The Case for AIG - Patience Required

by: Paul Price May 30, 2008 | about stocks: AIG    

Paul Price

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Extremely big investors have  recently injected $20 billion of new equity into the company [on top of the  previous billions from just a few months earlier]. They did this for only one  reason- they believe the company's core insurance business has been, and will  remain, very profitable.

The portfolio of securities has been the  problem. At today's 'fire sale' prices and with no ready bidders, the  accountants have forced AIG (AIG) and other financial firms to 'write-down' their  holdings to market value. Nobody can say exactly what they will ultimately be  worth but it is almost certainly much more than current liquidation prices.

By supplying the big capital infusion the new investors have avoided the forced sale of these illiquid securities at bad prices. AIG can now hold them until maturity or until the market prices come into line with their true values. At that time we will be seeing massive 'write-up' of billions in value and huge  gains on the 'mark-to-market' instead of the giant losses they've been forced to  book for accounting purposes.

Every mortgage backed security gets  interest and principal payments every month from all not-in-default property  owners. Thus the principal amounts are shrinking each and every month. The  discounts to 'fair value' on mortgage backed paper automatically decreases in  the same way a bond discount does as it gradually approaches maturity.

Value Line see $8.50 /share in earnings for AIG by 2011 - 2013 as do  most other services that are well aware of the present troubles. Even 15 times  that figure would bring AIG shares up to $127.50 from today's $35.10 - a gain of 264%. If it takes the full five years to achieve the goal, that's still a very good annualized return.

When the security 'write-ups' start coming,  people will be scrambling to buy back in at much higher prices.

Even  after this year's big first quarter loss, Value line thinks AIG will show 2008  EPS of $2.50. They look for $6.10 in 2009. While earnings predictability is low  right now, that also means these estimates could turn out way too low.

Check the Guru list of holders of AIG and you'll see a bevy of very  savvy managers with big positions. Ask yourself why AIG was able to attract $20 billion in new capital less than two weeks ago. Did those investors decide to  just throw their money away or do they expect a good return on their money?

All investors hate uncertainty and that's in abundance here in the short run. That's why AIG shares are so cheap. Nobody can tell you when the turn will come. If you have a 2 - 5 year horizon, though, you'll likely see a double, a triple or even more in gains.

AIG's price / book value varied between  168% and 478% in the years 1993 -2007. Estimated YE book value for 2008 is  $38.15. Even the lowest historical P/BV of 168% would lead to a $64.09 share  price or + 82.5% from the current quote.

AIG is a stock to buy and put  away for a while. Tune out the headlines and let things play out. In a few years  you'll be feeling pretty smart.


As of March 31, 2008 AIG was held by these Value-Oriented Managers:

Guru Name....... Portfolio Date........Current Shares

David Tepper............. 2008-03-31 .........500000
Arnold Schneider ..... 2008-03-31 .........715275
Ken  Heebner ............2008-03-31 .........883000
Richard  Pzena......... 2008-03-31 ..........11125
Charles Brandes .....2008-03-31 ........3055886
Dodge & Cox ...........  2008-03-31........ 52064030
Tweedy Browne ........2008-03-31  ........7936902
Michael Price .............2008-03-31  .........600000
Richard Snow ............2008-03-31 ....... 2644068
Chris Davis............... 2008-03-31 .......65427083
Jean-Marie Eveillard ...2008-03-31 ........105000
Brian  Rogers ............2008-03-31 .......5000000
David Dreman  ..........2008-03-31 .........17030
AIG...... Kenneth Fisher  .........2008-03-31 .........19620
AIG...... Tom Gayner.............  2008-03-31 .........42955
AIG ......Ronald Muhlenkamp ...2008-03-31  ......1366468
AIG...... Ruane Cunniff ...........2008-03-31 .......1159264
AIG ......Wallace Weitz ...........2008-03-31 .......4185644

To all  who think Ken Heebner is now GOD... He owns 883,000 shares of AIG. These  other guys are not riff-raff either.

Disclosure: Author is long AIG shares.
 

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This article has 19 comments:

  •  
    May 30 05:43 AM
    "Check the Guru list of holders of AIG and you'll see a bevy of very savvy managers with big positions." Very savvy indeed. I will not invest at any price in an outfit run in mob-style at arm's length by super-starr (get it?) Tony Greenberg and family. AIG is a sick joke, whatever book value or guru-speak are trying to tell us, and belongs in the FNM / CFC category of stocks to permanently avoid.
    Reply | Link to Comment
  •  
    May 30 08:11 AM
    I do believe the new 20 billion investment was not made on a coin flip but serious look at operations and holdings showing that with time they will be well rewarded.
    Reply | Link to Comment
  •  
    May 30 08:36 AM
    Writer will be shown to be correct if and when the Board boots Sullivan out the door! He's in a job that is much too big for him and nothing is going to turn around until a new captain takes the helm. Thanks to Spitzer's megalomania and Sullivan"s ineptitude, $80 billion has been vaporized. That's a long, long road to come back.
    Reply | Link to Comment
  •  
    May 30 12:42 PM
    marking to market assets is one of the most misleading areas of accounting.
    I think it causes more confusion than clarity.

