American International Group: Why The Warrants May be a Better Bet Than The Common Stock

Investors who believe American International Group is undervalued might want to consider its long-term warrants instead of the common stock to benefit from a rebound in AIG's equity valuation.

Jul 22, 2014 at 2:12PM
G

Source: Company

American International Group (NYSE:AIG) continues to be one of my favorite investments in the financial sector. While a lot of attention, naturally, focuses on AIG's common stock, there is another instrument with which investors can play a normalization of valuations in the insurance sector: Warrants.

As part of a comprehensive recapitalization initiative, American International Group issued an option dividend in January of 2011 for shareholders on record and distributed 0.533933 warrants for each stock owned at the time under the ticker AIG-WT.

Insurance companies are still cheap, especially AIG
Both American International Group's common stock and the warrants ultimately fell off the cliff in 2011 after the market corrected sharply and uncertainty with respect to AIG's survival prospects remained high.

Valuations of insurance companies largely remain depressed with many companies just managing to trade at book value. AIG continues to trade at a sizable discount of more than 20% to its book value.

Compared against Metlife (NYSE:MET) and Prudential (NYSE:PRU), two formidable competitors of American International Group, AIG is actually quite an attractive bet on increasing valuations which should be driven by a combination of operational improvements, share repurchases below book value and capital deployment initiatives within the company.

G

However, investors can also invest in AIG via long-dated warrants. AIG's warrants (NYSE: AIG-WT) have a couple of benefits that allow those investors wanting to get exposure to an undervalued insurance company with a low book valuation to play their investment thesis with a bit of leverage.

1. Long time-horizon
The first attractive characteristic of American International Group's warrants is that they are long-dated in nature. The warrants issued in 2011 expire on January 19, 2021, giving investors ample time for their investment thesis to play out.

It can't be stressed enough how important this feature is for investments in general.

Long-dated options fit perfectly into the strategy of long-term investors, who want to benefit from a cyclical normalization of equity valuations.

Long-term warrants give investors sufficient time for the market to correct its past excesses and for American International Group to transition to growth.

The recovery of American International Group, especially after the fallout in 2008, took a long time and is likely to take even more time. Long-dated warrants are perfect for this investment thesis.

2. Leverage
Of course, one of the most important characteristics of warrants is the power of leverage, that investors gain by purchasing the warrants instead of the common stock.

American International Group's warrants have an exercise price of $45. With AIG's common stock currently trading around $55 per share, the warrants are about $10 in-the-money.

The warrants currently also trade at about $26 which includes about a $16 time premium. Investors can understand the $16 as a premium they are required to pay in order to get access to the potential benefits of leverage for the remaining warrant term.

AIG warrants allow investors to get access to approximately 2x leverage by investing in American International Group's warrants instead of the common stock, which makes the warrants a potentially highly lucrative investment.

3. Anti-dilution adjustments
Warrents with anti-dilutive features are extremely attractive.

Generally, when a company pays a dividend, the stock price should go down. In theory, the decline in market capitalization of a company that pays a dividend should be equal to the cumulative amount of dividends paid on the shares. This is because dividends are a form of 'value distribution', not 'value generation'.

The value of warrants (or call options), which have anti-dilutive features, will not be affected by dividend payments of the company, which is an important characteristic to level the playing field between the common stock and the warrants.

The Foolish Bottom Line
American International Group's warrants are an interesting alternative to the common stock for investors who want to get more than short-term exposure to one of the leading insurance companies in the country.

AIG's common stock must reach approximately $71 per share in order for warrant holders to break even, but with six and a half years remaining before the warrants expire, there is a good chance the common stock can rise far above this level.

How to get even more income during retirement
Social Security plays a key role in your financial security, but it's not the only way to boost your retirement income. In our brand-new free report, our retirement experts give their insight on a simple strategy to take advantage of a little-known IRS rule that can help ensure a more comfortable retirement for you and your family. Click here to get your copy today.

Kingkarn Amjaroen owns shares of American International Group. 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.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

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.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

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. It's also featured on several dozen 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 ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers