AIG: Closing My Long Position

On September 22, the following article was being syndicated by Bloomberg with minor updates about every hour. Read the excerpt and then read my question at the bottom.

Sept. 22 (Bloomberg) -- American International Group Inc. shareholders, who saw their holdings decline by more than 90 percent this year, plan to meet today to discuss alternatives to an $85 billion U.S. takeover that may dilute their stakes.

Maurice "Hank'' Greenberg, the former chief executive officer of the insurer, will probably be represented at the meeting, said his lawyer, David Boies. New York Comptroller Thomas DiNapoli's office will also be present. Investors including former board member Eli Broad, Shelby Davis of Davis Selected Advisers LP and Bill Miller of Legg Mason Inc. will send representatives, said a person familiar with the planning.

"To pull this off strikes me as terrifically tricky'' said James Cox, a professor at Duke University who specializes in securities law. "A defensive takeover by investors of their own firm, on this scale, has never happened before.''…

AIG gained $1.11, or 28 percent, to $4.96 at 1:32 p.m. in New York Stock Exchange composite trading. The New York-based insurer sold for more than $72 in December 2006.

The investor meeting on alternative plans "is being organized by other people'' said Boies, whose client controlled about 11 percent of AIG shares through two investment firms and personal holdings before the government takeover. The meeting, in New York City, was reported earlier by the Wall Street Journal.

DiNapoli's office will be represented because New York held 10.8 million AIG shares in a retirement fund as of Sept. 12, said his spokesman Jim Fuchs. The top 12 or 14 shareholders, including Fidelity Investments and Dodge & Cox, may also attend, said the person familiar with the planning. The person declined to be identified because the meeting is private.

Representatives for Broad, Miller and Davis didn't immediately return calls seeking comment. A Fidelity spokeswoman declined to comment, citing a policy of not discussing the firm's holdings. Dodge & Cox also declined to comment….

AIG spokesman Nicholas Ashooh declined to comment and Willumstad couldn't be reached….

The insurer, the biggest in the U.S. by assets, already borrowed $28 billion as of Sept. 17, the Federal Reserve said last week, even though full specifics of the accord with the government haven't been publicly released. The revised terms still give the U.S. "a 79.9 percent equity interest in AIG'' the insurer said in its new filing. "The corporate approvals and formalities necessary to create this equity interest will depend upon its form'' the filing said.

Greenberg, who saw the value of the AIG stake he controls plunge by more than $5 billion this month, has said the takeover might have been avoided if AIG got a bridge loan, tapped private investors and sold assets. Greenberg, 83, sent a letter to Willumstad before the latter was replaced offering to help and complaining that his earlier offers had been rebuffed.

To contact the reporter on this story: Hugh Son in New York at [e-mail]

On the surface this sounds very promising. My question is, if this were the real deal, then why are the top twelve shareholders sending 'representatives'? Shouldn't the top honchos be meeting to work out the details of a new deal? It sounds more like a preliminary meeting where everyone is going to be asked if they have any ideas. Greenberg has already publicly expressed his dissatisfaction with the deal. Based on previous behavior, if he were putting together the final touches on a new deal he would not hide the fact that he was attending, just hush on the details.

I don't like the sound of this but I could be wrong. It's now 2:28 PM and short term (less than three days) long position has been sold. AIG (AIG) is now trading at $5.28. I can't advise others what to do as this could fly up. For clients, I have booked the profit.

Update 09/22/2008 8:00 PM

It seems like my hunch turned out to be correct. First, AIG closed at $4.72. Second, the latest Bloomberg article confirms my suspicions. Here are some excerpts:

The investors decided at a New York meeting today to ask AIG for data so they can raise money and keep the U.S. from taking a 79.9 percent stake, said the person, who declined to be identified because talks were private….

The investors "discussed possible alternatives that may exist that could relieve the taxpayers' burden while protecting'' AIG's customers, policyholders and employees, said Mickey Kantor, a lawyer for the shareholders, in a statement today. "These discussions will continue.''…

The group is advised by Roger Altman, CEO of Evercore Partners Inc., and may ask AIG for information on its balance sheet, the person said…

1. The group decided to ask for data. This means that they have no idea what they are talking about until they get the data.
2. The group discussed alternatives that may exist based on data that they don't have yet!
3. Obviously there is no concrete action to be taken so the "discussion" stage will continue.
4. We are all aware of Mr. Altman's track record. Managing a $1.2B private equity fund just seems like the little league trying to advise the majors how to pitch.
5. The 'group' isn't sure if it should ask for (confidential) information pertaining to AIG's balance sheet. Perhaps they wish to avoid the embarrassment of being denied.

