of useful here. We feel it sheds light on the PICO Board’s intentions.

The Palace Coup:

We go back six months. The PICO Board was dominated by Raymond “Delaymond” Marino and Hapless Howie Brownstein. To be brief, PICO’s corporate performance under these men was unacceptable. RPN wore our voice out with complaints about the poor stewardship of PICO under these men.

Then in early December 2016, the situation improved in an instant. Gone were self-interested Directors Marino and Brownstein, with the former removed as Chairman. In control were our shareholder oriented Directors. Simultaneously, we got welcome measures to strengthen corporate governance: Board declassification, a May 4 Annual Meeting, reduced number of Directors and compensation revision.

Granted, much of this was in the works before Messrs. Marino and Brownstein got the Boardroom stiff arm. But since then, the Board’s agenda and pace have been no less substantial (more on this in next post).

It would be easy to dismiss the Palace Coup as a power play by Messrs. Silvers, Cates and Speron. Surely a desire to play Empire at PICO was part of it. But for two reasons, we disagree that it was all about power. First, along with the removal of the self-interested Directors, this Board gave us improved corporate governance in the form of enhanced Director accountability. And since then, Director accountability has increased. That doesn’t sound like a pure power play to us.

Second, the shareholder-oriented Directors assumed considerable career risk by executing the Palace Coup, especially Mr. Silvers. As soon as one Director whispers into the ear of another Director, “I am sick of this nonsense. Let’s shake this PICO party up,” the risk meter skyrockets. The whisperer incurs the risk that the listener will turn Benedict Arnold and reveal the plot in pursuit of their own power grab. Such Boardroom conduct, if exposed prematurely, can be humiliating and damaging to a CV and to future earnings power.

But Mr. Silvers did not need just one fellow rebel, he needed three. The risk meter rose proportionally with each new recruit to the PICO Special Ops.

If at any time, the Palace Coup was either discovered accidentally or revealed deliberately, the participants — especially Mr. Silvers — risked a career damaging embarrassment. Such a mission must be consummated decisively, completely and flawlessly.

Messrs. Silvers, Cates and Speron did just that. The Palace Coup surprised everyone we talked to. All were pleased. And the blow was decisive and lethal.

We give these Directors high applause for both substance and execution of the Palace Coup. Perhaps we are too soft to be effective capitalists, but we continue to feel loyalty to these Directors for this bold and effective stroke which benefited PICO owners in huge measure.

Breaking Bogue – UCP:

We admire the PICO Board’s handling of UCP over the last few months. UCP has been an awful investee; corporate governance is poor, the business model is flawed, management is inept and profitability does not exist.

As the UCP deadline to nominate Directors and submit proposals neared, we wondered what PICO would do. We heard that at least one other UCP shareholder was poised to nominate a Director for Kathleen Wade‘s seat, in the event that the PICO Board went limp on this matter.

But the PICO Board appropriately went knuckles up against UCP. Not only was a rival Director nominated to contest Mrs. Wade’s seat, but a flurry of corporate governance improvement measures were proposed – all of which would have been approved, given PICO’s 57% ownership stake in UCP.

We salute the PICO Board’s posture in relation to UCP. In our experience, consensus building and harmonious negotiation only works when both parties are rational and honest. UCP Directors and Executives have a well established track record of ineptitude and dishonesty – so an MMA-approved approach was the only viable option.

In her fantastic book, “The White Sharks of Wall Street,” Diana Henriques quotes a takeover artist from a past generation: Thomas Mellon Evans. Mr. Evans reportedly said, “Pressure is often more effective than reason.” The PICO Board accurately assessed the UCP situation and took an appropriately firm stance. We believe this contributed to UCP’s willingness to sell itself and rid PICO owners of this burden. We applaud the current PICO Board for its appropriate activism towards Dustin Bogue and UCP.

Delaware Reincorporation:

We are all familiar with John “The Juicer” Hart’s 2015 and 2016 attempts to bait us into passing the Delaware Reincorporation Proposal. Juicer forced PICO owners into an unfortunate bargain whereby if we wanted protection of our economic value pursuant to Net Operating Losses, we had to provide Juicer and his corrupt and incompetent cronies with enhanced Director entrenchment and legal protection by voting “For” Delaware Reincorporation. Lost in the argument was the fact that the NOLs arose from Juicer’s incompetence.