    disclosure: I'm long
    Reply | Link to Comment
  •  
    May 30 02:07 PM
    Bear Stearns looked like they were going to come back also. Bottom Line: the fed needs to step in and increase regulation. Period.
    Reply | Link to Comment
  •  
    May 30 02:42 PM
    Assets get marked to market... which has been bad enough for AIG. Liabilities on the other hand are more open to interpretation and potential understatement. Does anyone know AIG's total exposure to credit default swaps? ... or specifically CDS on UBS, CIT, and other "can't fail" companies like Bear Sterns? How about AIG's counterparty risk to these companies?
    Reply | Link to Comment
  •  
    May 30 06:31 PM
    Home prices falling faster than the great depression. The bottom is not in. See "The Economist" on 5/29 and come back and tell me the SIV, CDOs, MBS and all the other financials will be written up.
    Reply | Link to Comment
  •  
    May 30 09:53 PM
    Paul's thesis makes sense. Mark to market is not relevant if the security is held to maturity. The remaining risk is default risk. The real value of the security is some where between the "mark of market" and the expected value.

    As more "write downs" cannot be excluded if the liquidity position does not improve, I do expect "write ups" to start sometime in 2009.
    Reply | Link to Comment
  •  
    May 31 01:44 AM
    Here we go, again. This time it isn't the little home owner guy, who doesn't realize how big and how bad this financial disaster-era is going to be. It's the alleged experts at AIG. Problem is, even THEY ain't seen nothin' like this, before. The operative catch-phrase here is not "write-up," or "mark to market." The operative phrase here is "Don't throw good money after bad."
    Reply | Link to Comment
  •  
    May 31 03:44 PM
    And while we are talking geniuses who invested money in losing companies, add Joe Lewis and his lost $billion to the BSC collapse.

    These value guys are no brighter than you or me. Just ask Bill Miller at Legg Mason how his fund is doing this year.

    Follow the leader here will just get you to the poorhouse quicker.
    Reply | Link to Comment
  •  
    Jun 01 01:31 AM
    Interesting post but logically flawed. Main question is where AIG stock is headed. Probably up, eventually, given how negative the sentiment is. More importantly, insurance is a pretty good industry. AIG is protected by regulation that serves as a barrier to new competitors. Plus, they have plenty of scale to drive earnings out of every incremental dollar of revenue. The long-term prospects are decent.

    However, banking on "write-ups" does not make sense. The point about write-downs being reversed is not well-presented here. Derivatives based on residential loans face a permanent valuation hit. It might come back a little but with the highest default and foreclosure rates in years coupled with severe housing price declines most of the value is gone.

    If it is gone, where did the value go? First, loan payments stop or decrease when a loan goes into default/foreclosure or gets renegotiated. The riskier loans (alt-A, subprime, etc.) with the higher interest rates are the ones that take the hit first. I don't know if these were the most profitable but they definitely paid a higher interest rate than the prime loans. Some will argue that there are still many performing loans and that the ones in default are a relatively small percentage. This is true, but if you then add 10:1 leverage and even minor increases in default will completely and permanently wipe out the value of those fun-loving CDO's.

    Thoughts?

    Is there value still there? Sort of. There's still a house standing and someone still owns it. Unfortunately that's of dubious benefit to AIG's derivative portfolio.
    Reply | Link to Comment
  •  
    Jun 01 01:01 PM
    actually this stock is getting really low now but the author recommended it a few months ago when it was 25% higher. If you do buy take a small position and average in,hurricane season starts today
    Reply | Link to Comment
  •  
    Jun 01 03:05 PM
    Warren Buffet says the insurance industry is going to face some near term headwinds. He's the only guru whose buys and sells make me take notice.
    However, this is a very powerful global brand and that's not to be taken lightly. If AIG keeps raising the dividend and you average in and have patience you'll be rewarded.
    Reply | Link to Comment
  •  
    Jun 06 11:58 AM
    Feds and SEC are going to go to town on AIG. Lots of confidence just went down the drain on this news.

    20 looks more likely every day or say... every minute
    Reply | Link to Comment
  •  
    Jun 15 10:57 AM
    This is a perfect of example of a stock that had mterial accounting regualrites when it was over 50.You would think people would have learned from cendant and Jackson Hewitt
    Reply | Link to Comment
  •  
    Jun 19 02:28 PM
    Jimmy-

    What is your alternative to mark to market? Whats the use in a balance sheet which doesnt reflect economic reality?
    Reply | Link to Comment
  •  
    Jun 25 12:47 PM
    Paul did the material internal accounting probe make you believe that recommending this around 46 orginally was unwise?
    Reply | Link to Comment
  •  
    Jul 12 10:10 AM
    Paul if you bought this down every 2 points from 46 how long would it take to run out of monney? A person now can sel the Januray 2010 puts at 10 and collect lmost 2 dollars . The risk reward now is great. Do you see now that you were wrong
    Reply | Link to Comment
  •  
    Jul 13 10:02 AM
    The correct move on thi stock is to start selling 20 srike price puts around 7 dollars for the Jan 2010.
    Reply | Link to Comment
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