Conclusion

This whole "Greenberg" related group is a lot of noise about nothing. For now and until there are some concrete developments, AIG shareholders are stuck with a 79.9% dilution.

Update 09/24/2008

For a better understanding of the AIG situation, the following is a general analysis of possible results which in turn will determine the trading range for AIG shares.

Strictly from a shareholders viewpoint, there are two venues that need to be considered. First, we need to assess the probability that the large shareholders will come up with a totally different and better rescue plan. This was addressed previously, concluding that the likelihood is very low for now. Second, the current in hand offer for an $85B loan with 79.9% dilution.

The entire rescue package relies on the ability of AIG to sell off enough assets over the next two years that not only repays loans but also provides the necessary liquidity for ongoing operations. This is a bit tricky simply because the healthier units that are sellable provide the cash flow that is needed for ongoing operations. Obviously, real estate assets are less problematic and will likely be sold first. Based on current estimates and valuations, the real estate assets should contribute approximately $10B out of the $85B total over the next two years.

The remaining $75B estimate is the problem. First, the amount is an estimate and the public, including me, have no way of assessing if this estimate is correct, too high or too low. Second, assuming that the amount is in the ball park, current analyst thinking is that AIG will have to sell 40% to 55% of existing businesses in order to raise the needed cash. Currently, analysts are working under the assumption that the 'new' AIG will be cut in half. This means at the very least, both revenue and potential future profits will be cut in half from year ago estimates.

Applying the above logic, we derive the following:

For argument's sake we will use fair value of AIG prior to the problems at $60.00 per share. Some analysts are working from a $70.00 figure while the low range is near the $50.00 mark.

Taking the $60.00 figure, we cut it in half based on the downsizing and get $30.00. Take $30.00 and give 80% away (dilution) and we get $6.00. Obviously this is a back of a napkin calculation. There are too many items to list for a letter and the spreadsheet is proprietary and confidential; however, I will point out a few items that need to be taken into account; not how the information is actually applied.

1. Assets that are sellable may be the more profitable units, resulting in lower margins for the 'new' AIG.
2. Problematic assets retained by AIG may become more problematic over time, though the likelihood is low with the $700B 'national' bailout.
3. Taking into account #2 above, the AIG rescue plan is contingent on the $700B national plan being implemented to AIG's benefit. This could also possibly explain why the warrants weren't issued as the whole rescue deal could possibly still fall apart.
4. Others, such as ABK may ultimately reap higher long term benefits from the $700B 'national' plan; without going into the fine details, suffice to say that the first beneficial outcome from stabilizing the CDO and CDS markets is that money will seek to flow to more secure debt such as municipal bonds that have a broader and stronger base for repayment.
5. Back of the napkin calculations are based on year ago growth and profit margins which may be substantially lower over the next twelve months or so. On the other hand, global growth could possibly explode rendering these estimates to be too low. In general, AIG seems to be indicating that it would like to retain as many non U.S. assets as possible, thus gambling on non U.S. future growth to beat projections.
6. The $28B loan received is a non issue as there are enough assets that can readily be seized to cover repayment should the rescue package fall apart.
7. Last but not least, as AIG unloads assets and some sort of national plan is adopted, AIG is no longer "too big to fail".

Conclusion

The maximum upside - under current plans - is $7.00 per share. Anything above that is very wishful thinking. The downside is still zero or close to it. In a year from now, things could be different, but until numerous items fall into place, including but not limited to the actual issuance of warrants, anything can happen.

From a trade viewpoint (in contrast with 'investing'), I was willing to indulge in holding AIG shares at around the $3.25 mark while there was a possible shareholder sponsored alternative that promised a quick resolution. Being that this is not the case and we are now left with the original 80% dilution plan, over $5.00 just doesn't appeal to me from a risk / reward basis.

Obviously many will see things differently which should create some interesting 'day trade' opportunities for those who wish to engage in the art. We rarely day trade so this is why we are not 'trading' AIG until several issues become transparent.

With best wishes and a healthy and prosperous "Jewish New Year" for all.

Disclosure: No current position.

Comments

[noni1:]

Thanks for selling, now the real longs can let their shares appreciate. The fast money can stay away from AIG for all I care.

And please, dont come back.