In both 2015 and 2016, PICO owners presciently decided to risk losing the value of the NOLs in exchange for retention of stronger corporate governance. Recall that if we wanted NOL protection pursuant to Juicer’s Reincorporation Proposal, we had to relinquish cumulative voting, the ability to call a special meeting and freedom to act by written consent. We prudently rejected Juicer’s despicable horse trade.

The Delaware Reincorporation Proposal of 2017, which was authored by this PICO Board, was different. Like Vito Correleone in word (but not in spirit), this Board made us an offer PICO owners couldn’t refuse: we were offered protection of the NOLs and retention of all our rights as owners to remove Directors and enhance corporate governance. We were offered cake and a fork and knife with which to eat it, too.

In other words, the 2017 Proposal was a win-win for owners and it left PICO Directors just as vulnerable, or accountable, as they were before.

To us, such a gesture speaks volumes about this Board’s intentions.

Next post, we will opine on current events. Several readers feel the current Board is stewarding PICO in sub-optimal fashion. We will address those concerns.

Century Debt Issuance – Pieces Falling Into Place

On May 12, Century Communities announced a successful private debt issuance of $400 million in Senior Notes due 2025, to J.P. Morgan Securities LLC. The debt was issued at par and carries an interest rate of 5.875%. The principal amount is noteworthy because Century originally intended to issue only $300 million.

According to the SEC filing, “The Company intends to use a portion of the net proceeds from the offering for the repayment of outstanding debt under its revolving credit facility, and to the extent not used for such purpose, the Company intends to use the remainder of the net proceeds from the offering for general corporate purposes, which may include among other things, working capital and acquisitions, including the previously announced merger transaction with UCP, Inc.”

The initial purchasers of Century’s new debt and the amounts taken are:

JP Morgan Securities LLC                                $240,000,000
Merrill Lynch, Pierce, Fenner & Smith              $112,000,000
BBVA Securities Inc.                                          $12,000,000
Fifth Third Securities, Inc.                                  $12,000,000
U.S. Bancorp Investments, Inc.                         $12,000,000
WoodRock Securities L.P.                                 $12,000,000

PICO Annual Meeting – The Max Webb Show.

Leading up to the 2016 PICO Annual Meeting, shareholders were in a disgusted mood. The Legacy PICO Board had committed one shareholder abuse after another. PICO stock price bounced around all-time lows. RPN had just revealed that John “The Juicer” Hart and Kenneth “The Slug” Slepicka had perpetrated an undisclosed related transaction that made both men conflicted.

At the Annual Meeting, Juicer spread disinformation and deception and implied that a shareholder-led conspiracy stymied his ability to create value. Carlos “NACD-Decorated Horse Thief” Campbell spun a prolonged lie to PICO owners with a straight face, thereby earning the moniker we have bestowed upon him. Raymond “Delaymond” Marino pretended like everything was under control and everyone was focused on creating value for shareowners. Stellar corporate governance, imminent assets sales, return of capital – all in the offing, Delaymond assured us.

In summary, the 2016 PICO Annual Meeting was the epitome of the Principal – Agent Problem manifested in real life.

(Bloomberg recently reported that protestors in Venezuela have begun hurling containers of feces at government forces. Called “poopootov cocktails,” these projectiles are intended to disgust, insult and repel. It is a good thing such events were not reported before the 2016 PICO Annual Meeting; a fecally enterprising shareowner might have taken aim at Juicer.)

2017 – The Max Webb Show

The PICO 2017 Annual Meeting was polar opposite. There were no incompetent or self-interested Directors in the room. Assets have been sold. A micro return of capital has taken place and profuse promises (which we believe are earnest) have been made to return more. PICO stock has reached $17 per share. UCP and its prodigal CEO Dustin Bogue are poised to be someone else’s problem.

It wasn’t exactly an audience with the Dalai Lama. But the 2017 Annual Meeting consisted of good shareowners communicating with good Directors, and everyone had good thoughts and good intentions in mind.

PICO’s CEO Max Webb did 99% of the non-Vidler talking at the Annual Meeting – and some of the Vidler talking. He was composed, articulate and at ease with his new, elevated responsibility. Mr. Webb showed us why his continued presence at PICO benefits shareowners – although he is not coming cheap. Mr. Webb has mastery of both UCP and the Vidler assets and is clearly the best choice to lead the liquidation process. PICO is no ordinary liquidation.

