New Business Plan Piques Activist Investor Interest

As originally appeared in Troubled Company Reporter, by Geoffrey J. Bailey

On Nov. 17, 2015, the Board of Directors for PICO Holdings, Inc. (Nasdaq:PICO), a diversified holding company based in La Jolla, Calif., authorized a share repurchase of up to $50 million “as capital becomes available.” PICO also outlined modifications to executive compensation “to better align compensation with an objective of returning capital to shareholders as assets are monetized,” whereby PICO CEO John Hart’s base salary is reduced by over 54%. According to the release, “compensation will be calculated based on value created from asset monetizations in excess of their current book value and payable only upon the return of capital to shareholders.”

These actions have piqued the interest of Central Square Management, LLC.

Background

PICO Holdings has 3 consolidated subsidiaries and a securities portfolio.

Water Assets: PICO owns 100% of Vidler Water Company, Inc., which acquires and develops water resources and water storage operations in Nevada, Arizona, Colorado and New Mexico. At September 30, 2015, PICO carried the tangible water assets at $42.518 million and the intangible water assets at $126.835 million, for total water assets of $169.353 million. However, the PICO 2014 Letter to Shareholders indicates that, “Considering market comparables, including all adjustments, and the current overall economic outlook in our markets, it is possible to arrive at a potential value for Vidler Water of approximately 2.2 times Vidler’s book value.” PICO management has made similar public statements recently.

Real Estate Assets: PICO owns 57.2% of UCP (NYSE: UCP), a homebuilder and land developer operating in California, Washington State, North Carolina, South Carolina and Tennessee. PICO formed UCP, LLC, the predecessor company to UCP, in 2007 to acquire finished and partially-developed residential lots in California and Washington State. In 2010, UCP, LLC formed Benchmark Communities, LLC to design, construct and sell single-family homes on lots owned by UCP, LLC.

On July 23, 2013, in an Initial Public Offering, UCP floated 42.8% of its shares at $15 per share, which left PICO with a 57.2% stake.

On April 10, 2014, UCP acquired Citizens Homes, Inc., a residential homebuilder in North Carolina, South Carolina and Tennessee. The purchase price was $14 million with $6 million in potential earnouts. According to PICO, the “Citizens Acquisition provides increased scale and presence in established markets with immediate revenue opportunities through an established backlog. Additional synergies are expected in the areas of purchasing leverage and integrating the best practices in operational effectiveness.”

Shares of UCP currently trade at $7.16 per share (12/11/15).

Oil & Gas Assets: PICO owns and operates Mendell Energy, LLC, an oil and gas venture operating in the Wattenberg Field in Colorado that has drilled and completed four wells. Mendell owns over 400 acres of oil and gas leases in the Wattenburg Field and owns over 600 other acres of oil and gas leases in Wyoming. In 2014, PICO recorded a $4.4 million impairment loss on Mendell, reducing its carrying value to $1.7 million. In the first 9 months of 2015, PICO recorded Mendell impairments of $1.8 million, which, when netted against 2015 investments, produced a carrying value of $2.5 million at September 30, 2015.

Securities

PICO owns the following securities:

(a) Synthonics: PICO owns $2.2 million of preferred stock, representing an 18.3% voting interest, in Synthonics. Kenneth J. Slepicka, a PICO director, co-founded, and is currently the Chairman, Chief Executive Officer and acting Chief Financial Officer of Synthonics. During 2014, PICO extended a $450,000 line of credit, at 15% annual interest, to Synthonics. The outstanding balance and accrued interest was repaid in April 2015.

(b) Mindjet: At December 31, 2014 PICO owned 28.4% of the voting stock of Mindjet (comprised of common stock, several series of preferred stock, and convertible debt) and held one board seat out of six. Mindjet, of San Francisco, California, is a privately held company that provides business innovation software. Mindjet markets its products worldwide and has offices in the US, Germany, France, Japan, Australia, and the UK.

At December 31, 2014, PICO carried Mindjet at $25.1 million, with an “estimated fair value was $32.9 million.” In 2015, PICO recorded a $20.7 million impairment loss on the Mindjet investment, leaving $1.3 million in value on the books.

Agricultural History

In December 2010, PICO paid $60 million for an 87.7% equity interest in Northstar Hallock, LLC, doing business as Northstar Agri Industries, of Hallock, Minnesota.

Subsequently, Northstar Hallock completed a $100 million debt financing comprised of $89.5 million senior secured term loan to fund the construction of the plant and a $10.5 million senior secured revolving credit facility for working capital. During 2012, the plant began operations and the revolving credit facility was increased to $27 million. Later, PICO purchased of $40.4 million of 10% Northstar Hallcok preferred stock. The plant, a canola seed crushing facility, had crushing capacity of 1,400 tons per day.

