One year ago today, the federal government began bailing out AIG (NYSE:AIG) in the wake of the Lehman Brothers bankruptcy. Although the endgame for the insurer isn't yet clear, there is no shortage of investors willing to bet on the outcome, if the stocks' recent rally is anything to go by. Is there an opportunity here for ordinary investors?
First, let's recap how the government became AIG's majority shareholder:
Timeline
- Sept. 16, 2008 -- one year ago today: With AIG facing a liquidity crisis due to its holdings of toxic securities and derivatives, the Federal Reserve Bank of New York swoops to the rescue with a two-year secured loan of up to $85 billion at a penalty rate. AIG has been officially christened "too big to fail."
- Nov. 10, 2008: Under the TARP program, the U.S. Treasury makes a $40 billion investment in AIG preferred shares paying a 10% annual dividend.
- March 4, 2009: The preferred shares initially issued to the Treasury are replaced with convertible preferred shares that represent a 78% equity interest in AIG. The government has effectively nationalized AIG.
Nationalization greeted with a huge stock rally!
Who would have foreseen it? Since March 9, the day on which the market hit its crisis low, AIG has been the 6th-best performing stock in the S&P 500, with a stunning 487% return. (Incidentally, two other financials that received massive government aid are also high up in this ranking: Bank of America (NYSE:BAC) is 14th (+353%) and Citigroup (NYSE:C) is 20th (+330%)).
AIG is part of the "junk rally" I wrote about last month. It goes without saying that those stocks that have performed best during this rally are those that were hardest hit when fear reached its peak. However, does this justify a rebound of this magnitude? My inclination is to answer "No," or at the very least, "It's highly unlikely."
Is there any residual value at AIG?
That's the $5.5 billion question. (The sum represents AIG's current market capitalization.) Let's take a look at how AIG stacks up against its competitors according to several valuation measures:
|
Price / Book Value |
Price / Tangible Book Value |
Price / Earnings
| |
|---|---|---|---|
|
Berkshire Hathaway (NYSE:BRK-B) |
1.34 |
1.91 |
18.3 |
|
Met Life (NYSE:MET) |
1.17 |
1.43 |
9.78 |
|
Travelers (NYSE:TRV) |
1.02 |
1.31 |
9.15 |
|
Prudential (NYSE:PRU) |
1.25 |
7.79 |
9.25 |
|
AIG |
0.09 |
0.69 |
10.6 |
Source: Capital IQ (a division of Standard & Poor's).
Based on closing prices on Sept. 15, 2009.
On the basis of its book value, AIG clearly trades separately from its peers -- its distressed multiples are evidence of the enormous uncertainty investors are assigning to the company's accounting worth. How else could one justify a stock value that is less than one-tenth of its stated book value?
But perhaps the liquidation value isn't particularly useful, since this scenario isn't in the cards (at least not fully, although AIG is trimming down, selling significant assets in the process). Surely there are future earnings on which to value AIG?
You can steer an aircraft carrier through these estimates
In fact, based on estimated earnings per share (EPS) for 2010, AIG trades more or less in line with its peers at a multiple of 10.6. Here again, though, there is huge uncertainty concealed in the earnings-per-share point estimate: The range of analyst estimates for 2010 EPS alone is $3.02 to $10.15! (Note also that as we go out to 2011, the price-to-earnings multiple drops abruptly to 4.1.)
Given the unpredictability that surrounds AIG with respect to: (a) remaining potential liabilities linked to securities, derivatives contracts, and litigation and (b) the government's role at the company, I'm forced to conclude that AIG is nothing more than a speculation at this time. Unless stock speculation is your full-time activity, I think you're unlikely to gain any advantage in this situation.
There may still be an opportunity for investors
AIG -- the holding company -- faces enormous challenges. AIG's insurance operations, on the other hand, still have some competitive advantages (huge scale, to name one) and continue to write profitable business. The company's most recent results don't suggest these businesses have suffered any significant loss of customers or staff.
What do you do if you want to own the insurance business without exposure to the holding company's liabilities? At present, the answer is "nothing" -- but that could change.
In fact, AIG is in the process of ring-fencing its property and casualty and general insurance operations into a separate entity under a new brand name -- Chartis -- and a dedicated leadership team. It is probable that AIG will ultimately seek to spin off this group. On a stand-alone basis (i.e., shielded from the liabilities of the holding company), AIG's insurance operations could be a very attractive investment.
Speculators to the left of me, investors to the right
Add to that the possibility that the market would require a discount, considering the insurance operations have been tainted by association, and value-oriented investors would do well to keep an eye out for a Chartis share offering; speculators, on the other hand, can continue to trade AIG's existing shares.
Believe it or not, AIG's insurance activity is a high-quality business. Morgan Housel has identified three other high-quality companies that are still cheap.
