Bloggers Say Synthonics Fails Value Investment Test

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 14% of PICO. Other activists at http://ReformPICONow.com/ have taken to the Internet to advance the shareholder cause.

The bloggers expect the PICO Strategy Committee to spring into action. “The PICO Board should sell at least one asset before 2016 closes out. The ideal asset sale would garner proceeds of about $13 million above carrying value. That way, all proceeds could be returned to PICO shareholders and Juicer would be left to pout on his La Jolla roofdeck.

The Strategy Committee has been the quiet stepchild of the PICO drama thus far, but it will be an influential player in the upcoming asset monetization game. We have come across no mention of the Strategy Committee in any of PICO’s public communications, SEC filings, press releases nor earnings calls. It has no Charter posted on the PICO website.

Eric Speron, Chair of the Strategy Committee, will ‘monitor’ asset liquidation and return of capital to shareholders. Fellow Committee members Andrew Cates and Daniel Silvers will likely aid Mr. Speron in a speedy manner. PICO Chairman Raymond Marino will most likely analyze interminably.

For a time, it looked as if the Strategy Committee would hibernate the rest of 2016. But given that a $13 million in Administrative Expense shield, worth $2.6 million to PICO shareholders, will expire at the end of the year, we’re optimistic the Strategy Committee has gone live in preparation to wheel and deal.

There was no love connection between Mr. Speron and RPN early in our relationship. But we see a reconciliation in the offing. We hear that Mr. Speron has been a diligent advocate of shareholder interests since our rocky beginning. Mr. Speron is a non-paid Director, who personally owns 60,190 shares. His employer, First Foundation Advisors, owns 860,493 PICO shares, or 3.7%.

Mr. Speron is the bravest of Directors. According to the Proxy Statement, Mr. Speron’s spouse owns 190 PICO shares in an IRA. The norms of corporate governance should be changed to acknowledge such bravery. Directors get one point for every share they own, but two points for every share their spouse owns.

Mothers-in-law are worth 3 points, plus a medal.

We take comfort in Mr. Speron’s large tripartite bet (personal, professional and spousal) on the horse named PICO. We look forward to congratulating Mr. Speron when the first PICO asset is sold and capital is returned to shareowners – before the end of 2016.”

Next, the bloggers turn to the PICO Board’s decision to retain the Synthonics stake. “For two reasons, we feel that retention of the Synthonics stake is a disservice to PICO shareowners. First, it is a violation of the principles of value investing. Second, the PICO Board has no mandate to husband assets and withhold capital from shareholders.

Yes, the numbers are small: the Synthonics stake has a carrying value of $2.2 million. But RPN views the Synthonics situation like a couple that gets a cat before they have children. Unsure if they are collectively ready for the heightened responsibility and challenge that children bring, the couple starts out small as a test. We view the Synthonics stake as the PICO Board’s cat. And the result does not leave us optimistic.

To us, Synthonics is capital allocation trash. We find it worrisome that the PICO Board has found Synthonics to be a viable investment. This concern is heightened by the fact that the PICO Board has a portfolio of water rights and a homebuilder, collectively trading at half of book value, in which to invest.

On the Q2 earnings call, Mr. Marino said, ‘PICO will continue to support Ken and his team at Synthonics since PICO is one of Synthonics’ largest shareholders. Ken and his team have made great progress with Synthonics, and we look forward to seeing Synthonics continue to expand their technology and bring products to the market.’

This sounds to us like the PICO Board has ‘analyzed’ the Synthonics investment, is optimistic about its commercial future and will hold it for a while, expecting a positive result. We find this course of action ridiculous. You can’t draw conclusions about an investment that is un-analyzable. You can only speculate.

Today, we examine retention of the Synthonics stake from the perspective of value investing. We compare Synthonics to a business PICO shareholders know a little bit about: a homebuilder.

Let’s review the basics of value investing. A value investment is:

— easy to understand;
— in an industry with some level of stability and predictability;
— managed by people worthy of respect, admiration and trust, who think like owners and manifest
high competence; and
— available at a price that is lower than intrinsic value.

1) Is Synthonics easy to understand?

Here is a description of Synthonics lifted from the corporate website:

‘We are a specialty pharmaceutical company focused on the discovery, development and licensing of drugs that incorporate our proprietary metal coordination chemistry. Metal coordination entails attaching a pharmaceutically acceptable metal, such as zinc, bismuth or magnesium, to a known pharmaceutical agent to create a new and more effective drug.’

