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.
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