RPN Proxy Card – Our Rationale. Century/UCP Deal Revisited.

The PICO Holdings Annual Meeting will take place on May 4, in Reno, Nevada. The Peppermill Resort Hotel is the venue.

Cinco de Mayo, the less important of two Mexican independence day commemorations, will take place the day following the Annual Meeting. In San Diego at least, this day is most enthusiastically celebrated by gringos. If visits to Old Town for margaritas and tequila shots with lime are a celebration of Mexican culture, then Cinco de Mayo is a bona fide cultural event in San Diego.

We suggest that PICO shareowners who remain in Reno on May 5, get together for an informal Cinco de Mayo celebration. Someone should bring a John Hart pinata. There should be plenty of PICO owners willing to take a few swings.

RPN Proxy Card

Below is the RPN Proxy Card:

  1. Director Nominees (5): “For”
  2. Chairman/CEO Combination: “Against”
  3. NEO Compensation: “For”
  4. Compensation Frequency: “1 Year”
  5. Auditor Ratification (D&T): “For”
  6. Delaware Reincorporation: “For”
  7. Adjournment: “Against”

Judging by opinions posted on the RPN comment board and sent in private emails, our endorsement of Delaware Reincorporation is likely to spark some controversy among our readers.

As it should.

Delaware Reincorporation is a polemical issue and we do not shout our rationale with confidence from the rooftops. We view a “For” vote as the slightly better choice today, but it could be many moons before the wisdom (or lack thereof) of this selection becomes clear.

We come down in favor of Delaware Reincorporation for a few reasons. First, this Board has mostly proven itself. While shareowners benefited from the palace coup in December 2016, many dismissed it as a power play, not a manifestation of shareholder orientation.

But along with the palace coup, these Directors moved up the date of the Annual Meeting, declassified the Board, got rid of self-interested Directors, gave owners a choice on Chairman/CEO fusion and took their compensation in PICO equity.

Since then, the Board has renegotiated pay (which turned out only OK, but the Board’s hand were tied), played hardball with UCP, brought large shareowner Greg Bylinsky to the Board (granting him “Observer” status so his participation began immediately), has sold assets and tenuously pledged return of capital.

Regards the Delaware Reincorporation proposal itself, the Board retained cumulative voting, written consent, the 10% threshold to call a special meeting and improved the terms of blank check preferred stock.

Cumulatively, we believe these are the actions of a Board that can be trusted. If we are wrong, as of May 5, PICO will have two large shareowners on a Board of 5 Directors and owners will retain plenty of tools with which to remove the self-interested from the Board room.

Let’s not forget that there is an economic purpose to Delaware Reincorporation: it will protect PICO’s NOLs. These deferred tax assets have the potential to create significant economic value for PICO owners if/when assets are sold above their tax bases. We believe that the two tranches of Long Term Storage Credits were sold at prices far above their tax bases, and utilization of the NOLs will make that gain entirely or mostly tax free to PICO owners. Our guess is that the savings might be $2-3 million.

This Board has disappointed in a few areas. First, compensation could have benefited owners more. We would have preferred that the Compensation Committee played a tougher hand with CEO Max Webb and CFO John Perri. Both men make around $500K. When UCP is sold, PICO’s assets will decline from $670 million to roughly $236 million and market capitalization will shrink from $370 million to $250 million. Half a million dollars per year, plus bonuses, is large compensation for two guys managing the liquidation of a nanocap firm – especially given that all the units have their own management.

Second, the cryptic and still unknown UCP monetization incentive bonus is economically irrational. We feel the Board, especially the Compensation Committee, has handled the issue very poorly, by not making the specifics known. The Board has essentially said, “We will pay it.” Shareowners have no idea under what circumstances, how it will be calculated or how much will be paid.  We strongly encourage the Board to disclose everything on this topic at the Annual Meeting.

Last, shareowners were disappointed when the Compensation Committee refused to “commit” return of capital in 2016. This swung a gross $25 million into the Bonus Pool for 2017, potentially increasing bonuses for PICO Management, all of whom have been paid handsomely for years while owners have suffered.

