PICO Reports Q2 Earnings. UCP Deal Closes. CEO Webb & CFO Perri Donate To Owners. Still No Capital Return.

On August 9, PICO Holdings reported Q2 earnings.

The UCP sale was completed on August 4 and by now, all UCP shareowners should have received their slugs of cash and shares in Century Communities. Recipients of such loot include PICO, which took in $55.3 million cash and 2.4 million CCS shares.

For those who clicked on the UCP link above, you noticed that the UCP website is gone; readers are diverted to Century’s homepage.

The sale of UCP is significant win for PICO owners. We celebrate all at PICO who got this deal across the finish line. Liquidation of the UCP stake is also significant to PICO owners going forward: PICO is now a water company. Stated with greater specificity, PICO is a holding company that maintains a portfolio of water assets through its subsidary Vidler Water. Call it what you like, but as one observer noted, “With the simplification of PICO, an acquisition of the entire water portfolio becomes far more likely.” Let’s hope so.

PICO – World Record Holder

The first surprise of the quarter (at least to RPN ), was that PICO did not repurchase any shares. We speculated that PICO would make opportunistic purchases of its own shares during Q2 and we took an educated guess that PICO had established a 10b5-1 Plan for more systematic purchases. On the former, we were wrong. It appears as though, during the first half of 2017, PICO only bought in enough shares to cover dilution from equity awards and there were no owner-oriented open market purchases. Friend to shareholders, Andrew Shapiro of Lawndale Capital Management, asked about the existence of a 10b5-1 Plan, but the question was suspiciously dodged.

We believe that PICO holds the world record for the longest unfulfilled promise to return capital to shareowners – approaching 2 years. The “Revision To Business Plan,” which first committed to return capital to owners, was made public on November 17, 2015. Thus far, not one single dollar has been returned to owners.

Granted, this John Hartian parry to shareholder activists was actioned under a different Board, a different CEO and effectively, a different PICO. But the Plan has not been renounced or qualified by the existing PICO regime. In fact, CEO Max Webb stated on the Q2 call: “The board is deeply committed to returning capital to shareholders.”

Problem is, promises of capital return by PICO are getting stale. They are beginning to ring as empty as a celibate lover’s repetitions of “I love you.” PICO has held $20 million in excess capital since early this year, and after April 11, when the UCP deal was announced, PICO was free to return it to owners. Now, PICO sits on about $92 million, of which about $80 million is free to return to owners. And PICO has returned zero.

Mr. Webb blew shareholders a kiss with a reminder that Greg Bylinsky and Eric Speron, who collectively own 8.1% of PICO shares, sit on the Board. But neither Mr. Bylinsky nor Mr. Speron have much Director experience and neither man is a commanding presence in the Boardroom. It is possible that Messrs. Bylinsky and Speron are being out-argued and out-voted at the Director’s table, when it comes to expeditious return of capital to owners.

Mr. Webb assures us that he, CFO John Perri and the Board are diligently preparing to return this capital. But thus far, the safety is still on and the trigger has not been pulled.

Here is the problem with PICO’s promises: the various options for returning capital to owners are well-known and uncomplicated.

Our panel is replete with Directors, C-level Executives, institutional investors and experienced businesspeople. And none of them can figure out why PICO continues to delay, both the explanation and the action. Special dividends have been done before; the calculus is not complicated. Dutch tenders have been done before; the calculus is not complicated. Returns of capital (in the tax sense) have been done before; the calculus is not complicated.

One PICO observer said, “Maybe they are waiting for a lower share price to get more bang for the buck.”

“You mean like market timing?” we asked.

We hope the PICO Board is not engaged in the speculative and dubious exercise of trying to time a bottom for the PICO share price. No one knows in the short term where market indices will price nor where PICO shares will price. Speculative market timing is anathema to value investing – and all our Directors claim to be value investors.

Our most skeptical PICO observer stated, “Interesting that they continue to hold your capital now that the firm has been reincorporated in Delaware and proposed Indemnity Agreements are filed.”