Do our Directors understand ‘metal coordination chemistry?’ Do our Directors comprehend how zinc, bismuth or magnesium can be attached to a known pharmaceutical agent to create a drug?

As we scan our current Directors’ bios, we don’t see “M.D.” after anyone’s name. We don’t see any biotech Directorships. We don’t see any pharmaceutical industry experience. We have no idea if Synthonics will develop a viable product. We have no idea if a market exists for a potential product. We doubt if anyone else does either.

Here is a profile of UCP lifted from that firm’s website:

‘UCP is a homebuilder and land developer with significant land acquisition and entitlement expertise in high barrier-to-entry West Coast and Southeastern U.S. markets characterized by attractive residential real estate fundamentals.’

Everyone understand that? We do. We think our readers do. We are sure that our experienced and intelligent Directors do.

Synthonics fails the first test of a value investment – it cannot be easily understood. UCP passes the first test – it can be easily understood.

2) Is Synthonics’ industry stable and predictable?

There is no industry for Synthonics’ offering. Their proposed product is entirely experimental. SEC filings indicate that Synthonics has between $1 and $1 million in revenue; revenue might be close to zero. All of the fundamentals of industry analysis are inapplicable to Synthonics.

UCP is a homebuilder with presence in California, Washington and the East Coast. Contract homebuilding has been around for hundreds of years. The Standard Industrial Classification Number for “Operative Builders” is 1531. We can get industry data on a national, regional or local level. We can analyze the competitors, market shares, product offerings. We can compare profitability across the industry. We can access decades of homebuilder data.

Synthonics fails the second test of a value investment – it does not operate in a stable or predictable industry. UCP passes the second test of a value investment.

3) Is Synthonics managed by admirable and respectable people who think like owners and manifest high competence?

The Synthonics stake has resided on PICO’s balance sheet for 6 years and, to the best of our knowledge, has not appreciated nor paid a dividend. PICO shareholders indicated that Kenneth J. Slepicka, Synthonics CEO and former PICO Board member, is unfit to serve as a Director. Mr. Slepicka failed to disclose a conflict of interest, related transaction to PICO shareowners. Mr. Slepicka received almost $1 million in cumulative compensation from PICO shareholders, and PICO stock went from $30 to $10 during his tenure.

UCP has exhibited similarly poor performance and corporate governance. UCP Chairman Michael C. Cortney and the Board removed the Officer Stock Ownership Guidelines from the Proxy Statement without explanation to owners. UCP CEO Dustin Bogue is out of compliance with those guidelines, but no clarification to the owners of UCP has been provided. UCP destroys economic value with every home sold – and shows no signs of slowing down. Two of UCP’s Directors, Juicer and Max “Tangled” Webb, have a history of corruption and incompetence.

Synthonics fails the third test of value investing – it is not run by respectable and admirable people who think like owners and manifest competence. UCP also fails the third test. However, we expect the situation at UCP to change shortly. We have no reason to believe that change is forthcoming at Synthonics.

4) Is Synthonics available at a price lower than intrinsic value?

We don’t know. PICO Directors don’t know either. Synthonics’ commercial potential is not subject to realistic analysis; it is pure speculation. Given that Synthonics fails the previous 3 tests, our experience suggests that Synthonics will turn out to be a loser. But again, who knows?

UCP is available at a price lower than intrinsic value, in the event of a change of control. UCP is worth its current price when valued as a going concern. The price to value question is answered by the probability each analyst attaches to the various scenarios for UCP.

Synthonics fails the fourth test of value investing – we cannot estimate its value. UCP passes the fourth test of value investing, under one scenario.

We have a suggestion for all Directors that voted affirmatively to retain the Synthonics stake: take your annual compensation in the form of PICO’s Synthonics securities. This would serve the dual purpose of cashing PICO shareholders out of Synthonics while allowing the Directors with confidence in Mr. Slepicka’s firm to put their money where their vote is.

If this solution is unpalatable, we have a question for these same Directors: if you will not invest your personal wealth in Synthonics, then why are you forcing PICO shareholders to invest our personal wealth in Synthonics?

We have invested in PICO because we want to own a portfolio of water rights and a homebuilder. This collection of assets is selling for half of book value. Shouldn’t our Directors increase our ownership stake in that?”