On Monday morning, AIG (AIG) announced it had agreed to sell ILFC (its aircraft leasing unit) to AerCap (AER) for $5.4 billion (press release available here). This marks the last major disposition of a non-core asset for AIG, ending a 5 year period of asset sales as the company recuperated from the financial crisis. Under this deal, AIG received $3 billion in cash and 97.5 million shares in AerCap, good for a 46% stake. After paying intercompany loans, AIG will have $2.4 billion in cash on hand for general corporate purposes. AER shareholders loved the deal, and shares rose 33%. This rally increased the value of AIG's holding by about $800 million, a nice one day gain for sure!
I would expect AIG to sell down its holding in AER over the next 12-18 months as the company looks to exit the business completely and focus solely on its core insurance business. As you look at what is now a focused insurance company, it is clear AIG is cheap. AIG continues to trade at a discount to book, with book value per share of $67 including AOCI. Most insurance companies are trading 90-110% of book value compared to AIG's 75% of book value. With the company still turning around and posting an imperfect third quarter, AIG should be valued near the bottom of its peers at 90% of book value. Even then, shares would trade at $60 or 20% higher than current levels.
In August, AIG announced a $1 billion buyback and $0.10 quarterly dividend as the company has successfully dealt with all of its financial-crisis related problems and government loans. With those in the rearview mirror, AIG can return to normalcy with its capital program. With strength in the life insurance business and strong underwriting results, I think AIG is poised to return more cash to shareholders in 2014, which will help to push shares higher.
Analyst consensus is for AIG to earn about $4.35 in 2014, though I am far more optimistic and think earnings could be closer to $4.75-$5.00 as rising bond yields will be very beneficial for its revamped life insurance business. Insurers invest life insurance premiums in stocks and bonds, so as rates rise, AIG's cash income on its portfolio will rise. Many of these bonds are held to maturity, so price declines when rates rise have no long-term impact on income. At the same time, its consumer insurance units have posted strong underwriting results, which will help profitability going forward.
While AIG is adequately capitalized at current levels with a 5.48 leverage ratio, the company is a SIFI (systemically important financial institution). As a consequence, the company is subject to stress tests and the Federal Reserve has been frowning on aggressive dividend and buyback plans. Therefore, investors should assume capital returns far below what AIG is capable of doing. I believe with its earnings power AIG could easily return $3 in the form of dividends and buybacks or $4.5 billion in total. However, to appease regulators, I expect AIG will do something more modest.
That is why this ILFC deal is so important for shareholders. AIG has sold assets and how has some excess cash sitting on its balance sheet. With at least $4.25 in earnings power, I don't believe even our regulators could argue with returning the ILFC cash to shareholders in 2014. I think $2.4-$3 billion in dividends and buybacks is a reasonable expectation for 2014. At current prices, investors should want management to focus its resources more on the buyback than dividend. When a company buys shares below book value, book value per remaining share increases. I could see management raising the dividend in mid-2014 to $0.15, which would cost $850-900 million over 12 months, leaving $1.5-$2.1 billion for buybacks.
On the whole, the ILFC sale is a final sign that AIG has emerged from the crisis as a new, focused, and leaner company. Still, shares are bogged down by remembrance of the financial crisis and trade at 75% of book value. I believe as investors recognize that AIG is growing life insurance and maintaining tight underwriting standards, its shares will move closer to book value, which could send shares up 20%. In 2014, investors should see accelerating capital returns, which while less than what AIG could deliver is a step in the right direction. Below $50, I believe AIG has one of the best risk/reward profiles in the insurance sector and see it as a top choice in 2014. The ILFC deal is positive for AIG and another reason to get long shares.