One plausible explanation for PICO’s delay and silence on return of capital came from our Crack Strategist. He said, “If PICO is going to do a Dutch tender, it is most beneficial if they start with the lowest share price possible. If PICO repurchases a few hundred thousand shares in Q2 and drives the price to $18, and they need a 15% premium on the tender, then they get less bang for the buck than if they start with a $16.50 share price.”

It is also possible that PICO is blacked out again due to pending asset sale announcements. But that would not explain why PICO did not initiate buybacks through a 10b5-1 Plan after the UCP deal was announced in early April.

In conclusion, PICO’s constant expressions of love to owners, without copulatory reinforcement, are starting to lack charm. The Board has returned zero capital to owners and it refuses to utter any words on the subject. Mr. Webb would not even confirm or deny the existence of a 10b5-1 Plan. We find this unusual, approaching suspicious.

Messrs. Webb & Perri Donate To Shareowner Cause

Messrs. Webb and Perri announced that they were annually donating $74,000 and $66,000, respectively, to PICO shareowners (total annual donation: $140,000). Both executives, with a nod to the reductions in size and complexity at PICO, agreed to lower their annual base salaries by 15%.

These men had rock solid employment contracts that awarded them their full base salaries for as long as they remained employed at PICO. We salute the voluntary contributions of Messrs. Webb and Perri to the PICO shareowner cause.

Over the last 5 years, PICO executives have almost exclusively been on the taking end of corporate resources; we can’t recall a single financial windfall that went shareholders’ way. Any economic value that inured to owners was wrested away by active shareholders/directors willing to throw punches.

Today is a bright day in PICOville because shareowners have received:

a) a financial benefit that;

b) was voluntarily relinquished, and;

c) came from executives.

We thank Messrs. Webb and Perri for their gesture of executive chivalry which warms the heart (and lines the wallet) of the collective shareholder base.

Blue Horseshoe Loves Anacott Steel

We all remember that great line from Oliver Stone‘s 1987 movie “Wall Street.”

On the Q2 Call, Mr. Webb uttered similar lines related to Century Communities, but without cloak and dagger implications. During Q&A, individual investor John White asked about PICO’s plans for its Century shares. Mr. Webb essentially said, “PICO loves Century Communities.” In other words, Mr. Webb waxed optimistic about Century and indicated that the principals at PICO are “big believers in Century.”

We agree with Mr. Webb’s optimism, analysis and public posture. We still hold our Century shares as well. Moody’s just changed its outlook on Century to “Positive.”

But we won’t hold them for long and we expect PICO to also make a quick exit.

We will be sellers of Century for a few reasons. First, the homebuilder industry has awful fundamentals. Barriers to entry are low, meaningful brand differentiation is impossible and returns on capital over the cycle are inadequate. Second, the builder industry is extremely cyclical and we are not in the trough nor the middle of the cycle. Third, the builder industry, over the long-term, is a consumer of capital.

PICO will be a seller for four main reasons. First, PICO has an articulated mandate to monetize assets and return capital to owners. Second, PICO now owns 9% of Century, so talking smack would be like telling a suitor for your sister that she has bad breath. Third, PICO wants to sell its Century shares into a strong market. Last, we believe PICO agrees with us: Century may be a great little homebuilder, but it is still a homebuilder. PICO already owned one of those, which it just sold for sub-historical cost. Been there, done that.

Financial Statement Analysis

The most interesting aspect of the Q2 financial statements to RPN was the jump in federal Net Operating Losses from Q1 to Q2.

At March 31, 2017, PICO reported $125.1 million of pretax federal net operating loss carryforwards. At June 30, 2017, this figure jumped to $162.3 million, an increase of $37.2 million. Given that the second quarter 10-Q was issued after August 4, we assume that this jump is attributable entirely to the UCP transaction.

As PICO owned roughly 10.4 million UCP Units (shares), PICO’s tax basis in UCP was about $3.58 per share higher than the deal price. In other words, PICO sold its UCP stake for roughly $115 million, but its tax basis was closer to $150 million.

Now that is what RPN calls destruction of capital. Way to go Dustin Bogue!

