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/ (RPN) have taken to the Internet to advance the shareholder cause.
The bloggers ask an important and provocative question: “Is UCP America’s worst publicly-traded homebuilder?”
Their answer: “A strong case can be made that the answer is ‘yes’ — not because the homes it builds are shabby or inferior, but because UCP’s Directors and Executives fail to maximize the value of the company’s assets in the marketplace.”
The bloggers explain why.
“UCP ranks near the bottom of the industry in all measures of operations and profitability, except for growth metrics. UCP’s Q3 gross margin was 18% in Q3 2016, placing it in the bottom half of the industry. Operating profit margin was 7.1% — also in the bottom half of the industry. If an appropriate tax provision of 38% is taken, hypothetical net income was $3.4 million, producing a net margin of 4.4%, at the bottom of the industry.
Over the last 12 months, UCP has earned $17 million in pretax income and $10.5 million aftertax. UCP’s shareholder’s equity is $217 million; return on equity for the last 12 months is 4.9% ($10.5/$217=4.9%). SEC filings reveal that UCP’s self-calculated cost of equity capital is around 14%. UCP is 900 basis points short of that threshold. When we multiply the 9% shortfall by $217 million in equity, UCP is destroying almost $20 million in shareowner value every year (.09x$217=$19.5).”
The bloggers offer some commentary on these metrics. “UCP is a value destruction machine that transfers wealth from shareholders to Directors, Executives and Employees. UCP CEO Dustin Bogue comes to work every day, but it would be better for shareholders if he did not.
Recently, UCP aborted a $200 million high-yield debt offering. This was a blow to both UCP’s image and its business plan. UCP told investors that it has numerous options, but UCP is now damaged goods in the market for debt issuance and none of its financing alternatives are appealing.”
The bloggers criticize UCP’s investments. “UCP’s capital allocation has been dismal.
“UCP’s unenviable 18% gross margin is due to certain poor real estate choices, high borrowing rates and high costs. UCP’s low gross margins are surprising given two factors – first that UCP has significant vintage West Coast land purchased at cheap prices during the downturn. Second, that UCP derives the majority of its revenues in high-margin California, where competitors typically produce gross margins of 20% or higher.
“The Citizens goodwill writedown is embarrassing. We do not know how a homebuilder acquisition, made in 2014, in some of America’s best homebuilding markets, during a period of strongly rising land prices, could go sideways.
“On the 2016 earnings calls, both Q2 and Q3, Mr. Bogue blamed weather for the problems in its Southeast Division. However, RPN has read the Q2 and Q3 earnings releases and listened to the earnings calls for every publicly traded homebuilder in the US. Not one single other homebuilder that operates in UCP’s Southeast markets, cited the weather as an impediment to deliveries or a drag on profits. Competitors that operate in the same markets as UCP’s Southeast Division did not experience operational shortfalls and they did not blame the weather for operational problems. Consequently, we find Mr. Bogue’s explanation for his poor results there – the weather – to be unlikely.
“We believe that the latter two explanations provided in the 10-Q, abandoned land deals and margin miscalculation, are to blame for the problems at UCP’s Southeast Division. And these two factors are the direct responsibility of management, namely Mr. Bogue who executed the Citizens acquisition.
“This distinction is important. The weather is out of Mr. Bogue’s control. Overpaying for an acquisition and botching operations thereafter, are not.”
Next, the bloggers excoriate UCP’s corporate governance. “When it comes to corporate governance and Director/Executive conduct, we believe that UCP is far and away America’s worst homebuilder. Mr. Bogue was bailed out of his Red Hawk deal with PICO Holdings‘ shareholder funds when a land deal for which he issued a personal guarantee went bust. When UCP went IPO in July 2013, Mr. Bogue engineered gross margins of 32% in the quarter immediately preceding. UCP’s stock traded as high as $17 per share, before plummeting to a low of about $5.50 in 2016. Correspondingly, gross margins deteriorated from 32% at IPO to 18% now – a decline of 44%. Michael Cortney, as Chairman of the UCP Board and Chair of the UCP Comp Committee, and the rest of UCP’s Directors, surreptitiously removed the Officer Stock Ownership Guidelines from the 2016 Proxy Statement. Despite our calls for an explanation and update, Mr. Cortney has failed to clarify this material alteration. Mr. Bogue has been a large net seller of UCP shares since the IPO. Since July 2013, Mr. Bogue has sold almost 175,000 shares for total proceeds of almost $2 million. During that time, he has purchased only 4,350 UCP shares. UCP is unable to remove John ‘The Juicer’ Hart from its Board of Directors. We view this as sloppy corporate governance.”
According to the bloggers, given the factors just outlined, an investment in UCP makes no economic sense. “On a risk-adjusted basis, it is irrational to invest in a sub-scale firm that produces economic returns below its cost of capital. Given its higher inherent risk, a micro firm must earns its existence every day by producing greater returns to its owners. A larger firm, with greater stability and less risk, has a lower cost of capital and therefore a lower economic hurdle to clear.
“The worst of all economic worlds is a small, unstable, risky firm (especially one that was just shut out of the high-yield debt market) that produces returns far below its cost of capital. In such a case, investment makes no sense. And the firm’s continued existence, under the stewardship of current leadership, makes no sense.
“Given the mosaic just laid out, we believe UCP is the worst publicly traded homebuilder in the US. Its financial results are below industry norms. It destroys value with every home sold and earns an uneconomic return for owners. UCP’s capital allocation is destructive. Corporate governance is wanting. UCP’s communication with shareholders is not forthright. We believe that the conclusion we draw is the only conclusion that can be drawn.”