January 13, 2011 - 11:12am EST by
2011 2012
Price: 32.28 EPS -$0.46 -$0.29
Shares Out. (in M): 23 P/E NA NA
Market Cap (in $M): 733 P/FCF NA NA
Net Debt (in $M): -69 EBIT 0 0

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Pico Holdings owns an undervalued portfolio of unique hard assets which are difficult for investors in public markets to access.  The company is trading at a discount to net asset value which I estimate to be >$40/share.  Pico's managers have re-oriented the investment portfolio over the past two decades away from insurance and towards water rights properties, distressed real estate, and most recently canola processing.

Company Overview and History

Pico Holdings was "formed" at the end of 1993, when John Hart and Ron Langley injected $5 million of capital into Physicians Insurance Company of Ohio.  When this investment was made, book value was $5.83 per share and the stock price was $3.25 per share.  Mr. Hart and Mr. Langley believed that the company was undervalued, but they were also looking for a publicly-traded investment vehicle to execute their investment strategy.  Beginning in 1995, the Physicians insurance business went into run-off mode (which is expected to end in 2015).

In the beginning, Mr. Hart and Mr. Langley limited their investment activities to buying shares in publicly traded value stocks.  Within several years, Pico expanded its investment activities into real estate and into water rights through a series of reverse mergers.  Today, less than 10% of the company's net asset value is represented by the run-off insurance businesses, and that figure will decline going forward.  The remainder of the company is water rights, distressed real estate, and cash not yet been deployed.  In addition, recently the company announced it is building a canola processing plant in Minnesota which will be operational at the end of 2012.

The Pico managers self-describe themselves as Graham-and-Dodd style value investors that seek to generate attractive returns by purchasing deeply undervalued assets which have limited downside and significant upside.  When Pico invests new money, the company's investment hurdle is to generate a 20% unlevered IRR or better.  What is interesting to me is Pico invests in asset classes that are typically difficult to access through the public markets. 

Until recent Pico mostly invested in raw land and water rights which are not cash flow generating businesses and are not marked-to-market each quarter or even each year.  As a result earnings and book value growth have largely come from realized gains on investments.  I expect this will be the case going forward, too.  Also, because the company does not have a recurring earnings stream, Pico does not pay out a dividend or take on holding company debt.  Pico does have some borrowings due to the fact that it has purchased some assets with non-recourse seller financing, but gross debt/equity is quite low. 

During 2009, the company raised $96.5 million in a secondary offering of 3.75 million shares at $25.75/share in order to expand the development of the company's water segment and to increase its investments in UCP, which is the company's California distressed real estate arm.  I believe they were also looking at the recently announced agribusiness initiative when they raised money in 2009.

Water Rights (Vidler)

Pico's strategy, through its Vidler water business, is to acquire undeveloped water rights, and, through its redevelopment activities, add value before selling the developed water rights to a water user.  Management looks to acquire water rights properties at prices where they believe downside risk is protected and the upside is significant; to date, they have not sold a water-related property at a loss.  In terms of downside protection, Pico looks at what price a piece of land (with water rights) could be sold for real estate, development, agricultural, and/or ranching purposes. 

In addition to buying water rights properties for redevelopment, Pico also appropriates new water rights in water basins (aquifers) where management believes water exists. Pico initiates the process of securing such water rights by submitting an application into the state engineer's office.  If Pico can demonstrate through water studies that water is available, that there is a sustainable source of annual replenishment, and that Pico has a beneficial use for the water, then Pico receives a permit to use the water.  Because these water rights, when granted, are a use-it-or-lose-it proposition, Vidler is attempting to develop water rights in several places within Lincoln County, Nevada, with the county working as Vidler's 50/50 joint venture partner.

The process from site identification to development to sale can take anywhere from 4 to 7+ years.  The ultimate buyer of Pico's water rights are developers, public agencies, energy (and alternative energy) companies, and providers of municipal and/or industrial water supplies.  In many areas, developers have to demonstrate that they can provide 50-100 years of water supply before they are issued zoning and building permits.  One of the attractive investment characteristics of water rights is that the value of water rights, while obviously critical, is fairly small in relation to the total cost of acquiring, designing, and building a new real estate development.

