Institutional investors have largely forgotten about AIG - presumably because its sub-$2/share price and multiple government rescues would imply there is too little equity value remaining to be of interest. However, even at $1.55/share, AIG has substantial equity value and remains expensive. An analysis of the balance sheet suggests the company has effectively no book value left after the most recent quarter putting the company's turnaround plan and equity value at substantial risk. Shares have downside risk to $0.75/share in the near term.
As a result of the bailouts, the US government owns 10.7 billion shares of AIG. Other shareholders own 2.7 billion shares for a total of 13.4 billion shares outstanding. At a share price of $1.55, this implies a market cap of almost $21 billion, still giving AIG among the highest market caps in the insurance sector and making it one of the 100 highest market cap companies in the US. This is very impressive for a company that was insolvent two times in the last few months.
As of September 30, 2008, AIG had a book value of $71.2 billion. Of this, $23 billion is phantom equity created by GAAP accounting for the 79.9% warrants issued to the US government for the bailouts (additional paid in capital created by the issuance of the warrants will be amortized on a straight line basis to 0 over the life of the US government loan to AIG). So as of 9/30, there was only $48 billion of "real" book value. Of this, another $10 billion is goodwill, meaning that AIG had $38 billion of tangible book value as of September 2008. This means AIG was trading at 0.55x tangible book value as of September. This is in line with other non distressed insurance companies which currently trade at 0.6x-0.8x 9/30 book value while still a premium to another distressed insurer HIG (0.3x BV).
However, in the last 3 months, AIG's assets have deteriorated materially and we already know that significant impairments are to come when financial results are published for the period ending 12/08. Two of the losses have already been documented and are "permanent" as AIG has moved assets off its balance sheet as part of the latest government rescue. SIVs were created for CDS on multisector CDO and securities lending RMBS - where AIG effectively transferred assets to special purpose entities, requiring AIG to recognize losses immediately. Before setting up one SIV, AIG took a $7.1 billion loss on its CDS on multisector CDO portfolio between September 30 and November 5 (page 119-120 of 10-q). In the last couple weeks AIG has issued 8-Ks indicating that the total losses from the CDS portfolio are over $10 billion (they have $71 billion of exposure, marked at 42.6 cents as of 9/30, paid 43.6 cents to settle at par, meaning 14 cents of additional collateral posted since 9/30). However, this is probably still conservative because AIG was unable to settle $12.3 billion of CDS exposure as of its Christmas eve filing. The securities lending RMBS SIV bought assets valued @ $23.5 billion on 9/30/08 for $19.8 billion, resulting in another $3.7 billion loss. The company has invested $6 billion of capital in these SIVs, which means that further losses are possible, and AIG gets minimal participation in any upside should the SIVs actually generate a profit.
In addition to the $14+ billion of SIV losses, AIG faces significant losses/impairments on other assets. The company has the following exposures that face significant potential losses as of 12/08:
- a $433 billion fixed income portfolio of which $44 billion is non-agency RMBS, $18 billion is CMBS, $8 billion is other CDO
- a $34 billion AIGFP portfolio that includes $4 billion of RMBS, $5 billion of CMBS, $11 billion of CDO
- a $34 billion equities portfolio of common and preferred stock
- a $34 billion mortgage portfolio
- a $28 billion portfolio of hedge fund and private equity partnerships
- a $30 billion portfolio of other investments including mutual funds, real estate, and other partnerships
Taken together, these assets represent approximately $210 billion of exposure with significant fair value losses, which could easily dwarf the $14+ billion of SIV losses.
Since the quarter ended September, equities are down 25%, BBB corporates are down 7%, high yield debt is down 25%, CMBS is down 30-50%, RMBS is down 20%+, and hedge fund indices are down 12%. AIG does have some discretion with the magnitude of losses and impairments taken on these assets. However, even using a very conservative $30 billion of losses on the $210 portfolio - AIG would take a $31 billion BV hit after tax ($44 billion * 70%).
Using analyst estimates for the core operations and the previous analysis suggests tangible book value of $10 billion at best in Q4. The core business may earn $2.8 billion after tax in the quarter before the government preferred dividend of $1 billion, leaving core earnings of $1.8 billion. Adding this to the 9/30 balance of $38 billion and subtracting $30 billion of losses gets the $10 billion tangible BV estimate or $0.75/share. Of course, the portfolio marks could easily exceed the $31 billion implied and other impairments/charges/losses are likely (e.g., deferred acquisition costs, goodwill, other investments), leaving zero or possibly negative tangible book value.
The core operations are reported to be in decline. Key employees are leaving to join competitors. Customers are in the process of moving business to other providers (the company denies this has happened as of early November, but the AIG bailouts only began in September and it takes time for customers to transfer insurance coverage). Competitors have reported that AIG is being extremely aggressive in pricing new business to keep clients from defecting (Liberty Mutual called AIGs pricing tactics "very stupid"). This leaves Q4, 2009, and forward core insurance earnings at risk.
The company is also trying to shed assets to help repay the government loans, preferred equity, and raise equity. However, credit markets are closed shutting out many potential buyers for the foreseeable future. Many strategic buyers lack sufficient capital to buy meaningful assets from AIG. Valuations for competitors are at 5-7x next year P/E and <1x BV, making it virtually impossible for them to make attractive offers for AIG assets. And AIG management has made conflicting comments about the magnitude and timing of divestitures that will be made. Therefore, it seems unlikely that AIG will generate material proceeds from asset sales.
AIG should trade at 1x its tangible book value, which would put it in line with other multi-line insurers. The calculations above indicate tangible BV of $0.75/share as of 12/08, with downside risk to this depending on the magnitude of marks AIG is forced to take. At the current share price, there is >50% downside.
-Q4 earnings release. Highly likely that above losses/impairments are taken this quarter.
-pre-release Q4. Possible that the company announces losses before mid-February.
-further government bailout funds required. Possible, but probably not before Q4 results.
- Major divestiture at attractive price. Doubtful in the near term.
- Major recovery in real estate, credit, and ABS markets. Unlikely in near term.
- Government relaxes terms of AIG loan, SIV investment, preferred equity, warrants. Doubtful in near term.
- Equities or financial stocks rally and AIG participates. Possible, but AIG may not participate to extent other stocks do in a rally.
Q4 and FY2008 earnings announcement shows extent of balance sheet impairment. Expected in February 2009.