Bruce Berkowitz was named the Domestic Stock Fund Manager of the Decade (2000-2010) by Morningstar. He is the manager of the Fairholme Fund (MUTF:FAIRX), and the owner of Fairholme Capital Management. The Fairholme Fund has net assets of just under $8.5 billion, and is heavily concentrated in financial stocks. His largest holding is AIG, an astonishing 32% of the FAIRX's net assets.
Berkowitz and his investment in AIG have been chronicled across all forms of media, but not much has been written about his investment in the AIG warrants. In my last article on AIG, I pointed out a pathway for the warrants to become a 10 bagger in 7 years. In the comment section, one of the posters pointed out that Berkowitz owns 1/3 of all the outstanding warrants. I knew he had a large position, but owning such a large percentage of the float introduces some new dynamics that should be studied.
AIG's TARP Warrants
For those that don't already know, during the bailout of AIG, done through the TARP program, long dated warrants (currently 8.5 years from expiration) to purchase AIG stock were created. The warrants were issued as an incentive for existing shareholders of AIG, so that they would vote in favor of converting the government's preferred stock into common. In this transaction, 75,000,0000 warrants were issued with an exercise price of $45 (significantly below book value). These warrants are traded, and can be followed through the Yahoo Finance ticker symbol of (AIG-WT)
Berkowitz's Position in AIG
As of March 31st, his position in the stock and warrants is as follows:
AIG Common Stock - 91,464,833
AIG Warrants - 24,575,860
Berkowitz's total investment in AIG is about $3 billion, which constitutes close to 35% of his total portfolio. Has Berkowitz lost his mind? Never before have I seen a large mutual fund manager have such a concentrated position. Berkowitz is betting his whole career on AIG, so I assume he knows an enormous amount about the company. If he knew of any major holes, I suspect his position would not be anywhere as large.
What's His Game Plan With the Warrants?
As you can see from above, he owns almost 1/3 of the warrants outstanding. That means the free float of the warrants at today's price of $10.5 is around $530 million. This is a pretty tight float, which I think may have become even tighter since Berkowitz's last filing on March 31. With the tiny volumes in AIG warrants traded on a daily basis, it is clear that Berkowitz cannot efficiently exit his warrant position. In my opinion, it looks like he will hold these all the way to expiration. This position he will most likely keep for the long-term, while he will most likely sell down the common stock, as it gets closer to fair value.
Free Float of Warrants Tight
With the free float of the warrants shrinking, I think there is significant potential for the warrant price to increase rapidly. The small float is an advantage for retail investors. Small investors can easily sell their position on price spikes, while Berkowitz is stuck. In the long-term, however, the best position is probably to be stuck with Berkowitz. Then, like him, you will be forced into a 10-bagger.
Disclosure: I am long AIG.
Additional disclosure: Long AIG through the warrants.