Description

For those of you able to buy micro-caps, California Coastal Communities is a stock with a significant catalyst. Henceforth abbreviated as Calc, the company is a Southern California homebuilder with a $50 million market cap and trading volume averaging 10,000 shares a day. The kicker is that California voters approved a bond measure yesterday that authorizes and
provides money for the State to buy the company's land. The land, as I'll explain below, is certainly worth more than $50 million.

At current activity levels, Calc sells thirty homes a year near Los Angeles and essentially breaks even. Administrative expenses and salaries cost around $4 million a year, and the total company sells for a bit over $45 million net of cash in the company's vault. They also own one of the most contentious parcels in Southern California, 350 acres overlooking Pacific Coast Highway at Bolsa Chica in Huntington Beach.

Bolsa Chica is three square miles of wetlands and grassland along the ocean in Orange County, surrounded by development on three sides. Calc has sold much of their original land at Bolsa Chica to the State of California over the years, and is left with only a handful of parcels on which it aims to build homes. The important thing to note is that the fight over what Calc can build at Bolsa Chica has been ongoing for some thirty years, and Calc has consistently lost.

In 1985, the State's Coastal Commission approved a 1300-slip marina, hotels, restaurants, and 5000 homes on the company's land. From that temporary high point, the ride has been straight down. Rescinding their prior approval, the Commission approved 4900 homes in 1989 as long as 775 acres remained wild. In 1996, the Commission rescinded that approval and allowed 3300 homes. Calc
sold the lowlands to the State for wetlands protection and ended up with approval for 1235 homes. In November of 2000, the Commission granted approval for development of 65 acres (roughly 350 homes) on the so-called "upper mesa" and prohibited development on the "lower mesa."

The company's prime building land consists of a long shelf near the upscale Huntington Harbor that is cut in half by an earthquake fault. Not surprisingly, the fault over the years has raised one mesa and lowered the other. Thus the upper mesa is 100 acres with views of all of Bolsa Chica, and 100 acres on the lower mesa are closest to the wetlands and Pacific Coast Highway. The Coastal Commission has deemed the lower mesa off-limits, and confined any building to 65 acres on the upper mesa. Assuming this ruling stands, Calc owns the upper mesa and 240 acres of land of diminished value spread around the parcel.

There is one overriding truth about Bolsa Chica: development always takes longer than expected. Having had approval almost twenty years ago for a substantial project, Calc today has only a few homes built on an area that was once almost totally under its control. The Bolsa Chica Land Trust, the hugely successful grassroots environmental group that has fought Calc every step of the way, has long desired to buy Calc's land and preserve one of the last undeveloped coastal mesas in Southern California. The problem was getting the funds to buy such a parcel. How could you afford to buy land approved for
1200 homes? Calc capitalizes the legal costs to develop its land and every year the value of Bolsa Chica on the company's balance sheet increases. Today, the company values the land at $150 million. This includes the $90 million the company says it has spent trying to develop its land.

At the moment, Calc is suing the Coastal Commission for a takings action for prohibiting development on the lower mesa. As the lower mesa winds its way through the courts, Calc completes its plans for the upper mesa. Orange County has approved construction of 380 homes on 77 acres of the upper mesa, and the only task that remains is Coastal Commission approval of the final proposal. Calc's Coastal Development Plan will be submitted to the Commission early next year. Calc's development plan, called Brightwater, envisions construction on 77 acres versus the Commission's recommended 65 acres. Calc's CEO tells me that the definition of what constitutes the upper mesa is open to debate.

It is likely that approval will eventually be granted. Brightwater, as
currently planned, is for 379 homes on 77 acres, with homes between 1600-4500 square feet and selling from $400k to a million plus. Comps in the immediate area are in the $600-800k range for homes built twenty years ago. Calc, through a technicality, built 16 homes on a distant corner of the upper mesa in the last two years. These averaged 3700 square feet and $840k each. As nothing will be built for at least a year, and quite possibly for two years or more, prices will likely be lower than today's. Throwing a rough $550k
guesstimate for average sales price on the board, I estimate that Brightwater will earn the company around $200 million in gross sales revenue. The company estimates that development and construction costs run at one-half of sales, so the company is reasonably likely to collect net cash flow of $100 million over the years it takes to build the entire development. That is after a
substantial haircut to recent comps, and for the record the company estimates that the development will earn the company $164 million in net cash flow.

The kicker is that yesterday voters passed Proposition 50. Prop. 50 was a $3.4 billion bond issue that funded a number of watershed protection projects. Among them was purchase of a handful of environmentally sensitive parcels that developers wanted to sell to the State. The text of the measure reads: "Not less than three hundred million dollars of the amount appropriated in this section shall be expended or granted for projects within Los Angeles and Ventura Counties. Of the remaining funds available pursuant to this section the Wildlife Conservation Board shall give priority to the
acquisition of not less than 100 acres consisting of upland mesa areas, including wetlands therein, adjacent to the state ecological reserve in the Bolsa Chica wetlands in Orange County." Largely written by a lobbyist representing the Nature Conservancy, and supported by significant donations from Calc (one newspaper reports that the company gave $350,000), the measure appears to have been tailored to facilitate the State's purchase of the company's major parcel.

For the record, Calc's CEO was adamant that the company was going to continue to build the development and only sell if the price were right. Obviously, since the company was a major contributor to the proposition's campaign, the company wants to entertain offers. Not coincidentally, Calc's CEO and a major member of the board of directors recently purchased shares, and it may have been the CEO's first ever purchase.

So how much are they going to get for the parcel? Are they going to get $150 million, the land's carrying value? Probably not. Might they get $80 or $100 million? Quite possibly. Calc was recapitalized in 1997 and the bondholders ended up the owning the company. There are three large holders of company stock today: ING Baring, Credit Suisse, and Merrill Lynch. They have added to their stakes received in bankruptcy proceedings and own 45% of the company. ING has a director on Calc's board, and all three have seen the stock price
plummet since they received their shares. Together with several other large holders, these motivated sellers would likely vote for a quick windfall from the State. And that windfall would be tax-free to the company. After exiting from bankruptcy, the company has $180 million in net operating losses that can be used to offset future taxes. In short, the company won't be paying taxes anytime soon.

What occurred yesterday was the creation of a floor on the stock. If the
company chooses to build the development, I conservatively estimate that they will earn $100 million in net cash flows over the life of the project, and the company estimates significantly more. Or, they could turn to a number of environmental groups eager to spend the State's money earmarked for just this purpose and rid themselves of one of the region's most contentious battles. It remains unclear what parcels would be purchased by the State, whether any other landowners would share in the windfall (another developer owns 22 acres near the upper mesa), or how the environmental liabilities would be assigned. But the company's numerous, large shareholders are unlikely to suffer in silence with a pot of money sitting just offshore.

Catalyst

The State of California will soon sell bonds to purchase environmentally sensitive parcels, and as the only parcel listed by name as a priority acquisition, Calc's land will be in great demand. Either Calc builds homes over many years across the mesa, earning at least $100 million in net cash flow, or the mesa is sold to the State for a quick windfall. Either way, the company nets significantly more than the entire company is selling for today.