AIG (AIG) is a world leader in insurance and financial services, and is the leading international insurance organization with operations in more than 130 countries and jurisdictions. Its companies serve commercial, institutional, and individual customers through the most extensive worldwide property-casualty and life insurance networks of any insurer. In addition, AIG companies are leading providers of retirement services, financial services, and asset management around the world.
At the current share price of about $35.70, down from a 52-week high of $37.67 hit last Thursday, AIG sells for about 50 cents on the dollar with a book value approaching $70.00. AIG has a current market cap of approximately one-third of the amount of money it required to be bailed out by the U.S. government in 2008.
Top-performing fund managers come and go, but few have the guts to invest 35% of their fund assets in their best stock idea. Bruce Berkowitz of The Fairholme Fund is the rare exception here. The Fairholme Fund is up 36% vs. the S&P 500's 16% this year thanks to a large extent to the performance of AIG stock, which is up 54% YTD (-96% over the past five years). He also was voted Morningstar fund manager of the decade. Over the past 10 years, the fund is up 10% vs. 7% for the S&P 500. Last year was the fund's worst year in its history, with a performance of -32%; Berkowitz was early getting into financials and was, as he is today, heavily invested in financials.
According to Berkowitz in the Fairholme Fund's second quarter letter:
There are few occasions when systemically important franchises sell for half of book value and are profitable. This is one of those times. AIG warrants held by the Fund (another 3% of the Fund) provide the right to 21+ million shares at $45, or maybe more shares at lower strike prices for the next 34 quarters if dividends above $0.675 per trailing 12-month period are paid.
(See the Berkowitz interview on Consuelo Mack's Wealthtrack from last week.)
Other top market gurus agree with the Berkowitz thesis on AIG. Daniel Loeb of the Third Point Capital hedge fund (1,022% 15-year return vs. 124% for the S&P 500) had the following to say about AIG common stock in Third Point Capital's third-quarter letter:
We originally purchased AIG shares in March after identifying the U.S. Treasury's impending sales of its AIG holdings as an instance of one of our favorite types of investments: "forced" (or non-economically-motivated) selling. We determined Treasury was both anchored to its $29 cost basis and intent on exiting its position as soon as possible, allowing us to purchase AIG at a discount to intrinsic value. In addition to the forced selling dynamic that created the opportunity, we believed AIG's substantial capital return - manifested as buybacks in the Treasury's offering - provided downside protection. Finally, we also liked the technical bid for AIG shares coming out of the offering, as its index weighting would increase with the reduction in government-owned shares, forcing index-sensitive investors to grow their position in the equity.
We soon realized that our initial thesis for AIG was only the prologue. Rather than simply a chance to create value from a short-term dislocation in pricing due to forced selling, AIG was actually more similar to another type of Third Point investment: a post-reorg equity newly emerged, with all of the attendant upside. We continued to accumulate AIG shares in Treasury's offerings in the second and third quarters, as well as in the open market, considering it a cheap restructured equity that was rationalizing its non-core operations while executing an operational turnaround. So while many investors argue the most recent placement from the Treasury was the last of AIG's main catalysts, we were not "renters" and instead view AIG as a core, event-driven investment with attractive post-reorg equity-like characteristics.
In the near term, we believe AIG's continued portfolio optimization should free up additional excess capital that, subject to regulatory approval, likely can be returned to shareholders. In December, AIG's lockup in its listed, non-core Asian life insurance business, AIA, will expire, allowing the company to monetize its unencumbered 13.7% interest worth some USD $6.1 billion at recent market valuations. Further, we believe the sale, spin, or listing of ILFC, AIG's aircraft lessor subsidiary, will not only generate $5+ billion in excess capital but also simplify the group's structure, reducing cost of capital.