Dorothy Timian-Palmer impressed everyone with her technical knowledge, as she always does. She adroitly fielded questions about Vidler’s water assets, with added commentary on the largest ones.

Corporate costs have come down since the last update a few months ago. Annual overhead was estimated at a $9.9 million run rate on the Q4 earnings call. This has been reduced to $9.1 million currently. Once UCP is transacted and certain Vidler projects are completed, Mr. Webb predicts general corporate expenses will come down still more.

The biggest disappointment of the 2017 Annual Meeting was the 9,993,802 PICO shares that approved the fusion the CEO/Chairman roles. We have articulated our opposition to this proposal. We feel it is structurally unsound, we don’t feel Mr. Webb earned the right to be Chairman and it rewards bad behavior. The flip side is that Daniel Silvers would have made an excellent Chairman. He has proven his shareholder orientation, he is unafraid in the Boardroom and he is unconflicted by compensation issues. Mr. Silvers also deserved the Chairman slot after leading the Palace Coup, which expelled the merchants from the temple.

Winston Churchill once said, “The best argument against democracy is a five minute conversation with the average voter.” We allocate the 9,993,802 “For” votes on this proposal into the same category.

Andrew “Andy” Shapiro appropriately asked the Board to be sensitive to base Executive Compensation as PICO is reduced in both size and complexity. We have been saying the same thing for a long time. Andy is right, but it will never happen – not in a million years.

Return Of Capital – Micro

It’s so small, you may have missed it. PICO returned capital to owners in Q1 2017. The 10-Q reveals that PICO bought back 13,400 shares at an average price of $13.70 per share, worth $184,000.

On the RPN Comment Board, many readers have been vocal about their desire for capital return. However, due to the Century/UCP negotiations, PICO was blacked out from repurchasing shares for the last several months. PICO has provided effusive assurances that more capital return is coming. Any such measure will be less effective with a $17 stock price, but most investors expect continued share buybacks and a Dutch Tender is probably in our future.

This brings us to an important question. How much capital does PICO have to return to owners? Let’s break it down.

PICO publicly stated on the Q4 earnings call that there was $20 million available for return of capital. At the close of the UCP deal, which is expected by the end of Q3, PICO will receive about $55 million in cash. Sixty one days after deal close, PICO can sell about 1.25 million Century shares. At the current price of $26 per Century share, such a transaction would yield another $32 million.

By the end of 2017, PICO could potentially return about $100 million to owners.

By the end of Q1 2018, PICO can sell the tag end of its Century position. At today’s price of $26, this sale of about 1.15 million shares would yield another $30 million. By Q1 2018, PICO could potentially return about $130 million to owners.

PICO Porn

We don’t want to get too excited. And we don’t want to get you too excited. But a few shareholders speculate that PICO won’t be around in 2 years. These shareholders believe that with UCP jettisoned, a strong economy in Vidler’s markets and a continued positive outlook for water assets, “patient capital” will bid for the entire Vidler portfolio. These owners theorize that a patient investor will buy the whole Vidler enchilada, cut overhead and public company expenses, preserve the Vidler employee core, and patiently liquidate the water assets piecemeal.

Such a scenario makes greater sense with the high potential for corporate tax reform which, in one swoop, will reduce the value of PICO’s (and all corporate America’s) NOLs. With the NOLs suddenly worth less, an “Ownership Change,” as defined by Section 382 of the Tax Code, does not produce such a scary reduction in value.

We have no knowledge of such a scenario. It is one possible scenario for PICO’s future. There are many others.

In conclusion, this is a different PICO. Corruption and incompetence have been replaced by shareholder orientation and capability. As we have been saying for several months, the future for PICO owners looks bright.

Century – Locked And Loaded

On May 8, Century Communities announced that it will offer $300 million of Senior Notes due 2025. Century will use a portion of proceeds to repay its revolving credit facility and the remainder will go to “general corporate purposes, which may include among other things, working capital and acquisitions, including the previously announced merger transaction with UCP, Inc.”

Go Century!

Century Files Registration Statement. UCP – The Girl No One Wants To Dance With.

On May 5, Century Communities filed its Form S-4 Registration Statement with the SEC. The S-4 is the controlling document for Century’s pending absorption of UCP. We suggest that PICO Holdings and UCP shareowners take a glance at it. There are some informational curiosities. We highlight a few.

