5 Things AIG Investors Should Know

How much does AIG owe the government? $60 billion? $120 billion? More? There appears to be much confusion regarding this question. Strictly speaking, the answer is nothing. As super-investor Bruce Berkowitz, who controls the largest non-government stake in AIG, told CNBC last week: "People are under the mistaken belief that AIG still owes the government a lot of money, $60 billion plus -- they don't." I have repeatedly heard the argument that AIG simply owes too much money to the government for there to be any residual equity value (we'll talk about the equity value below).

I think the confusion originates with the fact that people are using the term "owe" loosely to refer to all the money that the government injected into the company despite the fact that none of it currently ranks as debt. Properly speaking, at Oct. 31, 2010, AIG still owed the government approximately $20 billion via a credit facility extended by the Federal Reserve Bank of New York. As part of its recapitalization, AIG has since repaid the credit facility in full out of the $27 billion in proceeds generated by the AIA IPO and the sale of ALICO.

This does not mean that the government no longer has any financial interest in AIG: It is the controlling shareholder, but it is not a creditor. AIG will seek to maximize its equity value on behalf of all shareholders, but it has no contractual obligation to make the government whole on the original invested principal. I've never heard anyone who invested $1,000 in the shares of company X say: "This company owes me $1,000!"

How much of AIG does the government own?
AIG is effectively a state-owned enterprise: With the conversion of Treasury's preferred shares into common stock, Uncle Sam's equity ownership stake is 92%.

When will the government exit from its shareholding?
At the beginning of the year, the government held a beauty contest and selected four banks to underwrite the sale of its shares: Goldman Sachs (NYSE: GS  ) , Bank of America (NYSE: BAC  ) , JPMorgan Chase (NYSE: JPM  ) , and Deutsche Bank (NYSE: DB  ) . Despite the fact that the banks will take a big haircut on the standard rate for such an offering, the absolute size of the sales ensures that it will be a very lucrative assignment (if this were an IPO, it would rank among the largest U.S. deals of all time).

The first share sale was planned for March, but the government announced last week that this has been postponed until May. The government's exit from AIG's capital will require several stages and will take place over an extended period. Many investors are surely uncomfortable owning AIG with the knowledge that there is this enormous overhang of shares that remain to be sold on the open market, but that concern is perhaps the result of an inadequate expected holding period. Over to Berkowitz:

At Fairholme we are up to about $22 billion assets and we have to be long term investors now. ... We need to find companies that we can have a very long time span with and let time be our friend. I think AIG is gonna be one of those companies. ... I should only have the wherewithal to buy some of [the government's] shares down the road.

Are AIG shares worth anything?
Undoubtedly. The question is whether that value is greater than the current price. Here's Berkowitz once more:

The company is selling below book value -- [implying] there is no franchise value there. I think the company still has significant franchise value. Below tangible book, below book value, if you assume a modest return on equity of about 10% per annum, it's a big win.

What is the risk?
Beyond the obvious challenge of investing in a financial company with AIG's size and complexity, the main risk I see presently is external: In order for the government to begin -- and ultimately complete -- its share disposition, the stock market must remain buoyant. That could be a lot to ask over the medium term; it already looks overheated. Any period of stock market weakness would only push out the government's exit date -- something I believe is a precondition for the shares to be properly revalued.

Take Citigroup (NYSE: C  ) , for example: Between the time the government first authorized the sale of its shares on April 26, 2010, and the last shares were sold Dec. 6, Citi shares actually outperformed the KBW Bank Index by 11.3%. The U.S. Treasury earned a cumulative profit of $12 billion on Citi's bailout -- here's hoping for all of our sakes that it can produce a comparable result with AIG.

If you're looking for a high-quality financial stock that pays a rich dividend, you'll find it among the "5 Stocks The Motley Fool Owns -- and You Should, Too."

Fool contributor Alex Dumortier, CFA, has no beneficial interest in any of the stocks mentioned in this article. You can follow him on Twitter. The Fool owns shares of Bank of America and JPMorgan Chase. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (5) | Recommend This Article (8)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 15, 2011, at 12:23 PM, MegaEurope wrote:

    "The company is selling below book value -- [implying] there is no franchise value there."

    Actually, I think most market participants assume franchise value is positive. The more relevant question (since 2007) is how many more billions of toxic assets will be discovered in the books.

  • Report this Comment On February 15, 2011, at 9:21 PM, plange01 wrote:

    its time for the american people to force the government to take over aig break it up sell off its pieces and repay taxpayers..no more games with this disgrace...

  • Report this Comment On February 16, 2011, at 4:38 PM, mikecart1 wrote:

    Good article. Lots of info and not much "if you want more, buy this"

  • Report this Comment On February 16, 2011, at 8:33 PM, TMFAleph1 wrote:

    @mikecart1

    Thanks for your comment!

  • Report this Comment On August 01, 2012, at 4:48 PM, jmason012 wrote:

    To be totally honest, they never should've been granted a bail-out to begin with, nor GM or these banks, now back to giving the big bonuses again while I sit here on a disabilty check, Now lets set up a Retired Marine Major in Latvia to open a cigar bar and give the goverment contract to ship equipment back here from the Afgan region, I asked for a student loan to go to Le Cordon Blu in London worldwide best Culinary Arts school in the world, but "IT'S NOT ON OUR LIST" who cares about a list, don't the public see the ression came from WALL ST just like in 1929, it wasn't Europe who caused it, it was WALL ST, AIG thats nothing but another scam company that has how many stock holders that are in the Goverment, So sure bail them out or I might lose my 2 million dollar home............IDIOTS in DC

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