I feel like this story has been presented ad nauseum. So prepare to throw up. Everyone knows about AIG and what an awful company it was. On the flip side, value investors are pouring over it. I think this would qualify as a Michael Burry "ick factor" stock. In fact, I think that everything is overblown and a margin of safety exists that may be greater than any other insurance company out there. More so than even my favorite, Aspen.
There are four inputs to this: Insurance segment (Chartis/SunAmerica), management, the government, and everything else (all the auxiliary lines of business/wind-downs/IPOs).
Chartis
Personal and Commercial insurance arm of AIG. They will not win an award for being the best insurance company but they are certainly one of the bigger ones. In Q1 2012 they wrote $8.8B worth of net premiums and had a pre-tax income of $910M. They underwrote to a loss, so investment income was $1.2B for the quarter.
They returned $1B to the parent in Q1 2012 and $1.5B in FY 2011. Management expects Chartis to return between $2.5-4.5B to the parent in 2012. This is off $124.9B of total invested assets as of Q1 2012.
While I'm not overly impressed with their loss ratios it's not a total train wreck considering all the catastrophes the past two years. I give Chartis a "C" for a grade (average for those conditioned to grade inflation).
SunAmerica
This is their retirement and annuity branch. In Q1 2012 it returned $1.6B to the AIG parent. In the Q4 2011 earnings call management expected SunAmerica to return about $2B to the parent. This is off $192.8B of total invested assets as of Q1 2012.
SunAmerica is big, well known, and probably here to stay. With a fair amount of ignorance I would apply a "C" to SunAmerica as well.
Insurance Segment
Combined Chartis and SunAmerica have total invested assets of $317.7B. Backing out debt and reserves and everything else one arrives at a BV of ~$83B. Management expects annual dividends from their operating companies to come in at $4-$6B. This would obviously correspond to an ROE in the mid-single digits. Just like every other insurance company, AIG has "aspirational goals of 10% ROE."
I believe that in today's low rate environment, coupled with the insurance industry surplus this segment is worth 0.9BV or $75B. Perhaps that will improve in the future but for now I'll stick with a bland 0.9 assessment.
Management
In Andrew Sorkin's "Too Big to Fail" I remember when Lehman Brothers, hoping for a liquidity injection, sent Buffett an annual report and other documents. Buffett read them and made a note of anything he didn't understand. Supposedly the report was littered with notes by the time WEB was done reading it. Confusing annual reports are not good.
Financial companies are opaque at best. Reading an annual report should clear and concise.
Reading AIG's most recent annual report was a breath of fresh air. Everything was spelled out. Does this eliminate long tail risk? Of course not. I can only hope that the team hired to clean up the mess created in the crisis will actually clean up the mess. They are experienced insurance executives and they seem committed to returning money back to shareholders. Up to $30B by the end of 2015.
Everything Else
This will be a gross oversimplification but here goes.
ILFC: Looking at Whitney Tilson's presentation I think it's reasonable to believe that ILFC is worth book value. The S-1 for ILFC shows shareholder equity of $7.6B(pg 44).
Maiden Lane III: AIG received $5.56B on July 12th. They'll now get 33% of the remaining equity Conservative value = $5.56B
AIA Stake: Obviously this will fluctuate with the market. As of March 31, 2012 their remaining interest in AIA was ~$8.2B. With roughly 290M shares held this has declined in value to roughly $7.8B as of 7/16/2012.
I have ignored the other assets, such as United Guaranty, deferred taxes, etc. I think that "Everything Else" is worth $20-$21 billion. It could be worth more and perhaps in a serious market swoon/IPO bust it's worth significantly less. Again, my hope is that this is conservative.
The Government
The Treasury owns 61% of the shares outstanding. With roughly 1 billion shares and a break even price of $28.72 there's a worry that the stock price will be stuck at the break even price as the Treasury unloads shares on the market. Management knows this is the belief widely held.
"Conventional wisdom has been, as long as the treasury has a large position $29 is probably the ceiling for the stock.'' Robert Benmosche Q1 2012 Earnings Call
I have no idea what the end exit strategy for the government will be. Quite frankly, I don't care as long as they exit sometime soon, which is the stated intention.
So why do I believe AIG is a buy?
First, there is a skewed shareholder base. The Treasury owns 61% of the shares, Fairholme owns another 5%. Therefore, 66% of all shares are held by two groups. One group doesn't care that much about selling price. This would be an inefficiency. What fund manager would want to be caught owning AIG while the Treasury also owns shares?
Pretty much just Bruce Berkowitz and friends.
In small cap stocks large ownership stakes sometimes present inefficiencies. In this case we know that the Treasury wants to sell their stake. They are a forced seller. The exact details aren't known but as I've said earlier, we know they are exiting. Once the Treasury exits fund managers around the world can start buying. I believe this makes AIG act like a small cap that has a strange shareholder base.
If we believe that "Everything Else" is worth $21B and the core insurance business of AIG can make $3-$7B a year (3%-8% ROE) today's it's easy to see why Benmosche thinks that they can return $30B to shareholders in the next three years. As the Treasury exits shares should get bought back.
Will things change once the Treasury's stake drops below 50%? Yes I would imagine. Luckily we have the other banks that took TARP funds as a road map. They made it out OK and I think AIG will too.
The second reason I believe AIG is a buy comes from the margin of safety. The company is priced as if no other business segment ("Everything Else") has any value. Today's valuation gives the insurance segment alone a P/BV 0.67 ($58.7B MC $83B BV). I find it absurd that ILFC, ML III, United Guaranty and everything else has zero value. Even if it does you still get SunAmerica and Chartis at a discount.
Is that discount warranted? No, I think there is excellent clarity in conference calls, annual reports and public messages. Thanks to the Joe Cassano PR campaign, AIG is combed over by everyone. Luckily for us, the AIG of today is not the AIG of 2007. Once the government exits and non-core businesses are sold you're left with a large insurance company.
I think it's reasonable to value the insurance companies at $75B (explained earlier as 0.9BV) and "Everything Else" at $20B in value. AIG, in my eyes would be fairly valued at roughly $51 per share(1.875B shares 95B fair value).
Conclusion
In 2007 AIG was spread out and had it's hand in numerous cookie jars. Many of these jars had mousetraps and as a result AIG suffered. The company is completely different now and poised to return $30B to shareholders in three years.
Buying AIG at a discount today lets investors participate in a clear path to accretive book value growth. As the Treasury exits I believe management will buy back shares. This will grow BV and enhance the upside while reducing the downside of government intervention. This will also lift the stigma associated with owning common shares. Instead of a government backed entity you will have an insurance company selling for about 1/2 book value that generates 3%-8% ROE on an annual basis.
While there are many risks to this investment I believe the clear path forward and the deep discount to conservative book value is a compelling opportunity. Long AIG
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