Century – Persistent Suitor (And Only Suitor)

“Background of the Merger” is the most interesting section. The narrative reveals that Century and UCP already danced a few tangos before the current deal was signed. In the Spring of 2015, two homebuilders independently approached UCP about an acquisition, one of them was Century.  In response, UCP decided to test the market. With the help of deal banker Citigroup Global Markets, UCP shopped itself to 12 potential acquirers, with 10 signing confidentiality agreements. Four potential buyers submitted indications of interest, two completed due diligence, and one, Century, submitted a non-binding acquisition proposal. The Century offer envisioned an exchange of cash and stock worth about $10.00 per UCP share.

We make two observations. First, this would have been a big acquisition for Century at the time. In Spring of 2015, Century’s balance sheet wasn’t that much bigger than UCP’s. According to Century’s 2014 10-K, assets were $676 million and equity was $365 million. At that time, UCP’s assets were $377 million and equity $211 million. An acquisition of UCP by Century would have increased assets by 56%.

Second, although the current deal price at $11.35 per share is 13.5% higher than that offered in Spring 2015, PICO/UCP investors are economically no better off. Between Spring 2015 and today, the S&P 500 has gone from roughly 2,100 to 2,400, a gain of about 14%, which is approximately equal to the gain in deal price. In other words, if UCP had been sold in 2015, UCP/PICO owners could have taken their proceeds and invested in the S&P 500 and gotten the same result as the current offer of $11.35 per share.

There is one major “could have been.” If PICO had gotten its UCP money in 2015, it could have bought back millions of PICO shares when the stock price Valeanted to single digits in early 2016. Assuming PICO bought its own shares at $10 in early 2016, it could have bought back 10 million shares with the $104 million it would have garnered from a 2015 UCP sale at $10 per share. From RPN’s lips to God’s ears.

The 2015 deal was never transacted and Century came back to UCP a year later. The narrative tells us that in Spring 2016, Century proposed a deal for UCP at $6.58 per share. In colonial times, such an offer would have been seen as an insult and would have resulted in a pistol duel at 20 paces.

In early 2017, with UCP approaching financial distress after the 2016 botched debt offering, the Board and its I-Bankers began to shop UCP. “Party A” responded but indicated it was occupied in the near term. We suspect “Party A” was either Lennar or Pulte Group, both geographically logical buyers of UCP. Lennar would have been in the middle of the largish WCI Communities acquisition and Pulte had just completed a decent-sized deal in Atlanta, plus was navigating considerable Boardroom tumult.

When Century was contacted early this year, the talks began easily. Century already knew UCP from their previous flirtations. But once the initial overture was made, progress advanced arduously – the narrative is 2-3 times longer than normal.

There were a lot of issues that prolonged and complicated negotiations. Most importantly, instead of two parties, this deal involved three: UCP, Century and PICO – each with its own law firm. There seems to be an inverse correlation between the number of lawyers and deal expediency – which proved true in this case. Second, UCP’s hand was considerably weakened by its lack of options regarding the $75 million October 2017 debt maturity. The narrative indicates that UCP sought desperately for better terms and a higher price, but was mostly unsuccessful.

California Assembly Bill No. 199, which proposes to raise costs on builders operating in that state, caused Century to hesitate. Century wanted a higher vote percentage from PICO in the case of an Intervening Event. UCP wanted Century to deal a smaller percentage of shares, to avoid the risk of a Century shareholder vote. UCP wanted freedom to address the October 2017 debt maturity, and Century was reluctant. PICO wanted liberty to deal its stake.  On and on it goes.

Once the Century process went live, Citigroup I-Bankers diligently peddled UCP in pursuit of the highest and best price. Citi contacted 16 potential counterparties. Five entered into confidentiality agreements and received access to UCP’s virtual data room. On April 6, “Party E” proposed an all-stock transaction at around $9.50 to $9.75 per share.

On April 7, “Party F” proposed to buy UCP for cash at $14.29 to $16.67 per share. However, Party F had not retained legal or financial advisors and required 2-3 months to complete due diligence. Ultimately, Party F’s far higher offer was declined due to its delayed start, prolonged timeline and Citi’s belief that Party F had limited experience with transactions in the United States. Given the October 2017 debt maturity, UCP did not have the luxury of time nor the freedom to play one party off against the other.

UCP tried to use the Party F offer to extract better terms from Century, but the bluff was called and the rest is history.

