|Shares Out. (in M):||0||P/E||0.0x||0.0x|
|Market Cap (in M):||0||P/FCF||0.0x||0.0x|
|Net Debt (in M):||0||EBIT||0||0|
The warrants of American International Group, Inc. (AIG/WS) are significantly mispriced due to the long-dating/Black-Scholes phenomenon and significant mispricing of the underlying stock and should be acquired and added to on any weakness, providing the buyer both free non-recourse leverage on AIG and downside risk protection.
Price: $6.43 (52 wk high $24.00, low $6.00)
Price of Underlying (AIG): $22.50 (46% of TBV of $49.18)
Implied Vol: 37%
AIG @ 60% of TBV ($29.50) [9.4x P/E] and Implied Vol @ 37% = $10.67 (65% potential appreciation)
AIG @ 70% of TBV ($34.43) [10.9x P/E] and Implied Vol @ 37% = $13.95 (117% potential appreciation)
AIG @ 80% of TBV ($39.34) [12.5x P/E] and Implied Vol @ 37% = $17.44 (171% potential appreciation)
Background: As part of a series of integrated transactions to recapitalize AIG in January 2011, AIG's Board of Directors declared a conditional dividend on January 6, 2011 to holders of record of AIG common stock as of January 13, 2011, the record date. The dividend consisted of 10-year warrants to purchase up to 75 million shares of AIG common stock in the aggregate at a price of $45 per common share. The warrants were distributed on January 19. AIG common shareholders received 0.533933 warrants for each share of AIG common stock owned. Each warrant entitles the holder to purchase one share of AIG common stock at a price of $45 per share, subject to anti-dilution adjustment for certain events.
Anti-Dilution Protection: The initial exercise price is subject to anti-dilution adjustment for certain events, including (i) future stock dividends, distributions, subdivisions or combinations; (ii) the issuance of below market rights, options or warrants entitling the holder to purchase AIG common stock for a period of sixty days or less; (iii) dividends or other distributions of capital stock (other than AIG common stock); rights to acquire capital stock, debt or other assets (subject to certain exclusions); (iv) per share cash dividends in excess of $0.675 in the aggregate in any twelve-month period; and (v) certain above-market issuer tender offers for more than 30 percent of the then-outstanding AIG common stock.
Fairholme Capital: 24.1 million
Carval Investors: 2.2 million
Goldman Sachs: 1.8 million
Manikay Partners 1.6 million
Key Reference Documents:
1) Warrants FAQ: http://www.aigcorporate.com/investors/warrants.html
2) Q2 Presentation (business unit performance and Deferred Tax Asset breakdown): http://www.aigcorporate.com/investors/2011_August/2Q11_EarningsPresentation.pdf
3) Financial Supplement (detail regarding cap structure and relationship with Treasury): http://www.aigcorporate.com/investors/2011_August/Q22011_FinancialSupplement.pdf
Reasons for Mispricing:
Black-Scholes does poor job valuing long-dated warrants, as implied vol does not take into account the significant mispricing of the underlying AIG common stock nor the multitude of events that can drive value over the next 9+ years
1) The underlying common stock of AIG trades at 46% of Tangible Book Value ($49.18)
2) AIG is very profitable, and is expected to generate $3.15 of EPS (7.1x) for FYE 2011 and $3.00 (8.3x) for FYE 2012 (per CapIQ)
3) Very low expectations for AIG financial performance due to choppiness in AIG historical results
4) Government overhang from residual 77% ownership stake of U.S. Treasury
5) Market not giving AIG credit for addressing key risks from credit crises (i.e. reducing derivative and CDS books by ~90%, securities lending business shuttered, consumer finance business sold)
6) Hidden deferred tax asset of $25.6 billion which may have a PV in the range of $6-8/share
7) The Chartis, SunAmerica and ILFC businesses each have significant independent value and are worth substantially more on a sum of the parts basis (likely 60-80% of BV in aggregate).
Disclaimer: The author of this idea has a position in this security and may trade in and out of this position without informing the readers of this opinion.