When we summed the columns, we still come down in favor of these Directors and their proposal for Delaware Reincorporation. The Legacy PICO Board was awful. The intermediate Board under Raymond “Delaymond” Marino was bad. This Board configuration appears to us to be very, very good. When you have had an abusive lover for years, and you meet one that treats you well (both in and out of bed), you don’t give them the stiff arm because they leave the cap off the toothpaste. In other words, this Board may not have done everything we would like, but there has been plenty of good faith indicators, so RPN will extend the benefit of the doubt and vote “For” Reincorporation.

We vote “Against” Adjournment because we don’t believe in renegotiating deals on the fly. In our eyes, it should pass or be thrown out.

Many of our readers will disagree with our Delaware Reincorporation endorsement and we like it that way; healthy dialogue makes the world a better place. We welcome diversity of opinion and we encourage all readers to voice their thoughts on Delaware Reincorporation, and any other PICO corporate governance matters.

The UCP Deal Revisited

The Century Communities/UCP transaction has had time to sink in. To our surprise, builder pundits are not calling for a higher price for UCP (but M&A litigation attorneys are). Perhaps we are wrong about our UCP valuation – time will tell.

Century will release Q1 earnings on May 4. PICO/UCP shareholders should be rooting for the highest numbers possible. The Agreement and Plan of Merger contains no collar, so increases in Century’s stock price will raise UCP owners’ economic fortunes. Go Century!

We believe there will be another bid for UCP. We articulated several reasons last post. Today, we add to that discussion.

Century is an ambitious, scrappy upstart with an aggressive growth strategy that involves some organic expansion, but its emphasis is on acquisition. With the UCP deal, Century will enter the California and Washington geographies with designs for a greater presence in both markets.

Today, housing resources in California and Washington are scarce. Land is hard to come by and is increasing in price. Permitting, entitling, environmental and other regulatory hurdles take record time. There is an acute shortage of tradespeople.

Incumbent California and Washington builders shouldn’t be happy about Century’s entry into their markets. With the UCP deal, Century will establish a presence and then grow aggressively. It will compete with incumbent builders for land, regulatory resources, tradespeople and industry expertise – in markets where all such commodities are scarce.

Century’s proposed presence in these markets will surely make life tougher for incumbent builders. What is the alternative? The price Century is offering for UCP is low. We believe that a bigger builder can easily justify a higher bid for UCP, both from a value creation perspective and from a competitive strategy perspective.

A higher bid from a larger builder stands a good chance of winning. Century is not a large builder, its balance sheet today is only $1 billion in assets (CalAtlantic hefts around $9 billion).

While Century’s balance sheet is not weak, its debt to capital ratio is not conservative and is higher than larger peers. This, and Century’s short operating history, will limit its borrowing capacity. All of the above means Century pays higher interest rates, which further inhibits its ability to stretch a bid. In other words, Century cannot win a bidding war.

We believe the spreadsheets are being built right now.

Correction: Intervening Event

In our last post, we wrote that if UCP received a superior proposal, PICO still had to deliver 28% of votes in favor of the Century/UCP deal.

An astute PICO observer informed us that this was inaccurate.

If the UCP Board changes its voting recommendation in response to an “Intervening Event,” then PICO still must deliver 28% of its votes in favor of the Century/UCP transaction. An Intervening Event is described below, as per the Agreement and Plan of Merger:

Company Intervening Event” means an event, state of facts, change, discovery, development or circumstance that is material to the Company and its Subsidiaries (and not of a general economic, industry or market nature, except to the extent the Company is affected in a beneficially disproportionate manner compared to other companies that operate in the Company’s industry sector and which other companies conduct substantially the same businesses as the Company and the Company Subsidiaries currently operating), taken as a whole, that was not known or reasonably foreseeable by the Company Board as of or prior to the date of this Agreement, and which event, state of facts, change, discovery, development or circumstance becomes known to the Company Board prior to obtaining the Company Stockholder Approval; provided, however, that in no event shall any of the following constitute a Company Intervening Event: (i) any Company Takeover Proposal or Superior Company Proposal, or any inquiry, offer or proposal that constitutes or that reasonably can be expected to lead to or result in any Company Takeover Proposal or Superior Company Proposal; or (ii) any change in the price or trading volume of the Company Common Stock or the Company’s credit rating (except that this clause (ii) will not prevent or otherwise affect a determination that any change, effect, event, circumstance, development or occurrence underlying such change has resulted in or contributed to a Company Intervening Event).