Today, Party F represents UCP/PICO shareowners’ best hope for a superior  price for our asset. Party F indicated it needed 2-3 months for proper due diligence; that was in early April. Assuming Party F is still interested in UCP, it should only need 1-2 months more before it is ready to propose a deal. Party F is a foreign buyer and likely has considerably lower profitability hurdle rates than Century. Fingers crossed.

RPN Miscalculates (Probably)

A few weeks back, we told you that we liked UCP at $11.20 per share. Our rationale was based on the assumption that Century made an opportunistic offer for UCP, which started the bidding. The Registration Statement clarifies that our assumption was wrong. It appears that UCP has made the rounds among suitors and has been found wanting. We do not attach a high probability to an alternative offer from Party F. Therefore, our investment thesis for UCP at $11.20 per share now appears to be a miscalculation.

On a few occasions, we predicted that UCP would sell in the $13-$15 range if put out to bid. That prognostication now also looks faulty.

Our miscalculation fortifies the importance of Benjamin Graham’s margin of safety. We were fortunate to read Mr. Graham’s work early in our business trajectory. In Security Analysis, Mr. Graham makes a statement to the effect that, when margin of safety is properly employed, even if events do not work out as well as the analyst expects, the result should still be more than satisfactory.

Barring a higher offer from Party F, it appears that we have been overly optimistic in our valuation of UCP – an error which we take seriously. However, coherent with Mr. Graham’s margin of safety concept, we were conservative enough in our purchase price so that we are still poised to earn a more than satisfactory result. We hope the same for all our readers.

Life Isn’t Fair(ness)

Citi’s Fairness Opinion corroborates what we have been saying about UCP for the past year. On a standalone operating basis, Citigroup’s bankers agree that UCP is only worth $7-$9 per share. Citi also supports our contention that the deal price is at the extreme low end compared with recent comparable transactions.

Given the low deal price and the considerable concessions UCP made in negotiations, it is clear that Century drove a hard bargain. Dale and Robert Francescon, the brothers that Co-CEO Century, have done well by their owners. If PICO marries off UCP for an $11.35 per share dowry, Century is almost guaranteed to create significant value for its owners. We admire the Francescon brothers’ style, but we don’t like the result from the other side of the table.

As we have said many times, Chairman Michael Cortney and CEO Dustin Bogue got into a pickle with their mismanagement of UCP’s debt profile, the botched Senior Notes refinancing and their poor stewardship of UCP over the last 4 years. UCP’s debt difficulties and lack of profitability provided them little freedom or bargaining power throughout this process.

Messrs. Cortney and Bogue have created zero value for owners in 4 years as stewards of UCP. The firm went public in July 2013 with about $220 million in equity capital. Four years later, it is being sold for $210 million. Other builders have accumulated considerable equity during this time and builder assets are being transacted at 1.2 – 1.5 times tangible book value.

Messrs. Cortney and Bogue have earned rich compensation, while UCP has been a value transfer machine, donating owner’s capital from our pockets to those of directors, executives, employees and contract employees. Much valuable real estate has been sold off at zero (or negative) profit to the owners of the business.

We understand that Mr. Bogue wanted to make a go of it. He wanted to see if he could turn UCP into the next D.R. Horton. Dr. John Douillard, in his book “Mind, Body and Sport,” which everyone with a heartbeat should read, said, “To accept limitation goes against the grain of human nature, which is always to seek higher achievement…”

We, as shareowners, take issue with four aspects of Mr. Bogue’s effort: his frequent unethical conduct, his high compensation, his inability to accept reality when the dream was clearly not coming to fruition and the extreme measure by which he destroyed value for owners.

In the near term, life is often not fair. It is not fair that Mr. Bogue will walk from this transaction with a $2 million dollar payday while Daniel Silvers, Andrew Cates and Eric Speron earned around $115,000 for their 300-pound benchpress equivalent in 2016 (actually, Mr. Speron worked for free). If life were fair, Mr. Bogue’s payout would be cut by 75% and these three Directors would have earned twice as much in 2016. But life and fairness do not always run parallel.

These PICO Directors will have to be content with the knowledge that they have done right by owners and the broader financial community, despite deserving more pay. They have placed PICO on firm corporate governance footing for shareholder value maximization. They have participated in the monetization of UCP – which was the only economically rational result for such a value destroying machine.

These men are in good company. At RPN, we know a little bit about donating resources for the benefit of a greater community.