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.

Regarding 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 boardroom.

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 and 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 have 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 CommunitiesUCP 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 and 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 California and Washington 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 in 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 some influential factor that comes to the UCP Board which compels them to change their recommendation to UCP owners. But a superior proposal or a change in business climate do not meet this definition. It sounds like a low-probability scenario to us.

Conclusion

Barring significant news prior to 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.

5 responses to “RPN Proxy Card – Our Rationale. Century/UCP Deal Revisited.

  1. Your thoughts on competing bid makes a lot of sense. The land assets have always been there. Scale is necessary as long discussed here. I would bet a higher bid will come.

  2. Positive mention in Barron’s today for pico. The writer has been touting it for quite some time. Taking a victory lap now somewhat. References Kelly Cardwell claim stock could be worth 21 to 27.

  3. Your article mentions you may not post to your blog prior to the May 4 annual meeting. At least for the few people who might look at this comment thread, note that we published Lawndale’s voting intent and rationale this morning

    Lawndale Capital Management Announces Voting Intent On PICO Holdings’ 2017 Proposals
    https://seekingalpha.com/article/4067369-lawndale-capital-management-announces-voting-intent-pico-holdings-2017-proposals