I'm Selling AIG Stock and Buying Warrants

Check out this special situation.

Feb 27, 2014 at 8:00PM

My Special Situations portfolio has had a nice run in AIG (NYSE:AIG), and now I've decided to leverage that bet. So I'm selling my stake in AIG – now up about 43% -- and moving half the proceeds into AIG warrants (AIG-WT). The warrants offer substantial upside on not-too-aggressive assumptions about AIG's business performance.

A bumpy fourth quarter
AIG continues to improve its operations and create value for shareholders, though the fourth quarter looked a bit messier than I would have liked. The fourth quarter saw the accident year combined ratio deteriorate. While bothersome, this does not worry me. The focus is long-term profitable underwriting, and management is still focused on that goal, and the direction over the past few years is clearly better.

AIG is also creating value in other ways. It's in the process of completing the sale of its aircraft leasing unit, and it's been quite aggressive buying back its own shares at a price well below book value. That's immediately accretive to per-share book value, and I love to see that kind of capital allocation move. The company still has another $1.4 billion authorized for buybacks -- good for a bit less than 2% of the shares outstanding. The company also bumped its dividend by 25%.

Why warrants?
Currently trading at just over 70% of book value, AIG offers investors the opportunity to profit from multiple expansion as well as growth in book value. So why warrants? The short answer is that warrants give us leveraged exposure to any price gain in AIG common stock. The warrants expire in January 2021, and you can think about them like long-term call options. Like long-term calls, warrants tend to be ridiculously mispriced, so they're a good place to hunt for value. The warrants' strike price is $45, and they're currently priced around $19.

In addition, the warrants have anti-dilution provisions, including adjustments if AIG's annual dividends exceed $0.675 per share. So even the warrants participate a bit in dividends as they grow.

I've included two scenarios that show the potential gains from both the stock and warrants assuming a few things. First, I've assumed that the warrants bleed time value of about $2 per year. Then I assume that the valuation on AIG stock grows ratably over the seven-year period, about 6 percentage points per year. If AIG moves toward consistently profitable underwriting, I don't see a valuation at 1 to 1.1 times book value as too aggressive.

In the first scenario, I assume growth in book value per share of 5%, below trailing return on equity. In the second scenario I assume a more aggressive 10% growth in book value per share, echoing management's target of 10% return on equity, even though management backed off achieving this target by 2015.

The following table shows the potential returns assuming 5% growth in book value per share:











Book Value















In this situation, the stock goes up about 120% over seven years -- about 12% annually. The warrants soar 239% -- about 19% annually.

To see what an upside case might look like, I've included another table that shows 10% growth in book value per share.











Book Value















In this situation, the stock goes up 200% over seven years -- about 17% annually. The warrants scream 461% higher, or 28% annualized.

Foolish bottom line
In the next few days, my Special Situations portfolio will sell AIG common stock and reinvest about $1,500 of the $3,000 or so in proceeds into the warrants. With not too aggressive assumptions, the warrants could significantly outperform the stock even after a nice run-up.

Interested in AIG or have another stock to share? Check out my discussion board or follow me on Twitter: @TMFRoyal.

Jim Royal has no position in any stocks mentioned. The Motley Fool recommends American International Group. The Motley Fool owns shares of American International Group and has the following options: long January 2016 $30 calls on American International Group. 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.

Money to your ears - A great FREE investing resource for you

The best way to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as “binge-worthy finance.”

Feb 1, 2016 at 5:03PM

Whether we're in the midst of earnings season or riding out the market's lulls, you want to know the best strategies for your money.

And you'll want to go beyond the hype of screaming TV personalities, fear-mongering ads, and "analysis" from people who might have your email address ... but no track record of success.

In short, you want a voice of reason you can count on.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich," rated The Motley Fool as the #1 place online to get smarter about investing.

And one of the easiest, most enjoyable, most valuable ways to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as "binge-worthy finance."

Whether you make it part of your daily commute or you save up and listen to a handful of episodes for your 50-mile bike rides or long soaks in a bubble bath (or both!), the podcasts make sense of your money.

And unlike so many who want to make the subjects of personal finance and investing complicated and scary, our podcasts are clear, insightful, and (yes, it's true) fun.

Our free suite of podcasts

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. The show is also heard weekly on dozens of radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable. Rule Breaker Investing and Answers are timeless, so it's worth going back to and listening from the very start; the other three are focused more on today's events, so listen to the most recent first.

All are available for free at www.fool.com/podcasts.

If you're looking for a friendly voice ... with great advice on how to make the most of your money ... from a business with a lengthy track record of success ... in clear, compelling language ... I encourage you to give a listen to our free podcasts.

Head to www.fool.com/podcasts, give them a spin, and you can subscribe there (at iTunes, Stitcher, or our other partners) if you want to receive them regularly.

It's money to your ears.


Compare Brokers