American International Group (AIG) 4Q12 Results: What a Year

American International Group (AIG) reported 4Q12 earnings on February 21, 2013 [Source]; the results beat Wall Street expectations although the company did not meet all of its performance targets. However, it was an outstanding year showing progress on many fronts and demonstrating the earnings power that will provide shareholder returns for years to come.

Bob Benmosche, President and CEO, opened the conference call referring to the crises AIG’s emerged from; “As we look at the fourth quarter of 2012, we’re just about to close the door completely on all of the issues that AIG faced during this period of time.” The key words are “just about” as the solid fourth quarter is clouded with remnants of key strategic accomplishments that were needed to close that door and with the anticipated losses from Hurricane Sandy.

Beyond these clouds in the 4Q12 our investment thesis remains on track; a 42% margin of safety remains and patient long term investors focused on fundamentals and intrinsic value stand to realize a potential 100% in capital gains. That will likely be followed by annual returns on our cost of equity on the order of 20% for years to come. As a testament to what AIG has accomplished, it became the largest holding in the hedge fund industry during 4Q12 [Source] surpassing the long time holder of that distinction Apple (AAPL). A total of 142 hedge funds are long AIG according to 13F filings.

Our key metric, book value per share was $66.38/share a decrease of $2.49/share from the third quarter primarily due to the write down of International Lease Finance Corporation (ILFC) and Hurricane Sandy partially offset by improvement in operations and investment results.

AIG Thesis Progress 4Q12

Key Fourth Quarter Strategic Activities:

  • Increased liquidity with the sale of the remaining AIA shares for $6.5 billion.
  • Entered into agreement to sell 90% of non-core ILFC; recorded as held-for-sale.
  • Invested $500 million in PICC Group positioning AIG to build a life business in China.
  • The Department of the Treasury sold their remaining shares of AIG

Fourth Quarter Results as Reported:

NEW YORK–(BUSINESS WIRE)–Feb. 21, 2013– American International Group, Inc. (NYSE: AIG) today reported a net loss of $4.0 billion, or $2.68 per diluted share, for the fourth quarter ended December 31, 2012, compared with net income of $21.5 billion, or $11.31 per diluted share, in the prior year quarter. Full year 2012 net income was $3.4 billion, or $2.04 per diluted share, compared with $20.6 billion, or $11.01 per diluted share, for the full year of 2011. 

After-tax operating income in the 2012 fourth quarter was $290 million, or $0.20 per diluted share, compared with $1.5 billion, or $0.77 per diluted share, in the prior year quarter. After-tax operating income for the full year of 2012 was $6.6 billion, or $3.93 per diluted share, compared with $2.1 billion, or $1.16 per diluted share, in 2011. 

Fourth quarter and full year 2012 results included pre-tax catastrophe losses from Storm Sandy of $2.0 billion ($1.3 billion after-tax). Net income for the fourth quarter and full year of 2012 included a $4.4 billion net loss on sale from discontinued operations associated with the agreement to sell International Lease Finance Corporation (ILFC), which reduced book value per share by $2.97 per share. Net income for the fourth quarter and full year of 2011 reflected a U.S. consolidated income tax deferred tax asset valuation allowance release of $19.3 billion and $18.4 billion, respectively.

Fourth Quarter 2012 Key Themes:

4Q12 Highlights

AIG Conference Call Presentation [Source]

Financial Highlights:

4Q12 Financial Highlights

After-tax Operating Income (Loss):

4Q12 Operating Income

Strong Capital Position:

The company has a strong capital position at the parent and the insurance companies. Continued strong dividend flows from the insurance companies are helping to strengthen liquidity.

4Q12 Capital Position

Liquidity, Capital Management, and Other Significant Developments

  1. AIG shareholders’ equity totaled $98.0 billion at December 31, 2012.
  2. During the fourth quarter of 2012, the U.S. Department of the Treasury (Treasury) completed a registered public offering of its remaining shares of AIG Common Stock for proceeds of approximately $7.6 billion, marking the full repayment of America’s financial support of AIG. Since 2008, through asset sales and other actions by AIG, the Federal Reserve, and Treasury, the U.S. Government recovered its full $182.3 billion commitment to AIG, plus a combined positive return of $22.7 billion. Treasury continues to hold warrants to purchase approximately 2.7 million shares of AIG common stock, the sale of which is expected to provide an additional positive return to taxpayers.
  3. In December 2012, AIG sold its remaining stake of approximately 1.65 billion ordinary shares of AIA Group Limited (AIA) recognizing gross proceeds of approximately $6.5 billion and a gain of $240 million. For the full year, AIG recognized gains of $2.1 billion from AIA.
  4. In December 2012, AIG entered into an agreement to sell up to a 90 percent stake in ILFC to an investor group. The transaction, which is subject to required regulatory approvals, including all applicable U.S. and Chinese regulatory reviews and approvals, is expected to close in the second quarter of 2013. At closing, AIG will retain at least a 10 percent ownership stake in ILFC subject to dilution for management issuances (which, over time, would reduce AIG’s ownership by one percentage point).
  5. Distributions from insurance operations totaled $1.4 billion in the fourth quarter of 2012, and $5.3 billion for the full year of2012, in each case excluding a capital contribution to AIG Property Casualty of $1.0 billion following Storm Sandy.
  6. AIG Parent liquidity sources amounted to $16.1 billion at December 31, 2012, up from $11.6 billion at September 30, 2012, reflecting the sale of AIA shares.