If you read and understood all that, you are either an attorney or a member of Mensa. An Intervening Event is something influential factor that comes to the UCP Board which compels them to change their recommendation to UCP owners. But a superior proposal or change in business climate do not meet this definition. It sounds like a low-probability scenario to us.

Conclusion

Barring significant news pre-May 4, this will be our last post until the PICO Annual Meeting. As we will be unable to attend, we encourage readers to relay their impressions and opinions on what transpires.

When we wrote about the Annual Meeting, we did not predict the kindness of Mother Nature. The potential activities for attendees now include hitting the slopes of Tahoe for some skiing! Who would have thought PICO owners might be skiing in May? Life is wonderfully unpredictable.

Century Offers Lowball $11.35 For UCP. PICO’s Builder Now In Play.

Leave it to Michael Cortney and Dustin Bogue to strike the only homebuilder deal in the last several years priced below book value. But that’s the offer on the table from Century Communities, Inc., for UCP.

You know the details. Century offers UCP shareowners $5.32 in cash and .2309 shares of Century Communities for each UCP share owned. The deal is worth $11.42 per share as of Wednesday’s close. Tangible book value of UCP is about $12.13 per share; the discount is about 5%.

We don’t blame Century for offering a fixer-upper price for UCP. But as a shareowner, we are not thrilled with the offer. The SEC filings contain lots of minutiae, so let’s focus on the important points.

UCP Is In Play

Both the UCP and Century Boards have approved the deal. Both Boards will recommend it to their shareowners. PICO has entered into a Voting Agreement, whereby it will vote its roughly 57% stake in favor of the transaction.

Per the Agreement and Plan of Merger, UCP must terminate all conversations and interactions with other potential UCP purchasers. UCP may not actively solicit or seek an alternative transaction. While this may sound like a strict “No Shop” clause, one legally-versed member of our panel commented, “That just means UCP and its bankers can’t make outbound calls.”

If another bidder comes forward with a viable bid superior to the Century offer, UCP may pursue it. During that process, UCP must keep Century intimately informed. Century may match any alternative offer. Interestingly, if a superior transaction materializes and the UCP Board recommends it to owners, PICO still has to deliver at least 28% of UCP’s votes in support of the UCP-Century deal.

If the Century deal is called off in lieu of a superior transaction, Century will collect a $7 million termination fee.

Within 3 weeks, Century will file with the SEC its 2017 Proxy Statement combined with the transaction’s S-4. This document will contain the “Deal Narrative,” which will provide many clarifications. Stay tuned.

We view this transaction as an enormous positive for both UCP and PICO shareowners. If we had to guess, we’d say that UCP was probably talking to multiple potential purchasers. Century was the most aggressive and demanded certain protections and rights. UCP readily agreed.  As a result, there’s now a floor on the UCP share price, the October debt maturity has a solution, and UCP is effectively in play. We view a forthcoming superior offer as likely, given that we estimate the fair market value of UCP’s assets to be greater than $11.75 – which is the deal price plus the termination fee.

We believe UCP will garner a higher price for several reasons. First, we believe that the fair market value for UCP’s assets is higher than Century’s offer. Second, UCP and Century enjoy almost no overlap; an in-market strategic buyer can offer a higher price expecting to realize efficiencies. Third, we believe that no real bidding has taken place, as potential acquirers were scared off by tumultuous change and uncertain leadership at UCP. Fourth, the UCP portfolio has scarcity value; it’s not every day that a large builder can write one check to snatch 6,638 owned and controlled lots in some of America’s best housing markets. Last, UCP’s poor corporate governance and management present an unusual cost saving opportunity; no UCP executive or director need be retained.

Want evidence for that last opinion? No UCP Director or Executive will join the Century Board of Directors. It is especially telling that Mr. Bogue, only 42 years old, was stiff-armed from the Century Board.

Other PICO’s Money

Matters are simple for UCP owners: wait for a higher offer and if none arrives, collect roughly $11.35 per share in cash and shares sometime in Q3. But what about PICO owners?

At current prices, PICO stands to receive roughly $118 million in value. Upon closing, PICO will receive roughly $55 million in cash and 2.4 million Century shares. PICO must hold its Century shares for 60 days after the merger. Between Day 61 and Day 210 following the merger, PICO may sell 5% of Century outstanding shares every 50 days. After 210 days have elapsed, PICO may sell its Century shares at will.