2008 Sep 24 10:58 AM

[Potash:]

A I G has a great bussines after the bailout they will have their healthy parts working for them and the company will come back to 20-30 $ per share

2008 Sep 24 11:21 AM

[Sudoku:]

Thank you for your analysis of AIG's current status.

I have 2 related concerns about AIG:

-- What are the US government's options to acquire a piece of the company? (I believe they may acquire preferred stock with the option to convert it to common stock.)

-- How will the government's options affect dilution and share prices both in the short term and in the long term? (Ex - Should I expect the share price to be 80% less after the options are exercised?)

Any thoughts would be appreciated.

Thanks in advance.

2008 Sep 24 11:38 AM

[P12:]

A first for our country if the Feds take it over. Chrysler, Northwest Airllnes had the same fate and rebounded. If AIG is downsized by 50% when the dust settles 2 yrs from now AIG is still larger than all the rest in its market. Way too many smart minds, and assets for this one to fade away.

2008 Sep 24 11:54 AM

[VivaVegas:]

The columnists facts are wrong. The Fed is getting preferred shares vith an 80% voting right. The return on the preferred shares is to match the 11.5% interest on portions of the $85 billion credit line that are actually drawn (8.5% on portions not drawn). Consequently, there's no 80% dilution of the common shareholders but only their voting rights. At worst the Fed money reduces the net value of AIG by 11.5% per year. At $29.00 per share current book value that's a reduction to $25.00 over 2 years. Even if the book value is 50% wrong its still a $12.00 stock.

2008 Sep 24 11:54 AM

[malapraxis1:]

Wouldn't any private group attempting to put together their own AIG bailout package first want to wait to see what the Govt does first. If AIG risk is in insuring mortgages wouldn't you want to first see if the Govt first passes the 700B bailout and removes the risk of foreclosure on those mortgage assets. If they take that step, along with instituting CDS regulation wouldn't AIGs risk be greatly reduced and the company itself be a much more attractive investment. Why move on bailing out AIG privately, until after the Govt finishes up with their 700B bailout. I think if you believe the bailout passes, AIG looks pretty good.

2008 Sep 24 12:00 PM

[Saul Sterman:]

@VivaVegas

From Standard & Poor's research:
"09/23/08 02:46 pm ET ... S&P REITERATES HOLD RECOMMENDATION ON SHARES OF AMERICAN INTERANTIONAL GROUP (AIG 5.08***): The shares have more than doubled from their September 17 close of $2.05 but are down over 90% year to date. We tie the recent strength to enthusiasm that AIG's credit default swap assets may suffer less of an impairment if the Treasury's bailout plan is passed. But we note AIG's 6/30/08 tangible equity of some $26 a share. Adjusting for the 79.9% stake in AIG the Fed is expected to receive under terms of its loan, tangible equity would equal about $5.23 a share. Our target price of $5.50, raised today by $0.50, assumes the shares trade at about 1X adjusted tangible equity. /C.Seifert "

In plain English, the 'Fed' as you call it, takes an equity stake. The article is correct.

Saul Sterman

2008 Sep 24 12:06 PM

[malapraxis1:]

There appears to be great disagreement on the Govts 80% stake. My reading is they get that stake only upon default of the loan.

2008 Sep 24 12:15 PM

[VivaVegas:]

Saul you should read and inquire more carefully and not rely on other people who do not know the difference between preferred shares and common shares and have not looked at what is actually happening in any great detail. Preferred shares are a limited equity interest. They can be limited in any number of ways including that they essentially function like bonds (i.e. they are paid out first based upon some set percentage rate of return). That is exactly what's going on with the Fed and AIG. Because the Fed wanted the ability to vote and control the board they could not simply buy AIG bonds (debt interest that doesn't vote) but had to take some sort of an equity interest (i.e. limited preferred shares with a set rate of return). My analysis is correct.

2008 Sep 24 12:24 PM

[Saul Sterman:]

@malapraxis1

See stocks.about.com/gi/dy...

"In return for providing this essential support, American taxpayers will receive a substantial majority ownership interest in AIG."

The equity stake is not contingent on whether the loan is paid back or not. The stake is for giving the loan in the first place. This is precisely what the twelve largest shareholders are attempting to avoid.

Trust this clears things up a bit. Also see SEC filing here:
stocks.about.com/gi/dy...

"The summary of terms also provides for a 79.9% equity interest in AIG."

