WALL STREET HAS BEEN BETTING ON FINANCIAL turnarounds, as shares of companies like Freddie Mac, Fannie Mae, Citigroup and American International Group surge after being written off by the investment community just a few months ago.
The company's stock-market value is $35 billion, reflecting 135 million publicly held shares and the government's 80% equity interest; its total share count is almost 700 million. AIG's market value is double that of Chubb, one of the best-managed property-casualty insurers.
AIG stock looks overpriced. The rally seems to reflect a short squeeze in the shares, hopes for a potentially larger role for former CEO Hank Greenberg, and optimism that the rally in the markets will bolster AIG's enormous investment portfolio, credit-default swaps and other derivatives that nearly destroyed the company. AIG, however, faces big challenges as it weighs the sale of key overseas life-insurance businesses while reviving its core property-casualty insurance operations.
It isn't easy for investors to analyze AIG, given scant analyst coverage, limited communication from management and extremely complex financials. Some may be taking comfort that AIG trades below its stated book value of $83 a share, the figure cited in AIG's second-quarter earnings release. By our math, however, the company has negative tangible common shareholder equity, in contrast with the positive figures for nearly all major life and property-casualty insurers.
The $58 billion of AIG shareholder equity includes more than $42 billion in preferred stock issued under the Troubled Asset Relief Program (TARP). That preferred, owned by Uncle Sam, is senior to AIG common. Take it out, and AIG's common equity falls to about $15 billion, or $21.80 a share. The $21.80 figure is buried in a footnote in the second-quarter financial supplement as "book value per share assuming adjustment to AIG's shareholders' equity for U.S. Treasury equity investments."
Then there are some intangible assets, including $6.4 billion of goodwill and about $14 billion of a "prepaid commitment asset" linked to the government financial backstop for AIG. This will be written down by $5 billion in the current quarter as AIG reduces its $44.8 billion of Fed borrowings by giving the Fed equity stakes worth $25 billion in its two big international life-insurance operations. Strip out these two items and AIG would have had negative tangible common shareholder equity of $7 per share at the end of the second quarter.
AIG's new chief executive, Robert Benmosche, sounded a cautious financial note with the Wall Street Journal Friday. "The sum of the parts are a little below the whole," he said. "The whole has to be big enough to pay back the government, and with a little hard work, there will be something left called AIG." Benmosche, not surprisingly, wants a patient approach to asset sales in hopes that valuations improve. His comments suggest there isn't much equity value for AIG shareholders now.
Investors were encouraged that AIG reported a second-quarter profit of $1.8 billion, or $2.30 per share, compared with a loss of $5.4 billion a year earlier. AIG's core property-casualty operations had declining profits in the period as general insurance premiums fell 19% in the quarter.
In early July, analyst Joshua Shanker, then with Citigroup, wrote that there was a "70% chance that the equity at AIG is zero." He cut his price target to $14, citing risks in the insurer's credit-default swaps.
Investors attracted to AIG might do better to avoid the common and buy the company's debt, including its 8 % bonds due in 2018 that trade around 80 cents on the dollar, for a yield of 11.84%. AIG has NYSE-listed junior subordinated debentures (AVF) that now trade around $15, a sharp discount to their face value of $25, and that yield 13%. These securities are senior to the government TARP preferred, but rank below senior debt.
It's possible AIG's condition will dramatically improve and that its common will keep climbing. That bullish scenario seems too optimistic, given AIG's still-precarious finances, mountainous obligations to the government, tough business conditions and tarnished brand.
The Bottom Line
AIG shares look expensive, given its continuing troubles and our calculation of negative tangible common equity. Its debt offers a better play for adventurous investors.