We speculate that PICO will unload its Century stake at the first opportunity, which would be a sale of roughly 1.25 million Century shares on Day 61 and a sale of the remaining roughly 1.15 million shares on Day 111. There are a few reasons for this prediction. First, we believe that Daniel Silvers and his Board are aware that homebuilding is a tough business, characterized by low profitability, low barriers to entry, substantial operating risk and volatile industry conditions. Second, we believe that our large shareowner Directors Eric Speron and Greg Bylinsky will demand a return of capital. Third, no PICO representative will join the Century Board, which would be unusual for a 9% owner with long term intentions. Last, monetization and return of capital are the only mandates PICO has today.

If the UCP-Century transaction closes in the middle of Q3, PICO owners could see the capital related to the shares returned in early 2018. If the deal closes early in Q3, a late 2017 return of capital has an outside probability.

Dustin Bogue – Rogue Pays

We are no fans of Mr. Bogue. We have listed his corporate governance improprieties, track record of value destruction and abuses of shareholders in previous posts. There are many examples of each.

Much like John “The Juicer” Hart, Mr. Bogue surrounded himself with lackeys of low ethical profile who fortified his economic future at the expense of owners. As a result of the UCP-Century deal, Mr. Bogue will emerge far wealthier than his performance at UCP merits. The only manifestation of just rewards is that Mr. Bogue takes a serious demotion from CEO of UCP to Regional President – West, of Century. Mr. Bogue will not be an influential executive and will have no direct channel to the Century Board. We feel Century has read the situation correctly and such a position is more coherent with Mr. Bogue’s abilities and ethical profile. Only at the behest of the corrupt and incompetent Juicer would someone like Mr. Bogue get an unmerited shot at CEO.

Vesting of Mr. Bogue’s restricted stock units will accelerate over two years after the deal closes. Century will pay him a one-time deal bonus of three times the sum of base salary and average annual bonus for the past three fiscal years, which totals to $1,972,639. If our math is correct, Mr. Cortney and Peter Lori, members of the dubiously configured UCP Compensation Committee, awarded Mr. Bogue a bonus of $266,639 for 2016. Given that UCP’s annual metrics were below industry averages and UCP destroyed over $20 million in economic value, we find a bonus payment inappropriate and irrational. Messrs. Cortney and Lori continue to prove to UCP owners why they are unfit to steward a public corporation. We will wait for the UCP 2017 Proxy Statement to verify.

Mr. Bogue’s stock options will be canceled. This concession is meaningless given that the average strike price of UCP’s 116,652 outstanding options was $16.20.

The deal is an ignominious conclusion to Mr. Bogue’s unmerited run as CEO. UCP went public at $15 per share almost 4 years ago. Mr. Bogue’s UCP has underperformed all industry metrics and its share price has underperformed broader indices and builder industry averages. This chart compares UCP’s share price performance with the SPDR Homebuilders ETF (XHB):

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UCP Incentive Compensation Unjustified

PICO has indicated that it will pay CEO Max Webb incentive compensation to monetize UCP. Details have not been revealed, we believe for both strategic and legal reasons. We, and an overwhelming majority of PICO owners and observers, felt that such incentive compensation was ridiculous and irrational.

Now that a UCP transaction is out in the open, and it was managed by UCP, we call on Andrew Cates and the PICO Compensation Committee to clarify the proposed incentive compensation for the monetization of UCP. Transparency is the hallmark of dignified and just corporate governance; secrecy is manifest of darker goings on. If Mr. Cates and the PICO Comp Committee are confident in the Solomonism of the UCP incentive compensation, they should reveal it to the owners of the business. Anything less is suspect.

Given that UCP sold itself, with Mr. Webb as only one of 6 Directors (and soon to be one of 7), and given that the price is sub-book value, which is far lower than other homebuilders have transacted recently, RPN sees no reason to pay a bonus to anyone. The price is not high and Mr. Webb did not accelerate the process; $121 million in 2017 debt maturities took care of the motivation for a sale.

If Mr. Cates and the Comp Committee do not clarify the UCP monetization bonus before the Annual Meeting, we will grow very suspicious. Transparency is the linchpin of equitable corporate governance and any money paid to Mr. Webb will come from PICO owner’s pockets. We have been suspicious on this matter from the start and we gain no confidence from the April 11 SEC filings: the PICO Comp Committee suspiciously missed the opportunity to clarify this matter within the deluge of documents filed in relation to the UCP/Century transaction.

