AIG Jan 2021 Warrants AIG.WS
February 13, 2015 - 6:10pm EST by
stanley339
2015 2016
Price: 23.50 EPS 0 0
Shares Out. (in M): 75 P/E 0 0
Market Cap (in $M): 1,760 P/FCF 0 0
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT 0 0

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  • Warrants
  • Discount to book
  • Potential Buybacks
  • Discount to Peers
  • Insurance
 

Description

 
Pitch:
 
We believe these are an outstanding risk/reward because the common stock continues to be
undervalued and there is plenty of time for AIG’s business performance to improve enough for the stock
to trade at least at book value before the warrants expire. If that happens, the warrants should be
multi-baggers.
 
 
Background:
 
10 year AIG warrants were issued in January 2011 as part of the government rescue of AIG. The
warrants expire in January 2021 and have a strike price of $45.
 
We think about the value of these warrants in relation to the intrinsic value of the common stock over
the long term. Many/most market participants probably rely on the typical Black Scholes
methodology which systematically undervalues long term warrants.
 
AIG BVPS is $78 and it is currently trading at ~0.69x book. We believe that BVPS will continue to grow
steadily if the business continues to deliver solid and improving earnings and buys back stock. Should
the ROE of the business improve to peer levels, the valuation multiple of the common stock should
trade at least at 1x book. The S&P P&C Index trades at ~1.4x book today, similar to its long term
average.
 
 
Valuation:
 
Using modest assumptions of slowly improving performance and buybacks roughly equal to taxed net
income from 2015-2018 and none beyond that, we project BVPS to grow by a ~9% CAGR until the end of
2021. In this scenario, BVPS growth is slower than might be expected due to the utilization of the DTA.
 
2015 ROE (Net income / average total equity) should be around 6% and we think the business should
have improved and have enough capital returned to get to a ~10% ROE in 2021.
 
By the end of 2021, we project BVPS to reach $140.
 
If the common is trading at BVPS, that would mean the warrant is worth $95 ($140-$45) which is a 4
bagger, or a ~27% annualized return for 6 years.
 
If the business has improved even more and can trade at 1.2x BVPS, the warrant would be worth $123,
more than a 5 bagger, or a 32% annualized return for 6 years.
 
Alternatively, we can look at a more standard valuation approach to help us think about downside.
Current implied vol of the warrant is 45%. If we assume in 2 years, the stock trades to just the current
average analyst price target of $62 and vol compresses to 35%, the warrants should be break-even. If
vol remains constant, the warrants should appreciate by 15%.
 
 
Risks:
1. This is a leveraged way to participate in the turnaround at AIG.
2. If AIG trades at $45 or below in January 2021, the warrants will be worth $0.
3. From a trading standpoint, these appear to be illiquid with Fairholme owning 1/3 of the
securities.
 
 
Disclosure:
We and our affiliates are long AIG warrants (AIG/WS) and may buy additional shares or sell some or
all of our securities, at any time. We have no obligation to inform anybody of any changes in our views
of AIG/WS. This is not a recommendation to buy or sell securities. Our research should not be taken
for certainty. Please conduct your own research and reach your own conclusion.
 
 
 
 
 
 
 
 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Continued improvement of business performance and return of capital via buybacks

As ROE expands there should be mulitple re-rating to peer levels on an ever growing BVPS

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    Description

     
    Pitch:
     
    We believe these are an outstanding risk/reward because the common stock continues to be
    undervalued and there is plenty of time for AIG’s business performance to improve enough for the stock
    to trade at least at book value before the warrants expire. If that happens, the warrants should be
    multi-baggers.
     
     
    Background:
     
    10 year AIG warrants were issued in January 2011 as part of the government rescue of AIG. The
    warrants expire in January 2021 and have a strike price of $45.
     
    We think about the value of these warrants in relation to the intrinsic value of the common stock over
    the long term. Many/most market participants probably rely on the typical Black Scholes
    methodology which systematically undervalues long term warrants.
     
    AIG BVPS is $78 and it is currently trading at ~0.69x book. We believe that BVPS will continue to grow
    steadily if the business continues to deliver solid and improving earnings and buys back stock. Should
    the ROE of the business improve to peer levels, the valuation multiple of the common stock should
    trade at least at 1x book. The S&P P&C Index trades at ~1.4x book today, similar to its long term
    average.
     
     
    Valuation:
     
    Using modest assumptions of slowly improving performance and buybacks roughly equal to taxed net
    income from 2015-2018 and none beyond that, we project BVPS to grow by a ~9% CAGR until the end of
    2021. In this scenario, BVPS growth is slower than might be expected due to the utilization of the DTA.
     
    2015 ROE (Net income / average total equity) should be around 6% and we think the business should
    have improved and have enough capital returned to get to a ~10% ROE in 2021.
     
