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RPN’s Man Of The Year – 2017. Somewhere Over Dorothy’s Rainbow. RPN Sells UCP for $13+.

RPN’s Man of the Year – 2017

Max Webb

After considerable deliberation among the RPN principals and our panel of experts, we select Max Webb as RPN’s Man Of The Year 2017.

Let’s review events at PICO Holdings since Mr. Webb was named CEO in October 2016. First, Mr. Webb displaced John “The Juicer” Hart, a change that created much uncertainty among the PICO shareowner base.

Shortly thereafter, PICO announced two tranches of Arizona Storage Credit sales for $25 million, revision to Executive and Director Compensation, removal of sloth-like and impotent Directors Raymond “Delaymond” Marino and Hapless Howie Brownstein.

Early 2017 saw the battle for improved corporate governance at UCP, in which Mr. Webb played a key role. Most importantly, Mr. Webb sheparded the sale of PICO’s stake in UCP to Century Communities. And Mr. Webb presided over the the subsequent $5 per share return of capital to PICO owners.

Investors are now hopeful that, with the hiring of I-Bankers at JMP Securities, Mr. Webb will monetize the Vidler portfolio.

Mr. Webb would be the first to admit that he has not worked alone. The corporate governance overhaul at PICO was led by Daniel Silvers and Andrew Cates, which cleared the way for Mr. Webb to maximize value. In an acceptance speech, Mr. Webb would give gratitude to his able CFO, John Perri. A strong economy has given Mr. Webb upward markets into which to sell assets. And the presence of large shareowners on the PICO Board has been a positive influence.

Since becoming CEO, Mr. Webb has stewarded shareholder capital pretty much flawlessly. He has procured the best prices possible for assets, he has transacted them expeditiously and the vast majority of proceeds have been returned to owners in a tax efficient manner. Shareholders can’t ask for more.

At this point, RPN has to admit that we were wrong. For the first 18 months of our existence, we were not fans of Mr. Webb. Given that he worked alongside the most corrupt leader since Attila the Hun for almost two decades, we assumed Mr. Webb was an active accomplice in PICO’s crimes against shareowners.

Our negative assumption about Mr. Webb was not pulled out of thin air. Recall that Mr. Webb sat on the UCP Board while several shareholder-adverse actions were taken. Mr. Webb turned a blind eye to innumerable profligate misdeeds during his tenure as PICO’s CFO. And as one PICO observer said, “If you see the problem and you don’t do anything, you are part of the problem.”

However, thus far, Mr. Webb has shown himself to be not merely a passive follower as CFO but a decisive leader as CEO. He refused to make waves while Juicer robbed the PICO piggy bank, but he has been a champion of shareholder value once given the corner office. We feel Mr. Webb deserves applause from PICO owners for his stewardship of our enterprise since ascending to CEO.

For his expeditious and fulsome maximization of value at PICO in just over a year as CEO, Max Webb is RPN’s Man Of The Year – 2017.

Somewhere Over Dorothy’s Vidler Rainbow

Certain PICO observers are getting restless. They wonder why the delay to monetize the Vidler portfolio, especially the Fish Springs asset. A few PICO owners speculate that Dorothy Timian-Palmer, CEO of Vidler, is giving the PICO Board the runaround.

These observers note that Juicer, Mr. Webb and Mrs. Timian-Palmer have been talking up the Fish Springs property for the better part of three years. These Executives have told the investing public that if the right bid was received, they would take it.

Yet despite all the Executive optimism, no satisfactory bids have surfaced?

The Board put Mrs. Timian-Palmer’s money where her mouth was when JMP Securities was retained. The Vidler monetization should be progressing, cuz at least now it is formalized. But we still have no bids.

A few PICO observers speculate that Mrs. Timian-Palmer stands in the way. If Fish Springs is perfectly positioned, if its value is obvious and if its water assets are such a scarce resource, then why hasn’t any interested party hit the right bid?

Given that Mrs. Timian-Palmer is PICO’s foremost water expert and was the architect of the Vidler portfolio, she has the ability to talk water circles around everyone else at PICO – especially at the Board level, where none of the Directors are water experts.