Saul Sterman

2008 Sep 24 12:39 PM

[Saul Sterman:]

@VivaVegas

I've been in business for well over two decades and I know how to read an 8K. It is not by coincidence that I posted the S&P understanding of the 8K above.
Sorry my friend, but your understanding of what is transpiring is incorrect. Don't feel bad, others are confused as well. If your understanding was remotely true, AIG would be trading much higher and the S&P target price wouldn't be $5.50.
Think of it this way, there isn't a single analyst out there that has a $12 target price.

2008 Sep 24 12:48 PM

[Tom Armistead:]

The facts of the deal have been flopping around - first it was warrants, then preferred stock, then it was a corrected verson. Paulson's deal was extremely punitive, so now the FBI needs to investigate to support the punitive conditions. It appears a shareholder vote will be required.

The actual losses from the insurance on Super Senior CDOs are not known - nor do we have a clue as to how much of the 85 billion is needed.

Cooler heads will have a long time to examine Paulson's actions in the light of subsequent developments. I have a low cost position and plan to hold it through to a resolution.

2008 Sep 24 01:00 PM

[VivaVegas:]

Saul, we'll have agree to disagree. I would point out however that AIG never held 80% of its common stock as treasury stock. If you look at its June 30 '08 SEC filings, at best it was 55%. Consequently, AIG could not deliver 80% common stock ownership to the Fed in any event. As for there being no analysts that value AIG at $12.00 that's not entirely true. Thomson puts AIG's value between $14.00 and $18. However, even if no analysts value AIG stock at $12, waiting for anaysts' consensus that a stock is desireable guarantees that you'll miss the boat entirely. Be greedy when others are fearful and fearful when others are greedy.

2008 Sep 24 01:15 PM

[malapraxis1:]

The SEC filings don't even begin to address the issue of any agreement with regards to the Govt taking an 80% stake.
If the Govt. injected 85B for an 80% stake there doesn't then appear to be a need to set up a revolving credit facility. It can be one way or the other, but not both.

2008 Sep 24 01:16 PM

[VivaVegas:]

Take a look at this. It explains everything in great detail.

www.marketwatch.com/ne...

2008 Sep 24 01:17 PM

[Saul Sterman:]

@TomArmistead

Appreciate your comment.

The way I look at this is simply that there is a reasonable chance for a 'national' bailout of sorts, whether it is $700B or $500B is not a major factor.

This will create enough of a safety net that will create a 'bottom' value for CDO, CDS and other instruments. In other words, if the value falls enough, the government will buy.

Having said this, think how much potential upside there is for AIG. Compare this with let's say ABK as mentioned in the article. Because of the 80% equity stake, AIG has limited upside whereas ABK that does NOT have an 80% dilution can hit the $12 target that VivaVegas is looking for. ABK is depressed because of a possible Moody's downgrade. Once the 'national' bailout is completed, both should appreciate. The reason for a possible downgrade disintegrates into thin air as well. The big difference is, whereas AIG shareholders transferred 80% equity to others, ABK shareholders did not.

In other words, should the $700B plan go through, ABK will benefit far more than AIG. Should the plan fail, AIG's rescue is at risk as mentioned in the article. ABK on the other hand can dilute by 20% and stay in business. As it stands now, ABK is pricing in a 20% dilution and no bailout. In other words, no downside and only upside. I think the chance of some sort of 'national' bailout is pretty good...but waiting to see what the market says. Just like with AIG, I didn't get in at $2 and change but waited a bit. Likewise with ABK. If it jumps and I miss it, no sweat...there is always another. Just be patient.

2008 Sep 24 01:29 PM

[Saul Sterman:]

@VivaVegas

I take it that after reading the MarketWatch article it is clear that the Government holds an 80% equity stake in AIG.

I see how the format can be a bit confusing, but the reason it is being done this way is because of company bylaws. A shareholder vote is probably still needed before common can be issued.

2008 Sep 24 01:36 PM

[VivaVegas:]

Yes, but a limited type of equity. It does not give the Fed a right to 80% of the net assets. It only gives the Fed the right to 80% of dividends (if any), the repayment of the $85 billion and the interest rate. Only when the preferred shares are converted to common does the Fed get 80% of the net assets. However, conversion requires the vote of the common shareholders. The conversion provision is most likely there in case there is a catastrophic failure down the road. I would also suspect there's a limit on it (i.e. cannot be exercised until the 2 year time period is over or there is some catastrophic turn of events).