UCP has disclosed all relevant details. Century has disclosed all relevant details. It only makes sense that PICO should disclose all relevant details.

UCP’s fate is now sealed with a 99% probability. The chances of this deal coming unbuckled are almost nil. There is no longer a legal nor strategic justification for keeping PICO owners uninformed. Now is the time to disclose.

Lawyers, Lawyers Everywhere

There have been many lawyers involved in the UCP/PICO saga over the last few years. The UCP-Century deal has its cadre already lining up. No fewer than four law firms are preparing to challenge the UCP Board’s business judgment and failure to maximize value for shareholders. The salivating law firms (and links to their overtures) are:

  1. Kahn, Swick & Foti;
  2. The Briscoe Law Firm;
  3. Johnson & Weaver; and
  4. Rigrodsky & Long.

These attorneys will allege that the UCP Board failed to maximize value for UCP owners. They will also investigate self-dealing, conflict of interest and the like. Perhaps. But we don’t think a lawyer is needed to remedy the situation. We believe everyone and their poodle in homebuilding knows about the UCP-Century deal and those economically inclined to submit bids will do so.

If you contact any of these firms, please email us with pertinent details of your conversation. We will be curious to hear.

RPN Editorial

Given the low price of the UCP-Century deal — especially compared with other recent builder transactions — if no superior proposal materializes, UCP investors may want to consider exercising their appraisal rights. This proposition is a little complicated and will require that most investors engage the services of an attorney. More on this possibility later.

Our Crack Strategist made an interesting observation. He said: “These guys know how to keep a secret. UCP was trading in the low $9s in the days before the deal was announced. Clearly no word was leaked.”

Compliments to all involved for maintaining the integrity of capital markets.

RPN Likes UCP

About a year ago, we told you we loved UCP at $5.50 and $6.00 per share.  About 7 months ago, we told you we liked UCP at $8.50 per share. Now, we like UCP at $11.20 per share – yesterday’s closing price. Here is our logic.

This deal will go through; the probability of collapse is infinitesimal. On the UCP side, we have a very motivated seller. PICO has already agreed to vote its 57% controlling stake. The UCP Board has already approved the deal and will recommend it to owners. UCP is staring at a $121 million wall of debt maturity.

On Century’s side, they are getting UCP at a bargain price. Analysts and investors have voiced positive noises about the deal. S&P proposes to raise Century’s outlook based on the transaction. Century’s Board has also approved the deal and will recommend it to its owners.

We believe that investors have a firm floor on UCP shares in the $11 range. We believe that a superior proposal is likely. Therefore, we believe investors have small probability of a downside scenario and decent probability of making a few points to the upside within a short time. We are not normally fans of the naked long arb when it comes to mergers, but every case must be evaluated on its merits and we feel this is the rare exception.

Builder acquisitions close quickly, sometimes within 2 months. We are not talking about banks or companies that must get regulatory approval to combine. Any naked long arb position is likely to be outstanding for a relatively short time.

This play is not without risks. As our Crack Strategist noted, Century’s share price could decline, builder industry conditions could unexpectedly collapse or due diligence could produce a smelly fish, compelling Century to back out of deal.

Conclusion

RPN has many self-appointed responsibilities. One such duty is to apportion credit and blame where it is due. We don’t see a whole lot of room to complete that charge here. UCP was a motivated seller due to its bleak operational and financial future. Absent a change of control, we believe that $9 per share was about as good as it was going to get for UCP.

Century recognized a good deal when it saw one. So it pounced.

PICO has efficiently resolved what could have been an enormous headache. If UCP had gone corporate governance rogue, it could have been 2 years to monetization. Now, PICO gets a floor for its UCP stake, liquidity to monetize and a de facto auction to sell UCP to the highest and best bidder.

In this situation, there is not much blame or credit to distribute. Fate simply smiled upon UCP and PICO shareowners — something that has rarely happened in the last 5 years.

PICO Breaks UCP – Expands Board, Nominates PICO’s Locker, Supports 5 PICO Proposals. Homebuilder M&A Heats Up.

