The bullish thesis of AIG (AIG) keeps unfolding. Following my articles 'AIG - Undervalued And Misunderstood (Parts I and II)', additional steps were undertaken by the New York Federal Reserve Bank to move AIG closer to becoming a company owned by private shareholders again.
As recently suggested in my other articles, the Federal Reserve Bank was able to profit from increased interest in the sale of its CDOs which were held in the Maiden Lane III SPV. The announcement from Thursday, April 26th, highlights the success of the auction:
The Federal Reserve Bank of New York (New York Fed) today announced that it has sold the entirety of the MAX CDO holdings from its Maiden Lane III LLC (ML III) portfolio to a consortium consisting of Barclays Capital Inc. and Deutsche Bank Securities Inc. following a competitive bid process.
The New York Fed decided to move forward with the transaction only after determining that the winning bid represented good value for the public. This transaction substantially reduces the ML III portfolio and loan at a desirable price.
"I am pleased with the level of interest and the results of this process, especially with the strength of the winning bid, which represents good value for the public and significantly exceeds the original price ML III paid for these assets," said William C. Dudley, President of the New York Fed. "This successful sale marks another important milestone in the wind-down of our crisis-era intervention."
Consistent with the current investment objective of ML III, the New York Fed, through BlackRock Solutions, will continue to explore the sale of assets held by ML III. There is no fixed timeframe for future sales; at each stage, the Federal Reserve will sell an asset through a competitive process and only if the best available bid represents good value, while taking appropriate care to avoid market disruption.
A successful sale, as indicated by Dudley, is not only good for the Fed but also for AIG as it keeps a residual interest of $5.7 billion (book value). Now, AIG CEO Robert Benmosche indicated in March that the market value of the equity in ML III is around $7B. In the context of investors looking for higher yield as economic fundamentals improve, I carefully predict that that the competitive bidding for the remaining CDOs could result in even higher value for AIG and a share repurchase program that could start in 2012 already.
Access to a few of the cash sources to finance the repurchase program are still restricted through 2012. Escrow will become available in 2012, ML III looks available in 2012 and AIA might be available after the sale restriction expires in September, and depending on capital market conditions. I assume that ILFC will be IPOed this year. It could be quite possible that AIG will be able to repurchase shares in 2012 by an amount of $20B. According to the simple accretion model that I developed (which I am happy to disseminate per email if requested) a repurchase of $20B worth of common stock at an average repurchase price of $34 (representing around 35% of outstanding common stock) would yield a book value per share of $79.5 per share. This in turn represents a margin of safety of 57%. I have been more conservative in my original forecast, attributing the bulk of the share repurchase to the end of 2013.
Considering the progress AIG made over the last year alone, I consider the downside to be very limited, particularly in regard to the operating performance and the changes in the capital structure that I expect. I believe the upside to be huge. For more risk-seeking investors, the long-term warrants could prove to be good bargains if one has the patience to stick with them over the entire financial cycle.
Based on the responses and questions I received regarding my AIG articles, it seems pretty clear that the market still does not recognize AIG's value. In fact, AIG's progress is ignored and marginalized, which I cannot understand. Assuming that AIG completes its share program, investors are looking at a triple digit book value per share over the next view years. If the book value in 3 years time is $100, the IRR would be 43% per year based on a current stock price of $34. This seems to me to be more attractive than, for example, Apple (AAPL) which is a more widely followed momentum-driven stock. Extreme expectations are priced into Apple, which makes it likely that some of them will be missed and investors will be disappointed at some point. On the other hand, AIG faces dim expectations and a stock price significantly below intrinsic value. As a value investor, I choose AIG.
Disclosure: I am long AIG.
Additional disclosure: AIG long-term warrants