UCP Buyout To Close August 4. Bylinsky Named To PICO Comp Committee. Q2 Earnings Coming Up.

Wedlock Day – August 4

Although not disclosed in SEC filings, RPN has learned that the UCP Board of Directors expects the UCP purchase by Century Communities to close on August 4, 2017.

Recall that UCP Shareowner Joseph Tola filed a Class Action Complaint against the UCP Board of Directors, in the U.S. District Court for the Northern District of California. Mr. Tola is represented by Rosemary M. Rivas, Esq., of Levi & Korsinsky, LLP.

Mr. Tola claimed that the deal’s S-4 Registration Statement provided insufficient information. Mr. Tola also asserted that provisions of the deal prevented another suitor from seeking UCP’s hand in matrimony.

On June 21, UCP filed an Amended Registration Statement, which provided enhanced information and made clear that it was open to other potential grooms before UCP said “I do” to Century.

Mr. Tola was sufficiently satisfied with UCP’s efforts. The parties entered into a Stipulation of Dismissal pursuant to which Mr. Tola’s action will be dismissed “after the Transaction closes, which defendants currently expect to occur on August 4, 2017.”

You can read the Stipulation, on which Judge William Alsup placed his stamp of approval, here.

The implications for PICO are significant. Assuming the legal filing is predictive, in just 11 days, PICO will receive around $117 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.

Committee Composition

A quick glance at the PICO website, specifically the page entitled “Committee Composition,” reveals three interesting facts.

First, PICO CEO Max Webb serves on no Committees. We noticed Mr. Webb’s absence from Committees in the 2017 PICO Proxy Statement, but we assumed it was temporary. We guessed that once the Directors were settled, Mr. Webb would be joining at least one Board Committee. Since almost 3 months have passed since the PICO Annual Meeting, we now believe this situation is permanent.

It is not uncommon for a Chairman to serve on zero committees. A quick perusal of RPN’s investees indicates that about half follow this policy. But historically, the occupant of the PICO Chairmanship has sat on Board Committees. Kristina “Maleficent” Leslie sat on the Audit and Compensation Committees. More recently, Raymond “Delaymond” Marino served on the Corporate Governance and Nominating Committee.

The current Board appears to have changed that practice. Given Mr. Webb’s lengthy tenure during PICO’s period of shareholder abuse, and given the unique dynamics of the PICO situation, we view this omission as appropriate and favorable to shareholders. This opinion is strengthened by the fact that we view Mr. Webb’s Chairmanship as sub-ideal – especially given that Daniel Silvers would better fill that slot.

The flip side to Mr. Webb’s Committee absence is that all Committee members are Independent Directors. We feel this configuration suits PICO and its owners just fine. We commend the Board for its willingness to think differently.

Second, Greg Bylinsky of Bandera Partners has been named to Compensation Committee – a move we hoped the Board would make. We are confident Mr. Bylinsky’s inclusion will benefit owners and from a PR perspective, it looks a lot better. Between Eric Speron and Mr. Bylinsky, two of four votes on the Comp Committee hold an 8.1% PICO ownership interest. We like the sound of that.

We believe the presence of Messrs. Speron and Bylinsky on the Comp Committee will be more than pretty packaging. The Bonus calculations will get tricky as larger water assets are sold and there will be considerable room for interpretation as the definition of “Administrative Expense” is debated.

At March 31, 2017, PICO’s book equity was $332 million; of that sum, almost $27 million is owned by Messrs. Speron and Bylinsky. It is truly their money.

The third interesting fact gleaned from PICO’s Committee Composition page is that all Independent Directors serve on all Committees. The Committee Composition matrix reads like a 4 x 3 keno card: all squares are filled.

PICO shareowners do not pay more for this: the Nonemployee Director Compensation Policy indicates that only the Chairs of Committees are paid extra. In our experience, this configuration is unusual because it means more work for the Directors without more pay. We applaud our PICO Directors for their can-do spirit.

PICO should Q2 release earnings the first week in August. We expect an update on the UCP deal as well as news on return of capital to shareowners. Stay tuned!