Parent Liquidity:

AIG continues to expect $4-5 billion in annual dividends and distributions from the insurance subsidiaries. The available liquidity is $16 billion with the recent AIA sale proceeds. With continuing strong dividend flows from the insurance companies the company reiterated the capital posture from the previous quarter. Our highest priority is to make sure that we focused on getting high costs out, reducing our expenses for interest, and improving our coverage ratio. As the year progresses, we will then begin to look at things like could we add a dividend to the stock, and also could we have some kind of a modest stock buyback.

4Q12 Parent Liquidity

The one remaining major issue facing the company is AIG’s eventual regulation by the Federal Reserve as a Systemically Important Financial Institution (SIFI). In response to a question during the conference call David Herzog, CFO described the status; “We’re now just starting down the regulatory review process, so that’s on its way. We would hope that we could close this in the second quarter of 2012, and at that time we can say the door is completely closed and everything is behind us.”

Consistent with our investment thesis AIG repurchased about $13 billion in common stock during the year. The company will postpone further repurchases and focus on operational improvements and buying back higher interest debt to reduce interest expenses and improve coverage. Management is taking a conservative and prudent approach until SIFI regulations are defined by the Federal Reserve.

Bob Benmosche remarked during the conference call; “Our highest priority is to make sure that we focused on getting high costs out, reducing our expenses for interest, and improving our coverage ratio. As the year progresses, we will then begin to look at things like could we add a dividend to the stock, and also could we have some kind of a modest stock buyback.

The year 2012 was an outstanding year for AIG. Once the Federal Reserve defines the regulator requirements under SIFI, hopefully by the end of 2Q13 we can anticipate capital returned to shareholder in the form of dividends and share buybacks resuming.  While we wait, continued operational improvements leading to improved combined ratios, investment returns, return on equity will move the share price closer to intrinsic value.

Bob Benmosche summarized AIG’s status in the Earnings Release [Source]: “AIG’s operating profit this quarter shows the power and financial strength of our diverse global franchise,” said Robert H. Benmosche, AIG President and Chief Executive Officer. “We achieved these operating profits in spite of Storm Sandy – the second largest single catastrophe event for AIG in the U.S. These results show how the people of AIG are working together and getting the job done. 

“In so many ways, this was an historic quarter — from the positive return we delivered to the American taxpayers on the investment in AIG, to our ability to monetize non-core assets, and to again becoming a unified AIG. When history is written, we will look back and see that by the end of 2012, a new era for AIG had begun. As one AIG, we will expand on our accomplishments. Teams from our core businesses are working together, sharing experiences, and providing complementary skill sets to create new opportunities and better serve our customers. This partnership is AIG’s global foundation for growth.” 

Mr. Benmosche concluded, “We still have work to do, but we have confidence in the opportunities we will create in 2013 and beyond. We remain committed to investing in our business, but expect to take continued actions to improve our efficiencies through technology and streamlined work processes.”

Disclosures: Long AIG common stock and AIG warrants.

Comments

  1. Great summary. THis looks like the comany is not only on the mend but soon will be functioning as an independent for profit company. This has all the elements of a great investment
    1) low price – at least compared to book value
    2) share buybacks
    3) spin off characteristics

    These are the three key things to look for in a great investment and any one would peak my interest . AIG has all three. In fact number three I think is not given enough attention because it is an intangible in a way – but this company has been owned by the government for 5 years This is almost like a demutualization and huge value can be unlocked in this situation as the company takes on the focus of a for profit entity again.

    When I look at this I think the warrants are a better investment in the long term

    What are your thoughts on the warrants vs the stock?

    thanks

    • Good points Joseph; a demutualization is an interesting way to think about AIG going forward. I agree, once the Federal Reserve defines the Systemically Important Financial Institution (SIFI) requirements, management should be able to put some of the accumulated cash to work creating better returns. Two options are share buybacks and resuming a dividend.

      The warrants have some attractive features:

      They are long-term; and expire on January 19, 2021 with a remaining life of almost eight years (7 years and 10+monts). Once SIFI requirements are defined for AIG, hopefully later this year, I’m anticipating they will have excess liquidity to put to work that will start improving ROE. Improved ROE will eventually eliminate the share price discount to book value. A lot of good things can happen in eight years and I fully expect the intrinsic value of the company to continue increasing.

      The initial exercise price of $45/share is subject to anti-dilution adjustment for certain events including future stock dividends among others. A cash dividend in excess of $0.675 in the aggregate in any twelve-month period requires the adjustment. Management has expressed an interest in resuming a dividend, perhaps later this year. Any dividend over just 1% of current book value will cause a favorable adjustment to the exercise price.

      The economics:

      The current warrant price is $13.76 with a strike price of $45 the breakeven price is $58.76 or less than the current book value of $66.38 excluding opportunity costs.

      Starting at today’s prices; if management delivers on their aspirational goal of 10% ROE, the warrants potentially could deliver twice the gain as the common stock over a seven year period.

      Assuming the stock trades at 1X the then book value (because of the improved ROE) and no dividends are paid as a simplifying assumption. The warrants could show a return of about 500% vs. the stock of about 250%. At a 7% ROE and a 0.8X share price to book value multiple the warrants could return about 330% vs. the stock of about 180%. The key is improving the ROE to justify the higher price to book value multiples.

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