On March 30, 2017, the defenses were breached. In response to PICO‘s frontal assault, UCP took a seat at the bargaining table and negotiated a target date surrender. UCP did not surrender in real time. It will persist a little while longer. UCP, as it is currently conceived, will survive either another 7 months if the debt maturity goes sideways or another year (barring a surprise offer or other unanticipated transaction). Either way, value destruction at UCP will end sometime soon and shareowners may finally realize an acceptable return on their investment.

UCP produced the bold headline: “UCP Announces Expansion Of Board And Strengthened Corporate Governance.”

We find UCP’s tone amusing – as if UCP sought to improve corporate governance all along. The potential corporate governance improvements at UCP were not self-imposed. They are the result of PICO taking off the kid gloves.

But what should investors expect from UCP? The last few months have seen numerous dishonest communications from Chairman Michael Cortney, CEO Dustin Bogue and CFO James Pirrello.

5352124832_b3013f06e5_bMichael Cortney, Dustin Bogue & James Pirrello

The potential corporate governance improvements are warranted. Corporate governance – and shareholder returns – at UCP have been pure disappointment under Chairman Cortney and CEO Bogue. PICO had to do something.

Director Actions

UCP will expand the Board from 6 to 7 Directors. Kathleen Wade, incumbent Director up for reelection this year, will keep her seat. Filling the open slot will be PICO’s nominee Keith Locker.

The result is guaranteed as Director election at UCP requires a majority of votes, which PICO, with its almost 57% voting power, will meet by itself.

We got this one wrong in a few different posts. We didn’t envision a scenario in which Mrs. Wade kept her seat. This unfortunate result means that one of 4 UCP Directors focused on entrenchment and destruction of shareholder value gets more time to do more of the same.

stock-photo-colorful-female-clown-actress-speaking-out-having-fun-circus-entertainer-161080637Kathleen Wade

Mr. Locker will be named to the UCP Corporate Governance and Nominating Committee. Eric Speron will be appointed to the Compensation Committee, an addition that is long, long overdue.

In corporate governance impropriety that brings back John Hartian memories, the UCP Comp Committee, comprised only of Mr. Cortney and UCP Director Peter H. Lori, has been guilty of several offenses against shareowners. This dubiously configured Comp Committee without any explanation, removed the Officer Stock Ownership Guidelines from the Proxy Statement. CEO Bogue received the most undeserved salary increase in the homebuilder industry. And Mr. Bogue received Golden Parachute fortification as PICO sought to earn an adequate return on its investment.

Now that all the dubious and abusive compensation machinations are complete, Messrs. Cortney and Lori are willing to accept a non-corrupt additional member. The rotten Cortney and Lori apples don’t fall far from the diseased Juicerian tree.

As we said earlier, PICO now likely has a maturity date on its UCP investment. Assuming no unexpected transactions, UCP will likely cease to exist in its current form either in October 2017 or by the 2018 Annual Meeting. Both dates are a long way away. This incompetent UCP crew is capable of destroying a lot of value in the interim.

Messrs. Cortney, Bogue, Lori and Mrs. Wade occupy a shameful place in corporate America. These four value-destroying charlatans continue to hold two shareholder bases hostage. Despite the fact that UCP has destroyed millions of dollars in value since its July 2013 IPO, these self-interested Directors refuse to maximize value for two sets of owners and sell the firm.

We understand this unethical choice. As we have said, Messrs. Cortney, Bogue and Mrs. Wade will never occupy their respective positions ever again. Therefore, they cling to the prestige and compensation of their current positions as if they were drowning men and women reaching for a life raft.

Corporate Governance Actions

According to the Settlement Agreement with PICO, UCP agrees to include 5 Proposals, along with its positive recommendation, in its 2017 Proxy Statement.

First, UCP will pursue hard declassification, starting at the 2018 Annual meeting. All Directors and potential Directors with terms expiring after 2018 have signed resignation letters to facilitate the hard declassification next year.

Second, shareholders with 25% or more voting power of UCP Common Stock may call a Special Meeting. This provision pertains only to UCP holders of Common Stock, which thereby excludes PICO, which owns Class B Common Stock and Series A Units. PICO had sought a 10% threshold.

Third, stockholders will be allowed to act by written consent.

Fourth, Directors may be removed without cause, the size of the Board may be changed and vacancies on the Board may be filled by a 75% supermajority vote (for as long as PICO or another shareholder owns 35% or more voting power). In other words, PICO plus 18.4%. PICO had sought a 66 2/3% threshold.

