AIG: I Remain A Skeptic Despite Discount To Book Value And Appealing Earnings

Dec.18.13 | About: American International (AIG)

Investors in American International Group (NYSE:AIG) applaud the company's latest divestiture. The company finally sold the aircraft leasing business, in a deal which still gives the company indirect control to the attractive operations. AerCap's shares jumped up following the announcement, yet this only benefits AIG which is the largest shareholder in AerCap following the deal.

Despite the continued operational improvements, the full repurchase of the government loans and the discount to book value, I continue to be cautious. Current returns on capital remain unsatisfactory while the past history leaves me skeptic.

I remain on the sidelines.

The Deal

American International Group announced that it has sold the International Lease Finance business to AerCap Holdings (NYSE:AER). AIG stands to receive $3.0 billion in cash and 97.6 million newly issued shares of AerCap, valuing the total deal at $5.4 billion based on Friday's closing prices.

The deal is the last major disposition of AIG's non-core assets. The aircraft leasing business is not core to the insurance operations. IFLC owns and manages nearly a 1,000 aircraft and has committed to buy another 330 fuel-efficient aircraft which are in high demand.

CEO Robert Benmosche commented on the rationale behind the sale, "This transaction creates a strong foundation for ILFC and positions it for continued market leadership and strategic growth. The combination of AerCap's young fleet of in-demand aircraft and proven portfolio management capabilities with ILFC's attractive order book and broad marketing reach will continue to lead the industry."

The deal is expected to close in the second quarter of 2014. The deal is subject to regulatory reviews and approvals, as well as approval from AerCap's shareholders.

Note that Waha Capital which is AerCap's largest shareholder with a stake of 26% before the deal has been announced, has already voted in favor of the deal. The deal will improve the liquidity and credit profile of the company, allowing AIG to focus on the core insurance operations.

Valuation

At the end of October, AIG reported its third quarter results. The company operates with common equity of $98.8 billion, equivalent to $62.68 per share. This implies that the firm's debt/capitalization ratio stands at 12.6%.

For the first nine months of the year AIG generated revenues of $48.03 billion, down 4.8% on the year before. Earnings attributable to common shareholders fell by 3.9% to $7.11 billion. Annual revenues could come in around $63 billion this year while earnings could come in around $9.5 billion

Trading around $50 per share, the market values AIG at $74 billion. This values the company at 1.2 times annual revenues and around 8 times annual earnings.

AIG recently announced a quarterly dividend of $0.10 per share, for an annual dividend yield of 0.8%.

Some Historical Perspective

Long term investors have seen their investments being decimated. Adjusted for the reverse 20-for-1 split, shares traded around $1500 per share in the years ahead of the financial crisis.

Shares currently trade at $50 per share which is far above lows of $7 in 2009. Since the start of 2012, shares have steadily risen from $20 to current levels. So far in 2013, shares have already risen more than 40%. Since 2011, AIG repurchased about a fifth of its outstanding share base again, which is just a drop in the bucket after the dilution which occurred during the crisis.

Investment Thesis

AIG is transforming itself again, going back to the core roots. AIG now focuses on the property casualty business, mortgage guarantees and AIG life and retirement operations.

The divestment of ILFC marks yet another major step to achieving this goal. While the deal will fetch $5.4 billion, the net proceeds in terms of cash are much lower. Cash proceeds of $3 billion, are seen around $2.4 billion on a net cash basis, after settling intercompany loans. Given the huge stake of 46% which the company will obtain in AerCap, the company will recognize income under the equity method.

Shares of AerCap jumped up 40% following the news to levels around $35 per share in the first two days following the news. As such, AIG's holdings of 97.6 million shares would have increased by almost a billion, boosting the deal value to almost $6.6 billion. Aercap will now be a leader in the aircraft-leasing business competing with General Electric (NYSE:GE).

Aercap will quadruple its total fleet by the deal to 1,329 planes after ILFC adds a 1,002 planes to the fleet. The deal will create a company with $5 billion revenues and earnings of $1 billion, making the current valuation at $35 dollar still attractive given the market capitalization of about $7.5 billion, even when factoring in the newly issued shares.

So while AIG's performance in recent years has been strong, I still have not forgotten about the financial crisis. Derivative bets into the financial crisis resulted in a $182 billion bailout in 2008, as the company sold the last money owned to the Treasury in March of this year. Note that despite strong recent returns, investors who invested in AIG before the financial crisis are pretty much wiped out.

While AIG has made a great deal of progress in recent years, the share price has already largely reflected this. Trading around $50 per share, the firm still trades at a 20% discount to tangible book value. This is partially the result of the continued underperformance, even as the company has improved a lot. Returns in terms of equity being invested are still unsatisfactory, even as AIG aims to generate returns of 10% by 2015. The lower current returns and some healthy skepticism given AIG's past history warrants some sort of a discount, at least in my opinion.

While the company trades at attractive multiples in terms of earnings, and the transformation pace and strategy should be applauded, the past history makes me very cautious. For that reason alone, I remain on the sidelines despite the attractive discount to the book value, and appealing earnings multiples.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.