PICO Retains JMP Securities. Unloads Entire CCS Stake. Director Andrew Cates Resigns. Still No Return Of Capital.

After several weeks of silence, PICO Holdings‘ news releases have lit up the news wires, one after another.

On October 2, PICO made several announcements. First, PICO has retained JMP Securities to shop the remaining Vidler Water portfolio. Second, compensation for PICO CEO Max Webb and CFO John Perri has been revised to reflect this potentiality. Third, PICO Director Andrew Cates has resigned effective immediately.

Just as the latest issue of RPN was poised to roll the printing presses, PICO made the surprise announcement that it sold its entire stake in Century Communities.

RPN breaks it down.

PICO Poker Player

The retention of JMP Securities “to explore strategic alternatives,” has sparked a debate among PICO-watchers. Is PICO playing a high hand to win or is PICO bluffing for appearance’s sake?

Does the retention of JMP as investment banker signal the end game in which the Vidler portfolio is sold and shareowners are cashed out? Or is JMP’s employment a distraction, designed to make PICO Executives and the Board look proactive, while diverting attention from the recent lack of asset sales and zero return of capital?

We don’t have an answer. Both scenarios are possible and, as we consulted our panel, we got mixed opinions all around.

One investor said, “I view this as highly significant. It’s possible PICO already received a bid and JMP’s employment is the effort to get the highest and best offer. It could be a matter of months now.”

Another said, “It’s all smoke and mirrors to draw your attention away from the fact that zero capital has been returned and no assets have been sold in months. I’ll bet someone at JMP is friends with one of your PICO Directors and that’s how they got the gig.”

A third said, “Wait. Haven’t all of PICO’s assets been for sale since John Hart was fired over a year ago? What’s changed?”

Who is right? Or is the truth somewhere in between? We don’t know.

JMP’s retention looks positive and investors have reacted favorably, pushing PICO’s stock price to its 52-week high of $18.35 as RPN went to press. But the true probability of a transaction is unknowable to outsiders. Stay tuned.

One Certainty – Zero Return of Capital

One thing RPN is certain about: PICO has returned zero capital to owners and PICO steadfastly refuses to provide transparency.

With the most recent announcements and the increase in PICO’s stock price, any repurchase of shares, whether systematic, opportunistic or pursuant to a tender, just got a lot more expensive. And less economically potent for PICO owners.

After the UCP sale was announced in April, PICO could have initiated a 10b5-1 plan and could have systematically bought back shares for the last six months. A buy in of over 2 million shares by now would have been possible (20 trading days per month x 6 months x 20,000 shares per day = 20 x 6 x 20,000 = 2,400,000).

When we mentioned this to our most optimistic PICO observer, he said, “I don’t have an answer for that. I don’t know why they didn’t do that.”

Another shareholder roughly calculated that PICO could have created over $1.50 per share in value by purchasing 2 million shares at around $17.

Remember, for PICO’s inaction and lack of transparency to make sense, it must somehow create an extra dollar of value for owners that could not have been created by earlier action and greater transparency. Given that PICO could have been buying shares back for 6 months at lower prices than today, surmounting this hurdle is now more improbable for PICO. And it is more likely now than ever that the PICO Board has not served owners through its inaction and lack of transparency.

A sarcastic PICO-watcher commented, “It looks like the Board botched it.”

Dump It.  Dump It All.

In Oliver Stone‘s famous 1987 movie Wall Street, Budd Fox, as broker, advises Gordon Gekko to sell his entire stake in Blue Star Airlines before market close. After a series of expletives directed at Mr. Fox, Mr. Gekko accepts cold capitalistic reality and utters the famous phrase, “Dump it. Dump it all.”

Similarly, PICO has dumped its entire stake in Century Communities in one transaction, with the second half of the position sold 5 months earlier than mandated in the deal.

Recall that, pursuant to the UCP-CCS Plan of Merger, PICO could sell about 1.25 million CCS shares 60 days after the deal’s close. PICO could sell the remaining 1.15 million CCS shares in early 2018. However, according to the press release, PICO unloaded the entire 2.4 million share position on October 2, for $59.4 million, or roughly $24.67 per CCS share.

PICO now holds well over $100 million in cash on its balance sheet.

Cates Cruises

RPN was disappointed to read about the resignation of Mr. Cates. We have had our disagreements with PICO Executive Compensation over the last year. But Mr. Cates is significantly responsible for the value PICO has created for owners, and the value it is poised to create. Mr. Cates was one of two rough and tumble appointees that wrestled several Legacy Director alligators to clean up the PICO Boardroom and improve corporate governance.

Every milestone in the PICO battle for value – the firing of the corrupt and incompetent John Hart, the removal of dirtbag directors Kenneth Slepicka, Carlos Campbell and Michael Machado, the Palace Coup which tossed hapless Howie Brownstein and go-slow Chairman Raymond Marino, the piecemeal asset sales and the monetization of UCP – Mr. Cates played a significant role in all of them.

Mr. Cates and Daniel Silvers never took the easy way out. They were always willing to fight to improve PICO in the name of owners.

When Mr. Cates arrived at PICO, the stock price floated around $9 to $11 per share. As we admire our current fractional interests valued at over $18 per share, we should remember that Mr. Cates had an enormous role in this revaluation. From RPN’s desk, Mr. Cates gets a standing ovation as he walks off the PICO trading floor. We wish you all the best, Andy.

Max Incentives

Hand-in-hand with the JMP engagement, PICO supplemented the Executive Bonus Plan so that Messrs. Webb and Perri will be paid under double trigger scenarios. If PICO is acquired and these Execs are terminated, under certain conditions, they will receive a bonus based on deal price less cash and some expenses.

We speculate that Messrs. Webb and Perri are motivated to sell PICO. Mr. Webb owns 79,083 PICO shares that would be worth almost $1.6 million at $20 per share. Mr. Perri owns 29,902 PICO shares that would be worth about $600,000 at $20 per share. Our sums do not include any remaining options and the most recently granted RSUs owned by these Execs.

Plus, we speculate that an acquirer of PICO will likely use the same calculus as the existing PICO Board and opt to keep Messrs. Webb and Perri to run or wind down Vidler. They are unlikely to be paid half a million dollars annually (or somewhat less now that both men have voluntarily reduced their own compensation), but they would remain gainfully employed.

As an aside, we expect a Christmas card from John “The Juicer” Hart. Juicer owns 341,566 PICO shares and at $20 per share, he would walk away with almost $7 million pretax. Given that PICO stock was headed nowhere but down while Juicer was CEO, he owes all PICO owners, including RPN, a big “Thanks” and a Christmas card. We expect it any day.

Ticking Clock

Speaking of Webb and Perri, if these men want to realize a Bonus for 2017, they better get on their respective horses. Recall that the Executive Bonus Plan is calendar year based. Capital must be firmly committed to be returned to owners before December 31 for it to count in the annual bonus calculation.

Less than 3 months left!!!!

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!