AIG: Closing My Long Position

Sep.24.08 | About: American International (AIG)

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 hson1@bloomberg.net

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 (NYSE: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.