On March 31, 2015, River Road Asset Management, in a 13-D filing with the U.S. Securities and Exchange Commission, reminded investors that it owned 2 million PICO shares, which represented an 8.8% interest. Among other things, River Road encouraged PICO to “monetize the firms investment in Northstar.” On July 31, 2015, PICO closed the sale of Northstar to CHS Inc., a farmer-owned cooperative and global energy, grains and foods company. The price was $127 million; PICO recorded a loss on sale of the discontinued agribusiness operations of $18.3 million during the nine months ended September 30, 2015.

Activist Dialogue

On August 7, 2015, Kelly Cardwell, of Central Square Management, LLC, in a letter to PICO Chairwoman Kristina Leslie and the Board of Directors, indicated that his firm owned approximately 6% of PICO shares outstanding. Mr. Cardwell relates that he privately reached out to the PICO Board and CEO Mr. Hart on several occasions, but both parties were unresponsive. Mr. Cardwell intended to keep the dialogue quiet, but after receiving the silent treatment, his side has “become increasingly frustrated with the Company’s failure to substantively address the important issues” currently facing PICO.

In a section entitled “PICO – A History of Poor Performance,” Mr. Cardwell explains that PICO has underperformed all peers, indices, alternative investment options and expectations — over any and all relevant time periods. Mr. Cardwell attributes this remarkable negative performance to poor capital allocation. By his calculations, PICO destroyed $85 million on Northstar Hallock, $50 million on UCP and even more on various investments and securities.

In relation to the securities, Mr. Cardwell presciently notes that “future impairments are probable.”

Next, Mr. Cardwell addresses PICO’s executive compensation practices. His analysis, based on a 4 x 4 matrix with axes measuring total shareholder return in relation to executive compensation, places PICO squarely in the “Quadrant of Shame,” which is represented by low total shareholder return and high executive compensation. “After a period in which PICO was one of the worst performing stocks driven by terrible capital allocation decisions, the CEO’s total compensation package was increased by 135% year-over-year to over $5 million in 2014,” he explains.

Mr. Cardwell closes his compensation section by noting that PICO Officers and Directors own only 1.9% of PICO shares outstanding, “so they have little stake in the Company’s success.” With “so little ‘skin in the game’ and not enough confidence in the Company to engage in meaningful stock purchases, management and the Board do not have the same commitment to shareholder value,” as Central Square.

Mr. Cardwell encourages PICO to adopt a three-part plan to create shareholder value:

  1. Conduct a thorough review and overhaul of compensation policies;
  2. Conduct a formal sale process of UCP; and
  3. Use the UCP sale proceeds and other excess cash in an issuer self-tender.

Mr. Cardwell concludes his communication by stating, “Despite the Company’s poor performance, we believe there is still time for management to put PICO on the path towards significant shareholder value creation. In fact, if management follows the steps outlined in this letter, we believe PICO’s stock price could double or even triple.”

Central Square Strikes Again

On October 13, 2015, Central Square filed a second 13-D.

“Unfortunately, it has become clear that the Company does not intend to address our serious concerns or suggestions in a timely or meaningful manner. It is deeply troubling that the Company remains closed-minded to alternative value creation initiatives as its performance continues to be abysmal. Through our recent efforts to work with PICO, we have become increasingly uncomfortable with the leadership of the Company and believe significant changes are needed immediately.” Mr. Cardwell proffers three candidates for the PICO Board:

  1. Anthony Bergamo;
  2. James Henderson; and
  3. Daniel Silvers.

This request is justified because, “It is simply unacceptable for the Board to continue along the same path that has resulted in the destruction of more than $170 million of book value (reported shareholders’ equity decline from 3Q’07 peak) and more than two-thirds of its equity market capitalization over the same timeframe (approximate $530 million market capitalization decline).

Given PICO’s endemic underperformance and egregious compensation schemes, we believe it is crucial to have meaningful shareholder representation on the Board immediately.” Additionally, Central Square expands its list of suggested steps for PICO from three to four:

  1. Sell UCP;
  2. Use the proceeds for a self-tender;
  3. Monetize a portion of the Vidler Water portfolio; and
  4. Overhaul executive compensation.

PICO Investor Day

On November 17, 2015, PICO held its Investor Day in Reno, Nevada. Only certain investors selected by PICO were allowed to attend. The first hour consisted of an explanation and analysis of Vidler Water by that unit’s President and COO Dorothy Timian-Palmer and Mr. Hart, which was followed by Q&A. Mr. Hart admonished the hand-picked attendees, “Now we’ll open it up for questions, JUST on Vidler Water.”