Skeptical shareowners wonder out loud if Mrs. Timian-Palmer is talking down reasonable bids for Vidler assets, especially Fish Springs. They speculate that she is telling the Board that the various Vidler assets are worth more than current bids for three reasons:

a) she is unrealistically optimistic about their ultimate worth;

b) her bonus for selling Vidler assets is de minimis; and

c) she will be monetizing herself out of a job.

To summarize, some PICO owners fear that, in order to protect her own interests, Mrs. Timian-Palmer is talking down perfectly reasonable bids for Vidler assets. Since the Board lacks the specialized water knowledge to refute her conclusions, the Vidler monetization process is structurally flawed.

One clever shareholder had a simple yet effective idea: the PICO Board should hire an independent water expert to evaluate the Vidler portfolio and either corroborate or dispute Mrs. Timian-Palmer’s conclusions. Where there is disagreement, the two should have it out in front of Directors, thereby subjecting the process to competitive scrutiny.

At RPN, water asset valuation is far above our pay grade. But we see the potential for mischief in the Vidler monetization process. Mr. Webb has thus far proven himself immune to such temptations of self-interest, but Mrs. Timian-Palmer may not have the same constitution. Given that the carrying value of PICO’s water assets is about $170 million, we agree that retention of an independent water expert makes sense.

AT THE LEAST, there is something incongruous about Mrs. Timian-Palmer’s incessant optimism yet a shortage of reasonable bids.

The RPN Force Reawakens

Like bears in winter, RPN went into hibernation. In late December 2017, as we marked the 2-year anniversary of RPN, our website host commemorated this milestone with an invoice for a yearly renewal payment. After spending several thousand dollars of our personal funds on the PICO-UCP situation, with an excellent Board of Directors in place, a fine CEO, significant corporate governance improvement and lots of profits to go around, we decided to leave our fate to our readers.  In other words, we asked readers for money.

And we heard crickets.

The principals of RPN have never been good at taking hints (just ask our ex-girlfriends), so we petitioned a second time. While the response was not overwhelming, it was sufficient to put the economic ground back under RPN – and so we are back on our feet.

If you read RPN for the next year, give thanks to Dave and Jjs. These two generous individuals stepped forward to reactivate and maintain RPN for another year. Our gratitude goes out to these gentlemen.

We forgive our wealthy readers who have earned hundreds of thousands of dollars (some have earned millions of dollars) from the PICO-UCP situation, and refused to support us. As our Crack Strategist told us several months ago, “In this business, gratitude lasts the better part of a morning.”

RPN Sells UCP For $13.15

The principals of RPN recently liquidated their stake in UCP-CCS at an effective price of $13.15 per share. Wait, the deal price — announced in the press release — was $11.35 per UCP share, not $13.15.

In the noncommittal short term, we liked Century Communities. We liked the CCS management team, we perceived strong momentum in the builder industry and we believed that the benefits of the low UCP acquisition price would flow through to CCS. On August 14, 2017, we wrote, “[Max] Webb waxed optimistic about Century and indicated that the principals at PICO are ‘big believers in Century.’ We agreed with Mr. Webb’s optimism, analysis and public posture. We held our Century shares as Moody’s changed its outlook on Century to ‘Positive.’”

In other words, we were clear that we planned to hold our CCS shares, at least for the short term.

Plus, once the acquisition was announced, we did some investigation. We wanted to know why the bid for UCP was so low? We found a real estate expert and asked why so many potential buyers either passed on UCP or bid low? Among many other observations, these are some of the things he said:

“UCP is a land development company that happens to build homes when necessary. It’s how they should in theory make up for their lack of scale; by creating value in their land holdings…But that’s the problem with public money and land – you have to be patient and sit on land. Collectively as a whole UCP is kind of a tough pill to swallow.  Two great tastes that don’t taste great together: inefficient regional homebuilding or long term risky land holdings (remember homebuilders do not like holding on to land that they can’t or aren’t ready to build on immediately).”

At no time did this expert say that UCP was structurally flawed or inherently disadvantaged. As we all knew, UCP was a hybrid: part land developer with tracts that would take years to progress, and part conventional homebuilder. According to our expert, the bidders contemplating a UCP acquisition wanted one side or the other, but not both – hence the bids came in low.

