Why I Bought AIG

I have a confession to make, last week I bought AIG.  Even with all of its faults it was simply too cheap to pass up at 2 dollars and change.  Despite the governments bailout proposal there was and still is substantial value left in the company.  Even after accounting for an 80% dilution of the common shareholders, the company still has a book value as of the end of the most recent quarter of $5.80.  While there are significant risks in owning AIG, namely accelerating losses in the company’s credit default swap (CDS) portfolio, which I talked about back in mid May, the potential upside that exists as a result of the sale of company assets far out ways the risks associated with owning the stock at these price levels. 

The government bailout is certainly a terrible deal for AIG’s current shareholders.  The deal’s premise is built on the fact that a government rescue was necessitated by the possibility that a failure of the company would bring about an utter failure of the credit markets.  An intervention based on an attempt to provide the liquidity that the company needed was certainly warranted and as I mentioned earlier, I applaud the Bush Administration's rescue efforts.  The government’s $85B dollar loan and controlling stake in AIG will provide just what the company needs; however, I doubt the deal will go through, as it will still likely require shareholder approval. 

If AIGs large shareholders can block the deal, as it appears they are trying to do, the shares will soar as the company begins to unload its assets.  The tentative agreement between AIG and the government has without a doubt bought the company a small window during which it has the support of the financial markets to unload its assets.  If these asset sales can be carried out fast enough, the agreement can likely be terminated prior to the company having to ask its shareholders for the agreements approval.

In looking at the company’s assets, it is clear that significant value can be realized from the sale of numerous subsidiaries.  To start with, we can use Melissa Gannon’s article that was written over at thestreet.com, Ms. Gannon did a wonderful job of breaking out AIG’s three most likely U.S. domiciled subsidiaries to be sold.  They are the following:

1. Lexington Insurance (fire insurance) – $4.7B in Capital, $6.6 B in annual premiums
   
2. National Union Fire Insurance (liability) – $12.0B in Capital, $5.5B in annual premiums
   
3. American Home Assurance (workers comp & liability) – $7.0B in Capital, $ 6.7B in annual premiums
   

These companies, with their strong balance sheets and relatively sound investment portfolios will likely fetch one times book value, or about $23.7B.  While these sales will go a long way towards freeing up capital and much needed liquidity for the company, they cannot be the only ones undertaken.  AIG’s foreign subsidiaries are surprisingly sound and have been able to sustain their operating margins throughout the credit crisis.  As a result, their sales will likely be the most important for the company.  According to my rough calculations, the company could raise anywhere between $10.8B & $14.4B from the sale of both of its Foreign Life & Foreign General subsidiaries for a total of between $21.6B and $28.8B.  These sales will allow the company to refocus on the company’s core area of alleged competence, domestic insurance.      

In addition to the sale of three of its domestic insurance units and the sale of its foreign units the company will also be able to raise a substantial amount from the sale of its ILFC unit.  The company’s aircraft leasing business simply has no place in a slimmed down AIG.  If you were to assume that ILFC’s margins were only a little lower then GATX Corp. (GATX), the publicly traded railcar leasing company, I believe that we could safely value the company at somewhere near $5-$7B.  Other investments such as a controlling stake in Transatlantic (TRH) and a stake in Blackstone (BX) coupled with an investment being managed by the money management firm could be sold for nearly $3.9B.  For those keeping track the successful sales of the above-mentioned units could yield between $54.2B and $63.4B.

In addition, AIG could also attempt to monetize its massive money management unit.  The firm currently manages in excess of $750B dollars.  The majority of the money is tied to the companies investment portfolio related to its insurance policy reserves and the float that comes along with being an insurance company.  In my opinion, if the sale is structured appropriately, AIG could easily expect to generate an additional $15B-22B dollars.  While this would dramatically reduce the input that AIG has on its future, it is likely for the best and without a doubt the most critical piece of the value story at AIG.  Possible suitors include BlackRock (BLK) & overseas financial institutions and sovereign wealth funds.  The sale of AIG’s asset management unit would bring the total amount raised by the company through the above mentioned asset sales and the above assumptions into the neighborhood of 69.2B-85.9B.

While the subsidiary sales that I outlined above would be drastic and would lead to the dismembering of a storied company, they are likely the only option available to the firm and its investors in their effort to avoid the completion of the public bailout and the sacrifice of shareholder value.  The cornerstone of my plan, the sale of the company’s asset management unit, would likely improve risk management and allow what is left of AIG to focus on writing profitable insurance in its remaining domestic markets.  Upon the completion of these sales, it would be my hope that AIG could move towards competing directly with companies such as Travelers (TRV), Chubb (CB) & Allstate (ALL).  Its going to be a long trek for AIG shareholders but if we can force management to begin an immediate sale of the more valuable parts of the company we may just be able to unlock shareholder value that appeared to be lost not a week ago.  As I wrote in early May, AIG has truly fallen from a blue chip stock to unquestionable mediocrity; nevertheless, even broken companies, when reorganized appropriately, can yield great returns.    

For Further Review:

WSJ Article

Bloomberg Article

thestreet.com Article

Disclosure: Long AIG