After the Vidler Water presentation, attendees took a break and returned to hear Mr. Hart read the Revision to Its Business Plan and Board Authorization for a Stock Repurchase Program. Mr. Hart indicated that the PICO Board of Directors authorized a share repurchase of up to $50 million “as capital becomes available.”

PICO also outlined modifications to executive compensation “to better align compensation with an objective of returning capital to shareholders as assets are monetized,” whereby PICO Mr. Hart’s base salary is reduced by over 54%. According to the release, “compensation will be calculated based on value created from asset monetizations in excess of their current book value and payable only upon the return of capital to shareholders.”

Once Mr. Hart finished reading the press release, he announced that Q&A would follow, but that the webcast would be cut off to prevent its dissemination to the public.

Third 13-D by Central Square

Mr. Cardwell and Central Square Management were not pacified. On November 23, 2015, in a 13-D filing with the SEC, Mr. Cardwell again addresses Chairwoman Leslie and the PICO Board: “We had been hopeful following our October 29, 2015 conversation, in which you alluded to an ongoing near-term dialogue, that the Board was finally willing to work with us to implement the strategies we believe would materially improve the Company’s performance.

However, PICO’s recent announcements at its Investor Day held on November 17, 2015 flies in the face of our stated concerns and your apparent self-serving statements. It has become clear to us that the Company has no intention of addressing our concerns or our suggestions in a serious manner.”

“While on the surface these announcements appear to be a step in the right direction, we believe they fall short of the change required at PICO to improve the Company’s performance. Importantly, we, along with other PICO shareholders, as discussed in more detail below, believe that any steps to address the issues currently facing the Company cannot be implemented by the same individuals who should be held accountable for the Company’s failures. It has therefore become unequivocally clear that additional independent oversight is needed at the Board-level immediately.”

PICO’s changes to executive compensation represent an improvement, but they do not go far enough, according to Mr. Cardwell. He raises five issues:

  1. Mr. Hart’s base salary continues to be “unjustifiably high;”
  2. Incentive compensation remains misaligned;
  3. Mr. Hart’s additional bonus formula is “outrageous;”
  4. Insufficient detail pertaining to amendments to Mr. Hart’s compensation; and
  5. No detail on Mr. Hart’s golden parachute.

Addressing PICO’s decision to censor the general Q&A, Mr. Cardwell states “Putting aside the legitimate question of whether the failure to webcast this session is in compliance with the spirit of Regulation FD for investors who could not attend the meeting in Reno, we view this decision as indicative of management and the Board’s decided indifference to, and misalignment of interests with, the Company’s shareholders. The lack of webcast availability is particularly disheartening, as we are aware of a number of shareholders who sought to attend the event but whose requests were rejected by the Company. Notably, during the Q&A session, Mr. Hart indicated that the Board has engaged an executive search firm to identify new candidates for the Board — an important governance announcement that we believe should have been made available to all shareholders via webcast.”

Apparently, at Investor Day, PICO announced that its 2016 Annual Meeting would be held in August, despite its historical custom to hold such meeting in April. Mr. Cardwell demands that PICO hold the Annual Meeting no later than April 15, 2016, “to enable shareholders to establish a clear mandate for the Company, including the election of director candidates that they believe are most qualified to provide effective oversight of the Company.

Shareholders cannot afford to wait until next summer to address the shortcomings of this Board.” Mr. Cardwell warns the PICO Board that, “taking measures to further entrench itself is a breach of its fiduciary duties and will not be tolerated.”

Concluding, Mr. Cardwell states, “We hold each of the Board members accountable for the destruction of shareholder value at PICO that has occurred under their oversight. For over a year now, we have attempted to work constructively with you, other members of the Board and management team to implement meaningful steps to enhance shareholder value at PICO but to no avail. We will continue to closely monitor the Company’s performance and actions and will not hesitate to take any and all actions that we deem necessary to protect shareholders’ rights and maximize shareholder value. We once again strongly urge you to reconsider your uncooperative approach and to do the right thing for PICO shareholders by reconstituting the Board with the three highly qualified individuals we have identified. We expect the shareholders’ interests to remain of paramount importance and as we have repeatedly stated, we stand ready to meet at your convenience to discuss next steps.”

Bailey, Geoff J., PICO HOLDINGS: New Business Plan Piques Activist Investor Interest, 19 Troubled Company Reporter 349 (Dec. 15, 2015)

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