The supply/demand fundamentals surrounding water rights in the Southwest are very strong.  Over the past ten years, demand for water has been increasing driven by population growth and a commensurate increase in commercial activity.  The recession has hurt employment and population growth, particularly in Nevada, but longer term the Southwest remains an attractive place to live and retire due to the sunny climate, lower taxes, and an overall lower cost of living.  Immigration from Mexico should also contribute to population growth and demand for water.  In addition, water is increasingly being used for power projects, including solar power projects.  If the population of Western and Southwestern states served by the Colorado River were to increase 28% between 2010 and 2030, the region would require an additional 2 million acre feet of water per year.    

Meanwhile, the supply of water is limited largely to runoff from the Colorado River which feeds fresh water to most of the Southwest.  The 20th century average run-off was about 15 million acre feet per (MAF) year.  Furthermore, some hydrologists in the Southwest believe that water supply coming from the Colorado River is in permanent decline as a result of weather droughts.  I am not able to affirm or refute this forecast, but the fundamental case for buying water is strong even if water flow from the Colorado River remains constant.  Water is not cost efficient to transport long distances, as the cost of laying down water piping is approximately $1 million/mile.  As a result, water must come from a local source.  For that reason, in situations where Pico owns water rights in an area where water is scarce, Pico has strong pricing power.

Vidler's water investments have been focused in the states of Arizona, Colorado, Nevada, Idaho, and more recently New Mexico, although its presence is more significant in Nevada where water is particularly scarce.  The value of water rights transactions have been increasing in the Southwest at a high single digit CAGR since the late 1980s.  Of course, water pricing is dependent on the dynamics of each particular sub-market and can vary from hundreds of dollars per acre-foot of water to nearly $100,000 per acre-foot of water.  Vidler's management team looks for sub-markets with favorable water supply/demand characteristics. 

Real Estate

In 2008, Pico formed UCP in order to pursue opportunistic investments in well-located, finished (entitled with sewage, water, electricity, etc.) lots in small residential developments within attractive socio-demographic submarkets of California.  Pico's strategy is to pay steep discounts to current replacement cost.  Similar to the company's approach in buying water rights, UCP management looks closely at downside risk by examining developed lot replacement cost, agricultural value, etc. 

In 2008, the company purchased 40 finished lots, 73 partially entitled lots, and 960 potential lots in Fresno California for an undisclosed price from desperate homebuilders where employment has been relatively steady and inventory prices had fallen significantly. At the time of purchase, homebuilders were facing huge liquidity crunches and wanted to take advantage of tax legislation allowing homebuilders to carry tax losses going back 5 years in order to obtain a cash tax refund (by liquidating property at a loss). Between the pressures created by the liquidity crunch and the tax incentive (which has since expired) offered by Uncle Sam, homebuilders were highly motivated sellers during 2008. My understanding from Pico management is that the price paid was ~20% of current replacement value at the time of purchase and they expect to generate a 45% IRR over the course of the project.

 Now that the homebuilder liquidation opportunity has passed, UCP is buying finished lots from banks that are short sales. For example, during 2009, UCP purchased a $22.6 million note on a development outside of Monterey California which included 116 finished lots and 1,432 unfinished lots. Subsequent to purchasing the note, Pico foreclosed on the loan and is now developing the lots at an expected cost of $18 million over the next 2-3 years.

Since 2009, UCP has been selling a few Fresno and Monterey selected lots back to homebuilders at a ~50% markup to their cost. 

In addition to UCP, Pico owns 437,000 acres of land in Nevada along highway 80 which it originally acquired for $35.93/acre in 1997.  The original purchase was for 1,352,723 acres from Southern Pacific Santa Fe railroad, and the company has been developing water rights, developing land in and around growing cities and towns, and selling property ever since.  The average price realized on its sales has been ~$87/acre.  Management expects to realize ~$85/acre on its remaining ~437,000 acres of land.  In addition, Pico has retained the water, geothermal, and mineral lights on all of its Nevada land sales.


Pico's run-off insurance businesses include Physicians Insurance of Ohio (the original "Pico"), which provides medical professional liability insurance, and Citation Insurance Company, which provides property & casualty insurance and workers' compensation insurance.  The future worker's compensation claims have been ceded to various reinsurance companies. 

The insurance segment's surplus assets are invested in a portfolio of value oriented stocks.  Within that portfolio, 40% is invested in Switzerland and 15% in New Zealand and Australia. 

Going forward, I expect that the insurance business will continue to run-off and the assets will be reinvested in other opportunities. 