2008 Sep 24 01:47 PM

[johnny inca:]

what I don't see is the conversion price. AIG borrows 75BB which they must pay back in 2 years, and the price for that borrowing is the posting of these convertibles. But are they converted at 0? 5? 30 day average?

2008 Sep 24 01:54 PM

[Saul Sterman:]

@VivaVegas

Your lucky that I had a quiet day! Last reply...
I don't know where you are getting your info from. I read the same MarketWatch article that you did. The government owns 79.9% of AIG. Any further dilution doesn't come from the government's 79.9% stake but from your stake (20.1%).
Apparently AIG can issue preferred without a shareholder vote but not common. The commitment is to issue the common and replace the preferred.

That's all the article is saying.
BTW, If shareholders vote against, then AIG files for bankruptcy! Shareholders have no choice.

2008 Sep 24 02:02 PM

[Ishortyou:]

The thing that conerns me is that AIG good assets are considered for sale while the bad assets will remain in their books, the current CEO seems to have been hired to liquidate the good part of the company and leave they JUNK for repair over time, that really stinks.

2008 Sep 24 02:19 PM

[Smarty_Pants:]

It would seem to me that any company where the US Government has majority voting rights is one, as a rule of thumb, whose shares it would be wise to avoid owning.

One need only look at FNM and FRE to see that the government won't hesitate to change the rules on a moment's notice and leave the other shareholders with next to nothing for their troubles.

2008 Sep 24 03:06 PM

[malapraxis1:]

Is the situation with the Govt equity stake going to differ from precedence when they bailed out Chrysler and the airline industry.

Back when they bailed out the airlines they took warrants in America West alone for I believe 1/3 to 1/2 the companys value. Chrysler and the airlines all paid off their loans and the Govt. even cashed in all their America West stock at 9 dollars after exercising the warrants at 3.

Do we have any reason to believe the Govts equity stake here with AIG will differ from their moneymaking bailouts in the past. One would hope the position the Govt takes is one that promotes a payback of the credit and an appreciation of the stock price.

2008 Sep 24 03:46 PM

[noni1:]

BUY AMBACK? ONLY A JACKASS WOULD RECCOMEND THAT. AMBACK IS FINISHED. THEY WILL NEVER, EVER, EVER, EVER, RECOVER.

ITS TOILET PAPER. I BOUGHT $100,000 WORTH OF OCTOBER $2.50 PUTS ON AMBACK. AMBACK IS TOAST. AMBACK IS DEAD.

2008 Sep 24 06:22 PM

[I weep for ...:]

VIVAVEGAS: The article says: "As part of the deal, AIG will issue a series of Convertible Participating Serial Preferred Stock to a trust that will hold the new securities for the benefit of the Treasury. The Preferred Stock will get almost 80% of any dividends paid on AIG's common stock and will give the government almost 80% of the voting power. The securities will then be converted to common stock at a special shareholder meeting, AIG said." What don't you understand, the securities will be converted to common stock?!

2008 Sep 24 06:48 PM

[I weep for ...:]

VIVAVEGAS: The deal allows the fed to have 80% voting rights, therefore the vote on the conversion to common stocks!!

2008 Sep 24 06:49 PM

[TheNextGoogle:]

** Gov wants to help out Wall Street in the Worse Way - AIG pps shows it

They're having a hearing and the stock is crashing before their eyes and they can't figure it out??
Give me a break!!!!!

2008 Sep 24 08:10 PM

[TheNextGoogle:]

Tony Soprano would be proud of this deal - AIG be better off dealing through him

2008 Sep 24 08:11 PM

[sumosama:]

Sorry, Saul. You got it wrong. Only if the loan is not repaid do the feds get the shares converted.

2008 Sep 25 12:33 PM

[Question1919:]

So who is right and who is wrong now?

2008 Sep 25 12:55 PM

[Question1919:]

What I see is that the shareholders are all dumping the shares

2008 Sep 25 03:01 PM

[VivaVegas:]

User 269778

It's hard to say who will ultimately be proven right or wrong. That's what makes investing in equities so exciting. If you're right you can make a fortune. If you're wrong you can lose a fortune. At least in investing you make a more or less educated guess. Gambling on the other hand is just a matter of probabilities and is always a lose lose proposition. In any case, whether gambling or investing, don't play around with what you can't afford to lose. It's that can't lose mentality that caused all of these problems in the first place. As a final note, if everyone thinks we have problems, try Somalia, Liberia or hundreds of other such places. Those people have real problems.

2008 Sep 25 07:07 PM