Fifth, Stockholders may amend the Bylaws by a 75% supermajority vote (for as long as PICO or another shareholder owns 35% or more voting power). In other words, PICO plus 18.4%. PICO had sought a 66 2/3% threshold.

UCP refused to honor PICO’s request to adopt cumulative voting for Directors.

To pass, each proposal needs a “For” vote from a majority of the roughly 8 million Class A shares (about 4 million “For” votes).

PICO agrees to vote “For” all 5 Proposals. Going forward, PICO agrees to vote its securities in such a manner that at least 3 UCP Directors at all times will be “Independent.”

The passage of both the Director changes and the 5 Proposals is all but guaranteed. All independent UCP shareowners who can stand vertically and maintain a pulse will vote “For” each of these items. With UCP’s formal recommendation behind all measures, passive investors will also vote “For.”

Don’t use that as an excuse to go fishing instead of voting your UCP shares! No voting result is written in stone, so your “For” vote will count. Like a baseball pitcher that can hit, sometimes shareholders have to help themselves out.

UCP Subscale

We have been saying for some time that 200 homes per market, per year is the minimum efficient scale for a builder. UCP CFO Mr. Pirrello admits as much in the Q3 earnings call. Here is what he said in response to an insightful question from Alan Ratner, of Zelman & Associates:

As far as lots that are optioned, we have said in the past that we see opportunities in all of our markets but especially in those divisions where we are not operating at full kind of efficiency. And those would be in the Southeast and even in the Pacific Northwest where we are doing somewhere around 100 units per year. And the real focus there is to get the land supply up so that we can get them to be performing at a level similar to our Bay area in the Central Valley doing over 200. So that’s the low hanging fruit that we see.”

UCP is nowhere near 200 homes per market, per year, except in Monterey County, California, at the East Garrison project. This is probably why UCP has some of the worst operating margins in the builder industry.

UCP Should Sell Now

On March 15, Builder Magazine Editor John McManus wrote a provocative piece on homebuilder acquisitions.  Referring to builders that choose to be acquired, Mr. McManus writes:

“They face hard facts of real estate life, one of which is that paying high prices now to put future home sites on the balance sheet can be perilous to future returns on that upfront investment. Companies that, because of their lesser heft have to pay more per lot expose themselves to greater risk than deeper-pocketed companies who wield lots of cash and cheaper capital in the land game.”

We suggest you click the link above to read the post in full.

Homebuilder M&A Red Hot

We have said for some time that now is a great time to sell a homebuilder. Market participants concur. Several buyers and sellers have shaken hands on a bid/ask spread to close transactions. Given UCP’s pathetic valuation of about 85% of net equity and little hope for improvement, a sale remains the only way for these hapless Directors and Executives to maximize value for owners. Here is a summary of the latest transactions, in reverse chronological order:

  1. AV Homes buys Savvy Homes — On March 3, 2017, publicly traded AV Homes (AVHI) announced it will pay $50 million for Raleigh, NC based Savvy Homes. The seller has over 20 active communities and delivered more than 250 homes in 2016. Savvy owns 230 residential lots and controls over 1,900 lots. The transaction is scheduled to close in Q2 2017.
  2. Sekisui House buys Woodside Homes — On February 22, 2017, Sekisui House of Osaka, Japan, announced its acquisition of Utah-based Woodside Homes. The price tag for Woodside, the country’s 27th largest builder, is estimated at $468 million. Woodside has a presence in California, Nevada, Utah and Arizona. In 2015, Woodside delivered 1,644 homes worth $603 million in revenue.
  3. Daiwa House Group buys Stanley Martin Communities — On February 14, 2017, Daiwa House completed its purchase of 82% of Stanley Martin Communities. The target is based in Virginia and has a presence in  Washington, DC., Richmond and Charlottesville, Virginia, and Raleigh, North Carolina. Stanley Martin owned/controlled 8,700 lots and recorded $500 million in revenues in 2016. Toll Brothers paid $82.5 million for Coleman.
  4. Toll Brothers acquires Coleman Homes — On November 7, 2016, Toll Brothers announced its purchase of Boise, Idaho-based Coleman Homes. The seller owned/controlled 1,750 lots and had 135 homes in backlog worth $40.8 million. Toll Brothers paid $82.5 million for Coleman.
  5. Clayton Homes acquires Summit Homes — On November 3, 2016,  Clayton Homes bought Summit Custom Homes. The seller was founded in 2002, is headquartered in Kansas City, Missouri, and boasts 1,200 lots. Summit was ranked No. 129 by Builder Magazine, with 2015 revenue of $86 million. Fred Delibero is CEO of Summit. Financial terms were not disclosed.