We like investment situations such as this: where the optics may not be pristine but the economics are favorable. We reasoned that CCS would be able to create value from this configuration and eventually, such value would show up in the stock price. While no single buyer wanted both parts, we reasoned that if broken up, the parts would be worth more than $11.35 per share. And we reasoned that CCS had enough time in this housing cycle to realize at least some of that value.

“Phooey,” skeptical readers could say. “The acquisition only closed 5 months ago. What kind of value could CCS have realized in 5 months?” It’s a valid point. We don’t know why CCS shares soared over 40% during that time (from $24 in August 2017 to over $35 today). We do know that $35 surpassed our target exit price, so we gladly peeled off the position.

We also know that the more diligent effort we put forth, the more profits seem to flow our way. As Thomas Jefferson famously said, “I am a great believer in luck and I find the harder I work the more I have of it.”

PICO Reports Q3 Earnings – A Quickie. Special Dividend Record Date Passes.

On November 7, PICO Holdings reported earnings for Q3 2017.

There wasn’t much news, either in the SEC filings or in the earnings call. The earnings call was so short and uneventful, we thought we heard a cricket chirp in the background.

While not very exciting for PICO CEO Max Webb and CFO John Perri, we view the lack of participation as a positive indicator. We believe that investors have trust and faith in these Executives and this Board. As a result, there wasn’t a whole lot to inquire about.

Investors in general, and especially those with an activist slant, tend to focus their grease on the squeaky wheels. Two years ago, PICO was the squeakiest wheel in small cap corporate America. Today’s PICO is far improved.  Hence, less grease.

PICO itself damped much of the rationale for inquiry when it announced a $5 Special Dividend on October 26. With about $150 million in cash on the balance sheet, shareowners were wondering when a few of those greenbacks would hit their wallets. PICO has answered that question.

The most interesting detail from the Q3 Press Release was the steady increase in federal Net Operating Losses. The federal NOL balance was $125.1 million on March 31, 2017, $162.3 million at June 30, 2017 and and finished Q3 at $187.1 million. The sharp increase in NOLs indicates that PICO’s asset sales have been far below basis for tax purposes. We can thank John “The Juicer” Hart for that.

The numbers given above are federal only. PICO also carries significant state tax benefits which will shield some monetization proceeds from the Golden State of California.

Hopefully, these NOLs will benefit owners when the remaining Vidler assets are monetized. If such assets are sold at a premium to their tax bases, the NOLs should funnel a few more Benjamins to PICO owners. Fingers crossed.

Alternative Dividend Facts

We were surprised to learn the dates related to the PICO $5 Special Dividend. The Record Date was November 6, the Payment Date is “on or around” November 20 and the Ex-Dividend Date is November 21.

Huh? Since when does an Ex-Dividend Date come after the Payment Date?

Typically, the ex-dividend date is the deadline that matters. The ex-dividend date comes two business days before the record date and is the chronological dividing line between receiving the dividend or not receiving the dividend.

However, the PICO Press Release and Mr. Webb on the earnings call, make clear that the parameters of the $5 PICO Special Dividend are different. According to the Press Release:

“The dividend will be payable on or around November 20, 2017, and pursuant to FINRA Rule 11140, the ex-dividend date will be November 21, 2017 – one business day after the anticipated distribution of the special dividend.”

We looked up FINRA Rule 11140, because we’d never encountered it before. Section (b)(2) states in pertinent part:

“In respect to cash dividends or distributions, stock dividends and/or splits, and the distribution of warrants, which are 25% or greater of the value of the subject security, the ex-dividend date shall be the first business day following the payable date.”

For the full text of the FINRA Rule 11140 provisions, click here.

Best we can tell, investors can purchase PICO shares before the Ex-Dividend Date on November 21 and receive the $5 Special Dividend. The Special Dividend should be paid sometime after that, even though the Payment Date is “on or around” November 20.