Pico has engaged in private corporate investments in the past and could do so again in the future.  With that said, at the corporate level there's not much else besides cash and fixed income securities.

Recently Pico announced that it is investing $60mm of equity to build a canola processing plant in Hallock Minnesota, and management has secured a $100mm non-recourse construction loan to build the facility.  The location was selected due to its proximity to a bunch of rapeseed farms who currently have to ship their crops far distances for processing.  Unlike Pico's other businesses, this business should eventually generate steady cash flow, but the plant will not be operational until the end of 2012.


  • John Hart (17 years), the company's CEO and lead portfolio manager since 1994, is approximately 59 years old and is expected to be around for at least another decade. Prior to Pico, John Hart was a principal at Detweiler Ryan & Company (i-bank).
  • Rich Sharp (33 years), the COO, has been with the company since graduating from college and was the COO of Physician's Insurance before moving to the holding company.
  • Max Webb (17 years), the CFO, was formerly a manager at KPMG.
  • Ron Langley (17 years) was Pico's original Chairman of the Board through 2007 and continues to serve on the Board as a Director now that he is retired. Beginning in 1975, he worked with Ron Brierley, who appears to be New Zealand's version of Warren Buffet. He left Brierley to team up with John Hart in running Pico.

On the real estate side and on the water side, all capital investment recommendations are presented to holding company management for consideration and approval.  Decision making occurs by consensus although John Hart as CEO has more influence than the others.  Vidler employs about 12 people including hydrologists, engineers, and one lawyer.  The COO of Vidler, Dorothy Palmer, has been with the company since 1996 and apparently knows every water right that exists in the Southwest.  The UCP real estate business also employs about a dozen people, which include mostly real estate professionals (some with financial expertise) whose job is to source/analyze/present opportunities and manage existing properties. 

The management team earns base compensation plus a performance bonus based on 5-year book value performance relative to the S&P 500 plus a restricted stock and stock appreciation rights plan.  Vidler employees earn a bonus based on a percentage of net income, and UCP earns 20% of the upside of a deal once the holding company earns its 20% IRR.  Insiders own just under 10% of Pico Holdings, with John Hart owning 1.5%, Ron Langley owning 1.5%, and John Weil (Director and current Chairman of the Board) owning 6.5% of the company's shares. 


My sum of the parts valuation suggests a valuation of more than $40/sh.


Est. Value ($mm)

Vidler (water business)

Fish Springs NV Water Rights                $273.5

Tule NV Water Rights                              $53.2

Kane Springs NV Water Rihgts                $5.1

Dry Lake Valley Water Rights                  $8.5

Dry Lake Valley Real Estate                      $8.0

Carson River Water Rights                      $81.0

Carson River Real Estate                           $1.0

Sandy Valley, NV Water Rights              $13.3

Muddy Valley, NV Water Rights              $1.8

Harquahala Valley, AZ Water Rights     $12.1

Harquahala Valley, AZ (water storage facility)   $20.0

Phoenix, AZ Stored Water                       $15.8

Idaho farm land                                        $10.0

Colorado Water Rights                             $13.7

Santa Fe, NM Water Rights                     $13.5

Vidler Subtotal                                         $530.4


Real Estate                                                     

NV railroad land   $37.1

UCP distressed real estate in CA                      $122.8

Real Estate Subtotal                                       $159.9


Liquid Securities                                            

Cash                                                          $111.3

Fixed Income                                             $42.1

Equities                                                     $117.2

Liquid Investments Subtotal                   $270.6


Other Investments                                        

Other investments                                     $8.5

Notes and other receivables                     $10.1

Other Investments Subtotal                     $18.6


Corporate Liabilities                                     

Borrowings                                               $(22.0)

Rabbi Trust Deferred Comp Liability     $(36.3)

Net Insurance Reserves                            $(8.4)

Corporate Liabilities Subtotal                 $(66.7)


Total                                                          $912.8


Shares                                                    22,656,749

NAV/SH                                                        $40.29



The biggest risk for Pico is time.  Because the company owns illiquid investments, the longer it takes for the company to sell its properties, the lower the IRR.  This has affected Pico's water business over the last couple of years and will continue to affect the water business until development (and the need for water) returns again to their sub-markets in the Southwest.


 There is no immediate catalyst for this investment that I can think of, which is probably why it is trading below net asset value.
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