    By the end of 2021, we project BVPS to reach $140.
     
    If the common is trading at BVPS, that would mean the warrant is worth $95 ($140-$45) which is a 4
    bagger, or a ~27% annualized return for 6 years.
     
    If the business has improved even more and can trade at 1.2x BVPS, the warrant would be worth $123,
    more than a 5 bagger, or a 32% annualized return for 6 years.
     
    Alternatively, we can look at a more standard valuation approach to help us think about downside.
    Current implied vol of the warrant is 45%. If we assume in 2 years, the stock trades to just the current
    average analyst price target of $62 and vol compresses to 35%, the warrants should be break-even. If
    vol remains constant, the warrants should appreciate by 15%.
     
     
    Risks:
    1. This is a leveraged way to participate in the turnaround at AIG.
    2. If AIG trades at $45 or below in January 2021, the warrants will be worth $0.
    3. From a trading standpoint, these appear to be illiquid with Fairholme owning 1/3 of the
    securities.
     
     
    Disclosure:
    We and our affiliates are long AIG warrants (AIG/WS) and may buy additional shares or sell some or
    all of our securities, at any time. We have no obligation to inform anybody of any changes in our views
    of AIG/WS. This is not a recommendation to buy or sell securities. Our research should not be taken
    for certainty. Please conduct your own research and reach your own conclusion.
     
     
     
     
     
     
     
     

     

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    Continued improvement of business performance and return of capital via buybacks

    As ROE expands there should be mulitple re-rating to peer levels on an ever growing BVPS

    Messages


    Subject$45 put
    Entry02/14/2015 01:54 PM
    Membernha855

    It strike me that the payoff of buying this call is just the same as owning stock and a $45 put. why is it worth paying $15 for a $45 put struck in 2021? Are you worried the stock is going to tank?


    SubjectRe: Ending Strike Price/Dividend Adj
    Entry03/22/2015 12:20 AM
    Memberrsm

    I get a strike around 37 but its pretty sensitive to your assumptions.


    SubjectTime Value
    Entry07/08/2015 09:53 PM
    MemberTR1898

    Stanley - how do you think about amortizing the time value of the warrant over the next five years? 

    It doesn't appear to me the warrant pricing is corrrelated with BS model (double entendre intended).

    Thank you.


    SubjectRe: Icahn Letter
    Entry10/29/2015 11:17 AM
    Memberbpuri

    While not certain, I don't believe Section 4.04 necessarily implies a freeze of the dividend adjustment.  If you read to the end of that Section 4.04 it closes by saying in a Reorganization parties will enter into an agreement "providing for adjustments, which shall be as nearly equivalent as may be practicable to the adjustments provided for in this Article IV."  Article IV contains the two way dividend adjustment mechanism (adjustments to both the exercise price in 4.01 and the conversion factor or number of shares received per warrant in 4.03).  This implies that post a Reorg the parties are to provide for continued adjustments (dual path dividend adjustments) to the extent practicable potentially (my commentary) by reallocating the dividend threshold across the new entities in some pro rata manner.  While I obviously don't know what form it would take, that last sentence in Section 4.04 tells me they have to work to make the adjustment mechanism close to equivalent to what it was before any Reorg.  I would also note at this point that I am not an attorney so you should reach your own conclusions based on the language.


    SubjectWarrant Adjustments - Strike Price & Warrant:Share Ratio
    Entry12/17/2015 09:05 AM
    MemberTR1898

    I am posting a similar note for both AIG and JPM warrants.  I believe these are uniquely interesting investments.  Further, I believe a lack of appropriate attention has been paid to the share:warrant ratio adjustment coming into play for both warrants.  This ratio adjustment has a meaningful leverage effect on the warrant return, but has not received a lot of attention.

    The warrants ratchet down the strike price for dividends above a specified LTM amount.  This is well-discussed.  However, there is also a mechanism by which dividends increase the shares received for each warrant [ (beginning share:warrant ratio) * (current warrant strike price) / (newly-adjusted warrant strike price) ].

    The annual warrant threshold for AIG dividends is $0.675/share, and based upon the recently increased dividend, the warrant strike price now stands at $44.9036.  Importantly, the share:warrant ratio recently ratcheted to 1.002.

    As I model AIG through warrant expiration, the warrant strike price decreases to $42.65/share while the share:warrant ratio increases to 1.055.  I am effectively utilizing sell-side dividend expectations which equates to a yield of 1.7% to 1.8%.  This could prove conservative depending upon the course of AIG's share price and relative capital return between repurchases and dividends.

    At expiration, I expect AIG shares to be worth $105 to $120/share.  The ratio adjustment would thus represent an incremental $6 to $7 on the current warrant of $23 - an incremental 26% to 30% total return or roughly 200bps annualized.  

    In my view, the share ratio effect is gravy on an investment that otherwise stands on its own merits.  

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