Better Late Than Never

PICO may own the record for longest unfulfilled return of capital – over 2 years. Recall that on November 17, 2015, Juicer and Legacy PICO announced a “Revision to Business Plan,” which committed to asset sales and return of capital. Here is the exact wording from that Release:

“With the Company’s share price trading at a discount to its book value, the Company believes the highest potential return to shareholders at this time is from a return of capital. Therefore, as assets are monetized, rather than reinvest, the Company currently intends to return capital back to shareholders through the stock repurchase program approved by the Board or through other means such as special dividends.”

It has taken shareholders, certain Executives and certain Directors a long time and a lot of sweat equity to reach this milestone. Upon receiving the Special Dividend, we suggest that all PICO participants give themselves a pat on the back. We deserve it.

PICO To Return Capital To Owners – Finally!

Late afternoon, on October 26, PICO Holdings announced that it would finally return excess capital to owners.

PICO will pay shareowners a Special Dividend worth $5 per share. This will drain the PICO corporate coffers of almost $116 million. Expect the dividend to hit your brokerage account around November 20.

The best part about the Special Dividend: it qualifies as a tax free “return of capital.” Upon receipt of the Special Dividend, most investors will reduce the cost basis in their PICO shares by $5 with no immediate tax consequences.

We say “most investors”  because if you own PICO in an IRA or other tax deferred account, other rules apply. Given that most PICO shares are probably held in taxable accounts, the PICO Board did right by providing us with this temporary tax benefit.

Here is what the IRS says about return of capital:

“Distributions that qualify as a return of capital aren’t dividends. A return of capital is a return of some or all of your investment in the stock of the company. A return of capital reduces the adjusted cost basis of your stock. For information on basis of assets, refer to Topic No. 703. A distribution generally qualifies as a return of capital if the corporation making the distribution doesn’t have any accumulated or current year earnings and profits. Once the adjusted cost basis of your stock has been reduced to zero, any further nondividend distribution is a taxable capital gain that you report on Form 8949 (PDF), Sales and Other Dispositions of Capital Assets, and Form 1040, Schedule D (PDF), Capital Gains and Losses.”

For more information about this, see Topic 404.

JFK & PICO – A Big Week For Disclosure

We, and many other shareowners, have lamented the PICO Board’s heretofore unwillingness to return capital to owners and related secrecy.  One witty investor wrote to RPN over the weekend: “PICO’s secrecy and our government keeping thousands of pages of information related to the assassination of President Kennedy for more than 50 years end the same way.  What was the big secret?”

Another PICO observer said, “I’m not sure what all the prolonged lack of transparency was about. Who obtained any benefit from that?”

Several aspects of the Special Dividend are nice. It is tax-free. It is clean and uni-stroke. It will be paid quickly, as 2017 ends, so investors can collect the Special Dividend in November then only wait 5 weeks to sell for tax year 2018.

But the tax benefit is likely to be temporary. Many PICO owners will be sellers soon and PICO has retained I-Bankers at JMP Securities to monetize the Vidler portfolio.

One of the PICO Board’s stated objectives was to preserve optionality. It achieved that goal. When the second tranche of Century Communities shares was unexpectedly block traded, the PICO Board was able to return this slug of capital by writing one check. This is nice.

But RPN calculates that greater value would have been created if PICO bought in as many shares as possible at $16 – a situation which persisted in April/May and August/September, then returned the leftovers in a Special Dividend.

RPN wonders if there would there have been much difference if PICO bought back a million shares in May and issued a $4 Special Dividend? Or bought back 3 million shares in April and issued a $3 Special Dividend?

We never wanted PICO to shout “share buyback” from the rooftops. We wrote multiple times that we desired the opposite. But PICO could have repurchased shares quietly in either Q2 or Q3 at great prices.

Upon hearing this opinion, one PICO owner said, “I don’t know why they didn’t do that. If PICO is sold in the next year, the benefits of the Special Dividend exist only at the margin.”

Despite all the secrecy and suspense, the PICO result is as T.S. Elliot wrote: “The world ends not with a bang but a whimper.”

RPN Valuation Exercise

Announcement of the $5 Special Dividend brings us to an important question: what is PICO worth going forward?

