As originally appeared in the Troubled Company Reporter.
PICO Holdings, Inc. (Nasdaq:PICO), based in La Jolla, Calif., is a diversified holding company reporting recurring losses since 2008. PICO owns 57% of UCP, Inc. (NYSE:UCP), 100% of Vidler Water Company, Inc., a securities portfolio and various interests in small businesses. PICO has $662 million in assets and $426 million in shareholder equity. Central Square Management LLC and River Road Asset Management LLC collectively own more than 11% of PICO. Other activists at http://ReformPICONow.com/ (RPN) have taken to the Internet to advance the shareholder cause.
PICO subsidiary UCP, released fourth quarter 2016 earnings on February 27. The bloggers observe that since the release, UCP “stock has fallen 5%. UCP continues to destroy shareholder value. Dustin Bogue and James Pirrello, CEO and CFO respectively, spoke nonsense on the Earnings Call. If UCP hoped its 2016 performance would win over some shareholders, it failed. By all indications, UCP is in trouble.”
The bloggers observe that UCP claimed earnings per share of $1.15 and a return on equity of 6.5%. In the press release, UCP announces, “Net Income Increases to Record $1.15 Per Share of Class A Common Stock, Including $0.31 One-time Benefit in Full Year 2016.” On the Earnings Call, CEO Bogue stated that “Core Earnings” were $.81 cents per share.
“All these statements are nonsense,” state the bloggers. After several adjustments to the financial statements, the bloggers write, “This leaves us with Pretax Income at $9,405 million. We incorporate a reasonable provision for income taxes. Given UCP’s concentration in California, a blended rate of 38% is appropriate. Multiplying $9,405 million by 0.38 gives us a tax provision of $3,574 million and Net Income of $5,831 million. For RPN, UCP’s 2016 economic Net Income is $5,831 million or $.32 cents per share, or 60% less than the $.81 cents provided in the UCP press release.
“Reported return on equity is 6.5%, but true economic return on equity is 2.6%, also 60% less. At a 2.6% yield, investors could buy a 10-year Treasury bond and earn almost the same return. With no risk.
“So who is right — UCP or RPN? We offer three pieces of evidence:
a) Since the earnings were released, UCP stock has fallen 5%;
b) Respected builder research house Zelman & Associates released a report on UCP entitled “Improvement Continues But Valuation Discount Justified;” and
c) At $10.85 per share, UCP trades at a 15% discount to book value.
“By the way, UCP is the only homebuilder with a debt to capital ratio in the 40%s that trades at such a discount to net equity.
“Let’s calculate economic value destroyed. If we assume $222 million in average equity capital employed and an equity cost of capital of 12%, UCP had to earn about $27 million to economically justify its existence. As UCP only earned about $6 million in 2016, it is fair to say that UCP destroyed $21 million in shareholder capital — or $1.11 per share.”
The bloggers state they are unhappy with the UCP communication on the Earnings Call. “The UCP Q4 Earnings Call was an exercise in ridiculousness. Mr. Bogue and Mr. Pirrello tried to portray UCP’s situation as optimistic and stable. Despite that UCP is in real financial trouble, these men desperately and futilely tried to convince investors that they were playing offense,” they say.
“Don’t believe it for a second. UCP’s financial problems are pending and real. Financial distress is starting to show up in UCP’s operations. We had hoped Mr. Pirrello would be above such tomfoolery, but apparently Mr. Bogue’s penchant for guile has found a new supplicant.
“We have several questions for Messsrs. Bogue and Pirrello:
a) If UCP is so financially confident, why did share repurchases slow to a crawl?
b) If UCP has such financial flexibility, why did lots in the West decline?
c) If UCP’s operations are so efficient, why was backlog up an unhealthy 45%?
d) If money is no problem, why did land purchases slow and community count remain stagnant?
e) If UCP is stable, why don’t you have alternative funding 4 months after the failed debt issuance?
“The list goes on. We believe that Messrs. Bogue and Pirrello are trying to portray stability when imminent financial distress is the reality. Indicators of economic stress are showing up in many of UCP’s metrics. Executives can lie, but in UCP’s case, the numbers do not.”
The bloggers observe that the UCP share repurchase has slowed dramatically. They note, “UCP repurchased 22,710 Class A shares at roughly $11 per share during the quarter. We view this as an excellent capital allocation decision, albeit microscopic in size. At this pace — $250,000 per quarter — UCP will not complete the buyback before the authorization expires on June 1, 2018. In fact, at this cadence, UCP won’t even complete half of the allocation. When the authorization was announced, we mocked the small size and the extended timeline. Turns out, our sarcasm wasn’t ambitious enough.”
The bloggers express worry over UCP’s looming debt maturity and weak financial condition. They say, “Four months have passed since UCP’s failed debt offering. UCP continues to manifest a false and desperate confidence that everything is under control. On the Earnings Call, Mr. Pirrello mentioned that UCP entered into a $25 million secured borrowing base facility at LIBOR plus 275.
“That’s kinda cute, but what is $25 million going to do against over $140 million in debt maturities this year?
“The most humorous suggestion came when Mr. Pirrello implied that UCP could use internally generated funds to repay some of 2017′s debt maturities.
“What internally generated funds?