It sounds like there are more potential buyers for UCP than ever. Did we mention that it is a great time to sell a homebuilder?

In October 2016, Mr. McManus, editor of Builder Magazine, wrote an insightful piece on the arrival of Japanese acquirers to the US homebuilder industry. Among several astute observations, Mr. McManus notes:

“Motivating Japanese home building organizations in their pursuit of beachheads here in the U.S. are two strongly related forces: a need for yield on invested capital and diminishing opportunity to produce that yield in Japan, where the population is shrinking and household formation has stagnated.”

In the final paragraph, Mr. McManus made an accurate prediction:

“[W]ith two Japanese organizations–and other international players also seeking safe-haven residential real estate plays in the United States–as new bidders in the mix, it may serve to stir the pot on public-private merger and acquisition activity in the months ahead.

The buyer pool for UCP is now deeper than ever.  Self-serving UCP management is the only impediment to maximizing value for all UCP shareholders.

UCP Cash Earnings 2016

Many RPN readers enjoyed our expose’ of UCP’s Q4 earnings presentation. We entertained them by uncovering the dishonesty and desperation of Messrs. Bogue and Pirrello, both of whom futilely attempted to inflate UCP’s earnings to the investing public.

A few readers asked us about economic earnings, so we provide our version. First, a few notes. UCP does not disclose cash interest paid. We use interest incurred, which is likely higher, but not by much.

Like all builders, UCP capitalizes and expenses interest on debt, provided that real estate inventory balance exceeds debt balance. When capitalized interest is expensed, it is lumped in with cost of goods sold. Our “Incremental Interest Expense” figure is the interest incurred above and beyond what UCP expensed in cost of goods sold.

We always include routine depreciation and amortization, stock options and other forms of noncash employee compensation in our calculation of economic earnings. Although such P&L debits do not have immediate cash consequences, assets wear out and must be replaced. Equity equivalents granted to managers have an economic cost to owners. This inclusion may skew from cash earnings, but it is perfectly coherent with economic earnings.

Recall that Messrs. Bogue and Pirrello told UCP owners, with straight faces, that “Core Earnings” were $.84 cents per share and “Core ROE” was 6.5%. We laughed at their desperate attempt to artificially inflate UCP’s results in order to compensate for dismal performance, as measured by any and all relevant metrics. These men have a tendency to communicate dishonesty to owners and they are incompetent managers in the extreme. Below we show UCP’s economic earnings and compare it with the deceptive figures futilely championed by Messrs. Bogue and Pirrello:

   Item                               RPN Economic Earnings  
   ----                               ---------------------
Reported Pretax Earnings                            $9,163
Add:
  Goodwill Writedown                                $4,223
  Abandonment/Impairment                            $3,112
Less:
  Contingent Consideration                         ($2,347)
  Valuation Allowance                                   --
  Cash Tax Payment to PICO                         ($4,830)
  Incremental Interest Expense                     ($4,385)
                                      ---------------------
Total UCP Economic Income                           $4,936
Earnings Per Share                                    $.26
Return on Avg. Equity ($222M)                          2.2%

 Messrs. Bogue and Pirrello deceptively claimed credit for $.84 cents per share in earnings. Recall that they conveniently “forgot” to adjust for the contingent commission reduction and the cash tax payment to PICO.

We calculate $.26 cents per share, or 69% less that the dubious figure provided by Messrs. Bogue and Pirrello. Recall that Messrs. Bogue and Pirrello disingenuously told us that “Core ROE” was 6.5%, while we calculate an economic ROE of 2.2%, which is less than a 10-year Treasury bond.

Conclusion

Monetization of PICO’s stake in UCP is now in sight. But it could be a long way off. In the meantime, both shareholder bases of UCP and PICO will incur significant risk and value destruction as 4 Directors – Messrs. Cortney, Bogue and Lori and Mrs. Wade – whom we characterize as dishonest and inept, continue their pursuit of self-interest in the extreme.