We estimate that post-November 20, PICO will have $35-$40 million in cash on the balance sheet. PICO’s going-forward annual burn rate is probably about $7 million. As RPN went to press, PICO shares were trading at around $19.75 per share. Subtracting the $5 dividend indicates that investors value the remaining assets in PICO at about $14.75. Subtracting out the cash of around $1.50 per share indicates investors value the Vidler portfolio at about $13.25 per share – call it $13 bucks for ease. Given that PICO has no debt and there will be no tax paid on a monetization, Mr. Market believes that the Vidler portfolio is worth about $300 million ($13 per share x 23 million shares = $299 million).

Deal Of The Century (Communities)

The $5 Special Dividend was made viable by the unexpected block trade consummated between PICO, Century Communities (purchaser of UCP) and the buyer(s) of the second tranche of approximately 1.15 million CCS shares.

Recall that under the UCP Merger Agreement, PICO was permitted to sell about 1.25 million CCS shares 61 days after the Merger, but could not sell the second tranche of about 1.15 million CCS shares until early 2018. However, much to our surprise, a buyer(s) materialized and CCS approved a sale of the second tranche several months early.

As PICO shareowners express gratitude on Thanksgiving, they can add this confluence of events, which made possible the $5 Special Dividend.

Follow The Money

Cash is fungible, so it is impossible for outsiders to track the Executive Bonus implications of the Special Dividend. Is it being paid out of the Arizona Long Term Storage Credits proceeds? Are 100% of the LTSC proceeds included in the Special Dividend? If the answers are “yes” and “yes,” then PICO CEO Max Webb and CFO John Perri, plus some Vidler employees, stand to receive a Bonus in 2017.

For 2017, the Mendell Energy oil and gas properties were sold for $10.2 million, near historical cost, but about $8 million above carrying value. The Arizona Long Term Storage Credits were sold about $12.5 million above historical cost. UCP was sold several million dollars below both historical cost and carrying value.

The Bonus won’t be a whole lot. The Gross Gain from the LTSCs was about $12.5 million, but that amount must be netted against Administrative Expenses. Both the oil and gas properties and UCP were sold at less than historical cost, so these transactions are ineligible for Bonus Calculation inclusion. Our best guess is the Bonus Pool for 2017 may sum to $300,000.

Speaking of Bonuses, when PICO first announced the Revised Compensation Agreements, the press release stated that Executive Bonuses were reduced from the original Juicer Version.

“Not so fast,” said RPN. It all depends on which assets are sold for what prices. Thus far, our caution has proven warranted.

Recall that the Juicer Bonus Pool calculation was mostly similar to the current one, except the former used carrying value as the starting point, whereas the current version uses historical cost. Shareholders revolted against the Juicer version because many of the assets had been written down, which would have given Juicer & Co. a benefit from their past incompetence.

The final result remains to be seen. Is the current Bonus Calculation is better for owners than the Juicer Calculation? We repeat our familiar refrain: no one knows. It all depends on which assets are sold for what prices.

5 Years Of Burn?

Don’t call your broker with a “Sell” order just yet. There should be more capital coming.

If our calculations are correct, once the $5 Special Dividend is paid, PICO will retain about $35-$40 million in cash in the bank account. Given an annual burn rate we estimate at about $7 million, this seems like a lot. It is 5 years worth of corporate expenses.

When informed about this, one PICO owner said, “Wow. That’s a lot. I did not realize they held on to so much.”

We are not sure what the PICO Board plans from here. But, if history is any guide, we are pretty certain about one thing: there will be no action for a while and there will be no transparency.

RPN Gives Thanks

We do our share of griping and complaining and second-guessing. That is our self-appointed job. Underneath it all, is a sentiment of gratitude for those who have made value maximization at PICO a reality. We thank Daniel Silvers and Andrew Cates, who fought value destroyers who were dressed in creator clothing. Mr. Cates departed PICO before receiving adequate compensation for his efforts. We thank Eric Speron for playing a strongly supportive role. Thus far, Messrs. Webb and Perri have been very good stewards of the PICO enterprise, providing greater clarity to owners and moving deals forward.

In conclusion, this group of value advocates, with strong support from an active shareholder base, has turned a PICO situation that was utterly miserable into an opportunity for value realization.