Longer term, we believe the company's operational turnaround will help AIG realize its intrinsic value, as Chartis, AIG's property and casualty arm, improves its return on equity to the targeted 10%-12% by 2015. To achieve this ROE target, Chartis's management, led by the talented Peter Hancock, is emphasizing international and shorter tail consumer property lines, while investing in new policy administration and back office systems. We believe this ROE target is achievable, and view the early evidence as promising: a ~300 bps year-over-year improvement in Chartis' Q2'12 ex-cat loss ratio to 65.2% and a ~100 bps year-over-year increase in consumer share of premiums to 39% in Q2. We are further encouraged that Chartis' turnaround has the wind at its back with the mid to high single digit pricing growth in the property and casualty insurance industry.
Treasury's ultimate sale of its remaining 16% stake in AIG will serve as a critical catalyst for the company, allowing initiation of a dividend, a change in management's compensation structure to a more standard incentive-based bonus payout model, and the removal of the 'overhang' of Treasury ownership. Given these multiple paths to value creation, we believe AIG's current valuation at ~10x consensus 2013 earnings and 0.5x pro forma tangible book value of $65 per share has significant upside from these levels.
Even Bill Nygren, a seasoned value investor and skipper over at the Oakmark Fund, likes AIG stock and wrote the following about AIG in his fund's third-quarter report:
AIG is a large insurance company operating in both property and casualty (Chartis) and life (SunAmerica). It is a poster child of the financial crisis, having required over $180 billion in government aid, and the government still owns over half of its outstanding shares. While the rescue measures still dampen its current valuation, we believe AIG has made remarkable progress under the leadership of CEO Robert Benmosche. The government loans have been completely repaid, and the stock currently trades above the government's breakeven point of $29. Two years ago, we found it almost impossible to estimate the value of AIG's equity. The analysis involved guessing at proceeds from sales of businesses and valuing large, opaque, levered loan portfolios.
Today the analysis is the same as it would be for any insurer: What is its future earnings outlook? How good are its reserves? How will its capital be invested? Chartis went through a difficult period of writing unprofitable business just to grow revenues. That has stopped, and we believe that for the past several years Chartis has focused on only writing profitable business even if growth suffers. Reserves have been boosted to a level that we think is consistent with other high-quality insurers. Capital is being invested primarily in share repurchase-with AIG selling at just over half of book, this is nicely accretive to the company's per-share book value. We believe that AIG should earn over $3 per share this year and is on track to earn in excess of $5 per share within a few years. We believe that AIG is priced as if its future looks like its past. We expect the current discount to other insurers will diminish as the memory of the financial crisis fades.
Why else do I like AIG common stock?
1. Last Friday, AIG CEO Robert Benmosche said that he expects the Treasury Department to sell its remaining stake in the insurer "sometime this year," according to Bloomberg News. Although this "may" be a short-term drag on the stock (AIG common stock was down 4% on Friday vs. 2% for the Dow Jones U.S. Insurance Index Fund), longer term it will be a big plus when the government no longer owns shares in AIG.
2. AIG insiders are buying. In the past six months, there have been 21 insider purchases and zero insider sales.
3. AIG can buy back its own stock at about 50 cents on the dollar, which is very accretive to earnings. The board of directors of AIG authorized a share repurchase program on Sept. 6, 2012. Under the program, the company planned to repurchase up to $5 billion worth of own shares from the United States Department of the Treasury. One caveat regarding share buybacks: Regulation by the Fed will result in subdued capital returns, as greater scrutiny on holding company liquidity, capital resources, and leverage will likely limit future share repurchases to some percentage of retained earnings.
4. When you factor in close to $13 billion of share repurchases in 2012, AIG has returned a large percentage of market cap to shareholders. Its large-scale repurchases were driven largely by the sales of non-core assets, which have been accretive to book value, which I expect to surpass $70 by year end, up from $51 at the end of 2011. I also expect book value to continue to rise over time thanks to the return of AIG profits.
5. AIG is universally hated and I am a contrarian.
Disclosure: I own AIG stock indirectly as a shareholder in The Fairholme Fund (FAIRX). 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.