UCP Files Merger Proposal. Tola Shareholder Suit Settled.

On July 3, 2017, UCP filed its DEFM14A, which is a definitive merger proposal. There isn’t a whole lot that is new. But we provide some highlights.

UCP Special Meeting

The UCP Special Meeting to vote on the acquisition by Century Communities will take place on August 1, 2017, in San Jose, California. Given that PICO Holdings has already agreed to vote its 57% UCP stake in favor of the acquisition, the meeting and vote are mere formalities (assuming nothing bizarre happens).

PICO and UCP Class A shareowners stand to receive $5.32 in cash and .2309 Century shares for each UCP equity interest. As of this writing, such consideration was worth $11.12 per share.

Century did not update its timeline. It still expects “the Merger to close by the during the third quarter of 2017.”

Tola Complaint Settled

An Amended Registration Statement filed by Century on June 21, revealed that the Class Action Complaint, filed by UCP shareholder Joseph Tola, has been settled. The case was filed in the US District Court for the Northern District of California. Mr. Tola, represented by Rosemary M. Rivas, Esq., of Levi & Korsinsky, LLP, sought to stop the Merger unless and until Century/UCP provided greater disclosure to the investing public.

Century/UCP have done that. Most importantly, Century/UCP reveal that they heard nothing from “Party F,” the mysterious foreign bidder who was poor on execution but high on price.

Recall that Party F submitted the highest nominal bid, but its potential to close the deal was questionable. The Amended S-4 reveals that UCP’s bankers at Citigroup Capital Markets spoke with Party F and its representatives to flush out a fuller bid. But since those talks, “UCP and its representatives have neither received nor had any further communication with Party F with respect to a potential transaction involving UCP.”

Bummer.

Apparently satisfied, Mr. Tola and Century/UCP entered into a memorandum of understanding pursuant to which Mr. Tola withdrew his claims and Century/UCP provided the enhanced disclosure contained in the Amended Registration Statement.

This legal tussle was so quick and superficial, we aren’t sure if even the lawyers won.

PICO – Acquisition Vehicle

A few RPN readers have voiced both in private and in public, concerns that this Board will eventually turn PICO into an acquisition vehicle, to utilize the Net Operating Losses and continue their Directorships and paychecks. The fear, we assume, is that value will still reside in PICO and by changing mandates halfway through the ballgame, this Board will deprive PICO owners of that final tranche of value.

We disagree with this fear for a few reasons.

First, the end game is likely very far away and we support the Board’s decision to maintain silence on outcomes so uncertain and so far into the future. There are so many question marks, this Board is not promising anything.

Second, the specifics of the end game are unknown. As PICO sells assets, the portfolio gets simpler and simpler, making a final portfolio acquisition by an outside buyer ever more likely. No one knows if this scenario will materialize, if this buyer will be public or private, or if this buyer will pay with cash or stock. The Board is unable to clarify end game financial scenarios because it has no idea. No one does.

Third, it is our hope that the NOL Acquisition Vehicle scenario is rendered moot (or almost moot) by asset sales. We hope that the NOLs will be utilized for the benefit of existing PICO shareowners when assets are sold for prices higher than tax bases.

Fourth, we believe most PICO shareowners will be long gone before any NOL Acquisition Vehicle scenario materializes. If your PICO NAV is $22 and your time horizon is two years, and PICO hits $19 soon, there is a strong argument to exit the position at $19. As PICO stock continues to climb, we believe that the existing shareholder base will dwindle and new shareholders, some of whom might support an NOL Acquisition Vehicle, will take their place.

Fifth, using the NOLs to make acquisitions may make sense at some date in the future. If PICO assets are sold and NOLs remain, they aren’t much good unless and until they can be offset by operating profits.

To conclude, RPN is not worried by this Board’s unwillingness to declare perpetual allegiance to a return of capital mandate. We have zero concern that this Board would go rogue and change the strategy halfway through the campaign. At this point, there are so many open questions and so many possibilities, one would need an infallible crystal ball to make any promises.