On May 5, Century Communities filed its Form S-4 Registration Statement with the SEC. The S-4 is the controlling document for Century’s pending absorption of UCP. We suggest that PICO Holdings and UCP shareowners take a glance at it. There are some informational curiosities. We highlight a few.
Century – Persistent Suitor (And Only Suitor)
“Background of the Merger” is the most interesting section. The narrative reveals that Century and UCP already danced a few tangos before the current deal was signed. In the Spring of 2015, two homebuilders independently approached UCP about an acquisition, one of them was Century. In response, UCP decided to test the market. With the help of deal banker Citigroup Global Markets, UCP shopped itself to 12 potential acquirers, with 10 signing confidentiality agreements. Four potential buyers submitted indications of interest, two completed due diligence, and one, Century, submitted a non-binding acquisition proposal. The Century offer envisioned an exchange of cash and stock worth about $10.00 per UCP share.
We make two observations. First, this would have been a big acquisition for Century at the time. In Spring of 2015, Century’s balance sheet wasn’t that much bigger than UCP’s. According to Century’s 2014 10-K, assets were $676 million and equity was $365 million. At that time, UCP’s assets were $377 million and equity $211 million. An acquisition of UCP by Century would have increased assets by 56%.
Second, although the current deal price at $11.35 per share is 13.5% higher than that offered in Spring 2015, PICO/UCP investors are economically no better off. Between Spring 2015 and today, the S&P 500 has gone from roughly 2,100 to 2,400, a gain of about 14%, which is approximately equal to the gain in deal price. In other words, if UCP had been sold in 2015, UCP/PICO owners could have taken their proceeds and invested in the S&P 500 and gotten the same result as the current offer of $11.35 per share.
There is one major “could have been.” If PICO had gotten its UCP money in 2015, it could have bought back millions of PICO shares when the stock price Valeanted to single digits in early 2016. Assuming PICO bought its own shares at $10 in early 2016, it could have bought back 10 million shares with the $104 million it would have garnered from a 2015 UCP sale at $10 per share. From RPN’s lips to God’s ears.
The 2015 deal was never transacted and Century came back to UCP a year later. The narrative tells us that in Spring 2016, Century proposed a deal for UCP at $6.58 per share. In colonial times, such an offer would have been seen as an insult and would have resulted in a pistol duel at 20 paces.
In early 2017, with UCP approaching financial distress after the 2016 botched debt offering, the Board and its I-Bankers began to shop UCP. “Party A” responded but indicated it was occupied in the near term. We suspect “Party A” was either Lennar or Pulte Group, both geographically logical buyers of UCP. Lennar would have been in the middle of the largish WCI Communities acquisition and Pulte had just completed a decent-sized deal in Atlanta, plus was navigating considerable Boardroom tumult.
When Century was contacted early this year, the talks began easily. Century already knew UCP from their previous flirtations. But once the initial overture was made, progress advanced arduously – the narrative is 2-3 times longer than normal.
There were a lot of issues that prolonged and complicated negotiations. Most importantly, instead of two parties, this deal involved three: UCP, Century and PICO – each with its own law firm. There seems to be an inverse correlation between the number of lawyers and deal expediency – which proved true in this case. Second, UCP’s hand was considerably weakened by its lack of options regarding the $75 million October 2017 debt maturity. The narrative indicates that UCP sought desperately for better terms and a higher price, but was mostly unsuccessful.
California Assembly Bill No. 199, which proposes to raise costs on builders operating in that state, caused Century to hesitate. Century wanted a higher vote percentage from PICO in the case of an Intervening Event. UCP wanted Century to deal a smaller percentage of shares, to avoid the risk of a Century shareholder vote. UCP wanted freedom to address the October 2017 debt maturity, and Century was reluctant. PICO wanted liberty to deal its stake. On and on it goes.
Once the Century process went live, Citigroup I-Bankers diligently peddled UCP in pursuit of the highest and best price. Citi contacted 16 potential counterparties. Five entered into confidentiality agreements and received access to UCP’s virtual data room. On April 6, “Party E” proposed an all-stock transaction at around $9.50 to $9.75 per share.
On April 7, “Party F” proposed to buy UCP for cash at $14.29 to $16.67 per share. However, Party F had not retained legal or financial advisors and required 2-3 months to complete due diligence. Ultimately, Party F’s far higher offer was declined due to its delayed start, prolonged timeline and Citi’s belief that Party F had limited experience with transactions in the United States. Given the October 2017 debt maturity, UCP did not have the luxury of time nor the freedom to play one party off against the other.