“UCP earns barely any profit. Does Mr. Pirrello mean UCP will shrink the balance sheet by tens of millions of dollars, using home sales proceeds to pay off debt in an effective liquidation of the business?”
The bloggers admonish the UCP Executives for what they perceive to be deceptive communication. “It was an awful Q4 and an awful year for UCP. The false words of Messrs. Bogue and Pirrello do not change the economic results. We don’t mind abject incompetence per se; we do mind when ineptitude is combined with deception. UCP is facing a real problem. It is likely America’s worst public homebuilder with the worst CEO, and it has debt maturities worth about 33% of its balance sheet coming due within 8 months.
“We hope that on the next Earnings Call and the Annual Meeting, Messrs. Bogue and Pirrello aspire to communicate with owners with greater honesty and integrity. They aren’t fooling anyone and deceptive communication just makes them look incompetent AND dishonest.”
The bloggers explain UCP’s potential Boardroom strategy in regards to PICO’s alternative Director nomination. “PICO is aggressive, if not hostile, in its latest 13D/A, proposing a nominee to replace lame duck Director Kathleen Wade and proffering 7 corporate governance improvement measures. We don’t know if this is just one step in the negotiation tango or a true warning shot. Who will win this microcap boardroom battle?
“UCP holds the high card for this year. Any time before the Annual Meeting, UCP can shrink the number of Directors on its Board by one, removing Mrs. Wade’s Seat from contention. Once done, UCP will have entrenched its three Legacy Directors: Mr. Bogue, Michael Cortney and Peter Lori. From that point forward until the 2018 Annual Meeting, these men would square off against PICO’s two Directors, Max Webb and Eric Speron. On matters of import, like selling the company or improvements to corporate governance, voting results would be a predictable 3-2, placing UCP management’s interests ahead of shareholders’ interests.
“UCP owners and PICO would have to wait until 2018 for a shot at control of the Board (and even then, UCP could expand it).
“While UCP has a temporary high card in its pocket, it is not a foregone conclusion that this card will be played. If Messrs. Bogue, Cortney, Lori and Mrs. Wade take rogue action against shareowners, there would be significant negative consequences. First, proxy advisory firms ISS and Glass Lewis will frown. Second, Messrs. Bogue, Cortney, Lori and Mrs. Wade will be harshly criticized and their professional reputations will suffer. Third, shareowners will revolt, express scorn and may take unexpected measures. Fourth, PICO will likely take legal action. Fifth, this may have unintended consequences for UCP; PICO is its 57% owner.
“If Messrs. Cortney, Bogue, Lori and Mrs. Wade do go rogue and shrink the Board, expect a press release which articulates a false justification. UCP will cite expense reduction and streamlined decision-making as motivation for the entrenchment that is abusive to owners. Don’t believe any such press release. If UCP shrinks the Board, it will be only to further entrench Messrs. Cortney, Bogue and Lori in their cozy and lucrative Directorships.
“UCP has been economic quicksand and its Board has perpetrated poor corporate governance. Mr. Bogue is overpaid and just received an undeserved raise. UCP’s operations are uncompetitive; it has built almost no equity capital in 3.5 years as a public entity while competitors have galloped ahead. We characterize UCP’s communication with owners as dishonest. By every metric, UCP is sub-average and for the third consecutive year, investors could earn a higher return in US Government bonds than UCP earns on shareholder capital. The evidence doesn’t get much more persuasive.
“The only people who have benefited from UCP’s existence the last 3-1/2 years are its Directors, Executives, Employees and Contractors. UCP has been a wealth transfer machine, taking shareholder capital and distributing it to others, with nothing left for owners.
“We understand the reluctance of Messrs. Cortney and Bogue to sell UCP. Michael Cortney will never be Chairman of anything again. He was probably never Chairman material to begin with, and he has done an awful job at UCP.
“Dustin Bogue faces the same situation: He will never be CEO of anything again. Like Mr. Cortney, Mr. Bogue was probably never CEO material. He came to PICO when John ‘The Juicer’ Hart purchased Mr. Bogue’s budding land developer in 2008. Later, Mr. Bogue was personally bailed out by Juicer using PICO shareholders’ funds. Mr. Bogue was party to the busted Red Hawk land deal, where a bank was poised to seize his personal assets when Juicer came to his rescue. This is not conduct befitting a CEO.
“Both Messrs. Cortney and Bogue have one thing in common: their ascendant positions are the result of John Hart, probably the most incompetent and corrupt CEO we have ever seen. In other words, both Messrs. Cortney and Bogue owe their undeserved elevated status to foolish and flawed judgment in the extreme. This history is unlikely to repeat itself, hence Messrs. Cortney and Bogue cling to their offices with the desperation of drowning men.
“The UCP situation represents a peculiarity of American corporate governance: four incompetent and self-interested Directors hold two entire shareholder bases hostage. We are certain that a poll of PICO and UCP owners would almost unanimously vote for a sale. Yet these four — Michael Cortney, Dustin Bogue, Peter Lori and Kathleen Wade — despite destroying millions of dollars in value for owners — refuse to take economically sensible and just action. In exclusive pursuit of their self-interest at the expense of hundreds of owners, they refuse to put UCP up for sale. If karma is a reality, we expect these Directors to suffer a similar fate as the Legacy Directors at PICO.
“Some people have to learn the hard way.”