AIG: The New Math?

Am I the only one who just cannot reconcile this?

For the 2007 first quarter, AIG (AIG) reported net income of $4.13 billion or $1.58 per diluted share. First quarter 2008 adjusted net loss was $3.56 billion or $1.41 per diluted share, compared to adjusted net income of $4.39 billion or $1.68 per diluted share for the first quarter of 2007.

AIG also announced a plan to raise approximately $12.5 billion in capital to fortify its balance sheet and provide increased financial flexibility. The capital is to be raised through a common stock offering and an equity-linked offering for an aggregate of approximately $7.5 billion. At a later date AIG also expects to issue high equity content fixed-income securities. These offerings are designed to further strengthen AIG’s significant financial resources and will enhance its ability to grow while maintaining the strength to withstand potential short-term market volatility.

Commenting on first quarter 2008 results, AIG President and Chief Executive Officer Martin J. Sullivan said,

AIG’s results do not reflect the underlying strengths and potential of AIG; rather they reflect the extremely adverse external conditions affecting the spectrum of companies exposed to the U.S. residential housing, credit and capital markets. The sizable unrealized losses and decline in partnership income were among the key drivers impairing our overall net performance. With that said, it is important to underscore that our operating strategies are working well in our core insurance businesses. We believe that our businesses provide an attractive foundation for growth for AIG over the long-term. As part of this effort, we are taking appropriate strategic actions to ensure our businesses are well positioned to capitalize on opportunities provided by the current environment.

While we anticipated a difficult trading environment, the severity of the unrealized valuation losses and decline in value of our investments were beyond our expectations. Current market conditions also contributed to a significant decline in partnership income compared to a record level in the first quarter of 2007, as well as to declines in mutual fund income. However, the underlying fundamentals of our core businesses remain solid, and several performed quite well in the quarter, despite the challenging environment many faced.

Now, of course the "underlying fundamentals of the business" are strong. You are an insurer and last I checked the insurance business was still ok. It is your performance in that business that was horrible and does not look to improve soon. Contrast this to Owens Corning's (OC) results earlier this week that were very good in a industry that is current depressed. Given a choice between the two, I will take the latter.

Here is where it gets weird. Why is AIG announcing a 10% increase in the dividend? Why? This will cost $2.2 billion a year, an increase if $200 million. Not that much, but with a 6.8% dilution of shares coming up due to the offering, that amount will jump to $2.35 billion a year (not including whatever interest will be paid on the new convertible to be issued).

Now, if you need to raise $12 billion (10% of your market cap), you cannot also increase the dividend. How about keeping it and diluting shareholders less? They are going to be paying 6% to 8% on whatever is issued so the additional $200 million a year borrowed will cost another $12 to $16 million a year in interest to shareholders. The stock only yields 2% so it is not like we are talking big bucks for shareholders. Cutting it 10% would have saved $200 million.

This is just a sadly transparent attempt to pacify shareholders into thinking things are much better than the numbers would appear to prove.

Disclosure: No position AIG.

Comments

[fxtrader07]

good points. this is a value trap of sorts. i am glad i resisted the temptations to buy into this stock.
longterm succes in the insurance business has to do a lot with prudence, patience, integrity, credibility and a proper understanding of risk. if you don't understand the risks properly, you can't quantify them properly. And if you can't quantify them properly you will charge too little in premiums for the risks taken.
AIG has no merits in this regard. if they ever had - they have lost them by now. I simply don't see why anyone would want to invest into them. you may make a quick buck in a bounce, fine. but for a long-term stable investment there are way better insurance companies out there. AIG may be the biggest but is just one of the many lousy companies operating in this field.

[winslow]

The CEO and Board of Directors should be prosecuted and all of their assets siezed and returned to the shareholders

[Shetty]

You've made a valid point, but I'm sure the management is aware of the math. I think it has more to do with the fact that the stock is predominantly held by Institutions & Pension Funds, who need this yield and end up supporting the stock. If AIG decides not to pay this dividend for this Quarter or eliminate for the time-being, that would result in a decrease of institutional participation in the stock - and ofcourse much lower stock price...and ofcourse the management is wear of such a move.

[helplessobserver]

What's happened to AIG is they have gambled with their reserves and lost big time. Eventually they will need a bailout.

[orca]

Whatever they say or report, I will not invest at any price in a business run like some sort of mob outfit with enforced omerta rules. Of course I refer to Greenberg's Carribean shell set-up with regard to higher management. This week's numbers, coupled with the idiotic dividend play, only confirm my decision.

[Vegasjoe]

AIG, Almost Investment Garbage, needs to keep its investment grade rating so raising capital makes sense. No institution I know of cares about a 2% dividend when the principal goes down 20%!

[Dave Cain]

Wow, this gives new meaning to "smoke and mirrors". I'd say it's high time to return to basics...and learn what the term 'underlying business' truly means...

[WAKEUP]

Having been a mid-level manager for AIG, I can tell you that there is no telling what the AIG folks are liable to do. They invented smoke and mirrors; they even used same on us, the very people who diligently pursued what we were told were the normal business interests of the company, only to be betrayed in a massive firing of people, all of whom had excellent records of production, just to satisfy some short-term goals of top management. AIG is a poisonous environment; now, it is a poisonous stock.

[anon79]

AIG's capital study published with the results showed that company is holding $2.5 to $7.5 billion of excess capital. The excess compares to 2007 year-end position of $14.5 to $19.5 billion of excess capital. Therefore the math seems to indicate that AIG is looking to restore its excess capital position to prior level. Though in other market conditions, a firm would be penalized for excess capital, the surplus capital position would suit the risk averse institutional investors.