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Special Situation: American International Group (AIG)

May 13, 2011

I had a small position in AIG prior to the 2008/2009 financial meltdown. By mid 2009, my small position had become much smaller, and I sold my few remaining AIG shares (after the 1 for 20 reverse split) for something like a 99% loss. My experience, I’m sure, was not unlike that of many professional portfolio managers. After all, AIG was widely held by funds and institutions prior to the crash. Today, is it any wonder that those same portfolio managers might be a little leery about buying shares of AIG for their portfolio? “Once burned, twice shy”, as they say. Furthermore, you have to remember how Wall Street money management works; those who take a risk and are wrong have to find new employment. Those who stick with the crowd are pardoned their oversight.

“So what?”, you say, “What do I care about all of this? You’re supposed to be identifying some little known microcap company with more cash on its balance sheet than market capitalization that’s a slam dunk, shoe-in to triple over the next year”. Actually, that’s not quite what I said when I started this blog. I said that I would be looking at areas of the market where I have some kind of competitive advantage, smaller capitalization stocks being one of the more logical areas to traffic in. But recently, I haven’t been able to identify any fabulous small-cap Graham net-nets, at least none that are a slam-dunk for a triple. And anyway, my focus here is simply to identify the best investments out there for ME, so why would I want to ignore the elephant in the living room?

That’s the question for today. “Is AIG the elephant in the living room?”  Is AIG so reviled that it is now a value investment?  Let’s review a few key factors:

  • AIG is not loved in the investment community (as we said before) due to its history
  • AIG shares are not widely held (there are only 142 million shares in public hands of which 40 million are held by the Fairholme Fund)
  •  The US Treasury is AIG’s largest owner holding just over 92% of shares outstanding,
  • The Treasury has made little secret of its desire to sell its AIG ownership over the next year or so
  • The Treasury may be under political pressure to sell its AIG stake quickly (bragging rights to say that the bailout monies have been repaid may be worth a few election points)
  • There is a great deal of uncertainty as to when and at what price the Treasury’s AIG shares will be offered to the public
  • There is a great deal of uncertainty as to what is really on AIG’s balance sheet.

Since the beginning of 2011 AIG’s share price has trended down from the upper $50’s to today’s price of around $31 a share. I attribute this to Mr. Market’s concern over the terms and timing of Treasury’s public offering of AIG shares. The May 11 announcement that the initial offering would be 300 million shares (200 from the Treasury’s holdings and 100 million new AIG shares) reduced the uncertainty somewhat and gave a quick boost to the share price. But the primary questions about ongoing operations and the Treasury share overhang remain, and I don’t see things becoming clearer until well into next year. I imagine that any subsequent share offerings by Treasury will be post hurricane season, i.e. end of the 4th quarter.

On the first quarter call for the Fairholme Fund, Berkowitz reaffirmed his investment thesis for AIG, saying only that, like most good value investors, he had gotten in too early and that he never contemplated a scenario in which the US Treasury would sell its shares below their cost (about $28.70/share). Recent rumblings out of AIG seem to support this last thesis, that, indeed, Treasury might postpone any offering if the market price falls below the cost basis. The number of shares for the preliminary public offering, at the low-end of the initially announced range, also seems to confirm that this is Treasury’s thinking; with the lower number of shares to be offered there is less chance that the supply/demand equation will drive down the offering share price below break-even.

So what does all this background noise mean? Not much for a long-term investor, except possibly to calculate an appropriate entry point. The real question is, is there value here. I’ll leave the quantitative analysis of AIG to more knowledgeable souls; read the Value Line analysis or get ahold of your favorite brokerage house’s analysis on AIG if you want this information. Better yet, read the 10K and do your own analysis. For me, as usual, I will keep my analysis very simple:

  • Book value is around $48 a share
  • A new CEO,Robert Benmosche, was brought in after the Treasury bailout. I expect he has done what I would have done; cleaned all the skeletons out of the closet and written everything down that could possibly be justified.
  • The new CEO is in this for the prestige (he was already rich and retired) not just the money; I think ego is a bigger driver than even money can be in situations like this
  • At a market price of $31 a share AIG is trading for less than 2/3 book value while most property casualty companies trade for at least 85-90% of book. If you believe that AIG can get at least an average rate of return in the future, there’s your margin of safety.

I made my first purchase of AIG at about $31 a share and I will be looking to load up if and when the share price declines below $30.

  1. On interactive brokers, the cost to borrow shares is something like 30%.

    If you are thinking about buying the common stock and your broker does not pass on borrowing costs to you, then it can be cheaper to use a synthetic options position. Buy the call and sell the put at the same strike price. You will lock in the short lending interest, though you may have to pay the spread. Also be careful when trading options because there are less investor protections, e.g. exceptions to the NBBO rule.

    Also… the short sellers are often right. You need to be careful if you’re on the other side of their trades. Though the borrowing costs can be so high that the shorts don’t make money.

  2. Really enjoy the blog (although that’s probably expected, if you look at my blog at it sounds like we agree on a lot of holdings and even have similar investment approaches).

    Anyway, back to AIG – do you have any thoughts on the warrants?

    • Thanks for reading and commenting. I’ve read your blog several times and found it interesting so I’ll be adding you to my blogroll.

      As to the AIG warrants, because of my position in BAC warrants I was initially attracted to the AIG warrants. But on reflection, I decided my investment thesis for AIG was built around the current discout to book value and that discount narrowing over the next couple of years. I’m not predicting any kind of long-term home run for AIG, though it could well happen. I’m just not smart enough to know.

  3. (1) Nice blog.

    (2) Looking at AIG’s most recent 10Q, their balance sheet leverage is 7.2x (assets / equity). In other words, small changes in asset levels and/or claims results in lost “margin of safety”. How do you think about the balance sheet risk here?

    • Thanks for reading my blog and commenting. You are absolutely right that with the leverage of AIG so high any changes in asset values of their holdings are magnified on the balance sheet. My margin of safety thesis here is a bit more qualitative than quantitative.
      1) I expect that write downs were conservative (for all the reasons outlined in my post) and
      2) what do you think would happen if within 2 years of the Treasury selling their interest in AIG it was discovered that the value of AIG’s holdings was overstated? Don’t you think the Treasury would step in to avoid any whiff of the government taking advantage of private investors? That’s kind of my real Margin of Safety. I see it as the same kind of trade that Appaloosa made in early 2009 with the banks. Maybe I’m being naive….

  4. Gary permalink

    I have to say the best way to play AIG is with the warrants. I think they offer an extremely compelling risk/reward. Especially if you think they can get back to generating a decent ~10% ROE. My analysis suggests that they could be an 7-9 bagger over the life and 20-25% IRR, much more attractive than the BAC warrants. It seems like a nice time arbitrage.

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