1) Market recognizing the underpricing of the warrants, increases implied vol
2) Sale or public offering of equity in one or more divisions (ILFC has made a preliminary filing to sell 20% of equity)
3) Continued performance at Chartis and SunAmerica build investor confidence in earnings power
4) Potential for excess cash flow to be used to repurchase shares, possibly directly from the Treasury, reducing overhang and indicating confidence/stability
5) Bringing deferred tax asset back on balance sheet after continued profitability would provide immediate increase to book value
|Entry||09/26/2011 04:42 PM|
If I am reading Section 4 of the Warrant Agreement (dated 1/6/11) correctly, the warrant holders are not compensated for the lost time value of the warrants in the event that the company is purchased (or large units are sold).
This is frequently why long-dated warrants appear cheap and why BS cannot be blindly applied, even when there are anti-dilution provisions.
If I am correct, then you could be correct on all your fundamental points but still lose money. Let's say AIG is sold for $40. If I buy AIG stock right now in low 20's, I am happy. But if I buy AIG warrant instead, I get a donut.
As well, from the perspective of the blind arbitrage trader who is long the warrant and short the delta of equity, he gets hurt badly as the stock rallies while the warrant falls to zero because cash has no volatility.
Also, your reasons for why we should not apply BS are not an indictment of BS. They are a criticism of the current underlying price. Your reasoning seems to be that the stock is cheap so call options on stock are very cheap. Fair enough, but this has nothing to do with BS.
The reason I state this is because I think that your write-up misses the real reason why it is dangerous to apply BS to long-dated warrants. There is a huge risk in buying the warrants rather than just buying the equity.
But I reserve the right to sheepishly apologize if I mis-read the Agreement in the 15 minutes I looked at it!
|Subject||Do we really have an edge on Volatility?|
|Entry||09/26/2011 06:08 PM|
I agree that B/S can have problems on tails and I think generally the time to exploit options are on leaps when you can apply a fundamental basis to the situation. But this is about the fundamentals of vol, the stock price in the equation is the stock price, as straw I believe was saying.
What makes you say 37% is cheap? Sure its less than atm vol in the low 60s but you simply cant equate these two. If I look at the Jan 13 35-45 calls they have a vol around 40, so this doesn't strike me as some really off situation. In fact that would maybe argue the warrants are overpriced.
Furthermore I would argue that if your thesis on AIG is correct, it's going to turn back into a stable low vol large/mega cap in 3-4 years around 40-50 and then your 37% vol doesnt look that cheap.
Maybe theres something interesting to be done buying the warrants and shorting jan 13 otm 20 strike puts for 4 bucks, but this still doesnt strike me as anything that special. If you think downside is limited and this isnt a binary bet this is probably a much better idea, since you are effectively paying up for an option if you are not concerned with downside.
There are so many attractive vol plays in market conditions like today, I'm just not sure I see the edge here. If we want to look at warrants what about the 2019 13.3 BAC calls for 3bucks. Sure vol is pretty expensive at 60% but at least there we are making a binary bet with potentially huge upside.
I dont know if anyone has read about Ed Thorpe in Fortune's Formula (great book as an aside) but I don't think those conditions exist like that anymore, particularly on such a liquid contract.
|Subject||RE: Do we really have an edge on Volatility?|
|Entry||09/26/2011 08:05 PM|
Okay, once again I will say that I believe that the vol is low because of the numerous potential major corporate transactions that are possible or likely to occur in the near to mid term for AIG, and the 2021 expiration provides tremendous amount of runway for such events to occur. Further, management is taking steps now to realize sum-of-the-parts value and it wouldn't be surprising to see additional transactions in the near future.
BUT, my investment case explicitly was based on the misvaluation of the underlying not based on a bet that vol will increase. There are a number of reasonably likely/possible cataysts that could result in a revaluation of AIG significantly higher, which would make the warrants an asymmetric bet if you also believe downside is limited given the present valuation.
|Subject||RE: AIG Warrants/Insider Buying|
|Entry||01/18/2012 08:19 PM|
Implied volatility everywhere has come in from the days of August and October. I would be careful reading too much into the decline.