UCP tried to use the Party F offer to extract better terms from Century, but the bluff was called and the rest is history.
Today, Party F represents UCP/PICO shareowners’ best hope for a superior price for our asset. Party F indicated it needed 2-3 months for proper due diligence; that was in early April. Assuming Party F is still interested in UCP, it should only need 1-2 months more before it is ready to propose a deal. Party F is a foreign buyer and likely has considerably lower profitability hurdle rates than Century. Fingers crossed.
RPN Miscalculates (Probably)
A few weeks back, we told you that we liked UCP at $11.20 per share. Our rationale was based on the assumption that Century made an opportunistic offer for UCP, which started the bidding. The Registration Statement clarifies that our assumption was wrong. It appears that UCP has made the rounds among suitors and has been found wanting. We do not attach a high probability to an alternative offer from Party F. Therefore, our investment thesis for UCP at $11.20 per share now appears to be a miscalculation.
On a few occasions, we predicted that UCP would sell in the $13-$15 range if put out to bid. That prognostication now also looks faulty.
Our miscalculation fortifies the importance of Benjamin Graham’s margin of safety. We were fortunate to read Mr. Graham’s work early in our business trajectory. In Security Analysis, Mr. Graham makes a statement to the effect that, when margin of safety is properly employed, even if events do not work out as well as the analyst expects, the result should still be more than satisfactory.
Barring a higher offer from Party F, it appears that we have been overly optimistic in our valuation of UCP – an error which we take seriously. However, coherent with Mr. Graham’s margin of safety concept, we were conservative enough in our purchase price so that we are still poised to earn a more than satisfactory result. We hope the same for all our readers.
Life Isn’t Fair(ness)
Citi’s Fairness Opinion corroborates what we have been saying about UCP for the past year. On a standalone operating basis, Citigroup’s bankers agree that UCP is only worth $7-$9 per share. Citi also supports our contention that the deal price is at the extreme low end compared with recent comparable transactions.
Given the low deal price and the considerable concessions UCP made in negotiations, it is clear that Century drove a hard bargain. Dale and Robert Francescon, the brothers that Co-CEO Century, have done well by their owners. If PICO marries off UCP for an $11.35 per share dowry, Century is almost guaranteed to create significant value for its owners. We admire the Francescon brothers’ style, but we don’t like the result from the other side of the table.
As we have said many times, Chairman Michael Cortney and CEO Dustin Bogue got into a pickle with their mismanagement of UCP’s debt profile, the botched Senior Notes refinancing and their poor stewardship of UCP over the last 4 years. UCP’s debt difficulties and lack of profitability provided them little freedom or bargaining power throughout this process.
Messrs. Cortney and Bogue have created zero value for owners in 4 years as stewards of UCP. The firm went public in July 2013 with about $220 million in equity capital. Four years later, it is being sold for $210 million. Other builders have accumulated considerable equity during this time and builder assets are being transacted at 1.2 – 1.5 times tangible book value.
Messrs. Cortney and Bogue have earned rich compensation, while UCP has been a value transfer machine, donating owner’s capital from our pockets to those of directors, executives, employees and contract employees. Much valuable real estate has been sold off at zero (or negative) profit to the owners of the business.
We understand that Mr. Bogue wanted to make a go of it. He wanted to see if he could turn UCP into the next D.R. Horton. Dr. John Douillard, in his book “Mind, Body and Sport,” which everyone with a heartbeat should read, said, “To accept limitation goes against the grain of human nature, which is always to seek higher achievement…”
We, as shareowners, take issue with four aspects of Mr. Bogue’s effort: his frequent unethical conduct, his high compensation, his inability to accept reality when the dream was clearly not coming to fruition and the extreme measure by which he destroyed value for owners.
In the near term, life is often not fair. It is not fair that Mr. Bogue will walk from this transaction with a $2 million dollar payday while Daniel Silvers, Andrew Cates and Eric Speron earned around $115,000 for their 300-pound benchpress equivalent in 2016 (actually, Mr. Speron worked for free). If life were fair, Mr. Bogue’s payout would be cut by 75% and these three Directors would have earned twice as much in 2016. But life and fairness do not always run parallel.
These PICO Directors will have to be content with the knowledge that they have done right by owners and the broader financial community, despite deserving more pay. They have placed PICO on firm corporate governance footing for shareholder value maximization. They have participated in the monetization of UCP – which was the only economically rational result for such a value destroying machine.
These men are in good company. At RPN, we know a little bit about donating resources for the benefit of a greater community.