Should You Buy AIG as Uncle Sam Sells?

by Jeff Reeves | September 10, 2012 10:48 am

Should You Buy AIG as Uncle Sam Sells?

On Sunday we learned[1] the government is dumping even more of its stake in bailed-out insurance giant American International Group (). According to reports, the U.S. Treasury will sell $18 billion worth of its AIG stock to get the company out from under the onus of majority ownership by the government.

This sale could result in taxpayers winning a small profit on their “investment” in AIG — the biggest bailout of the bunch. With $182 billion in total federal aid committed aid to the company, it dwarfs the $85 supplied to both Chrysler and General Motors (NYSE:GM[2]) to avoid bankruptcy or the TARP funds dished out to banks like Bank of America (NYSE:BAC[3]) and Citigroup (NYSE:C[4]).

Of course, all these facts are a clear signal that this AIG sale is driven almost wholly by politics because it may deliver a profit to taxpayers on their “investment.” President Obama is clearly looking for good headlines before Election Day.

But I’ll leave the bailout analysis to the pundits. For investors with an IRA or a brokerage account, the big question here isn’t about free market philosophies but about whether AIG stock is a buy.

Let’s take a look at the pros and cons:

Pros

AIG has been profitable for three quarters running. Top-line growth isn’t all that grand, but thanks to a number of high-profile asset sales — from a $15.5 billion deal [5] to sell its Alico health insurance operations to MetLife (NYSE:MET[6]) to selling its Japan life insurance businesses AIG Star and AIG Edison to Prudential Financial (NYSE:PRU[7]) for $4.2 billion — it’s hard to get a fair assessment on the revenue front.

And though divestitures have been necessary to pay back the government, the sales have also allowed management to refocus. The business has abandoned global derivatives and other kinky investment schemes. Now, AIG is driven by three simple divisions: a global property insurer via its Chartis businesses, a U.S. life insurance and annuity company SunAmerica and the market-leading mortgage insurer United Guaranty.

Shares are up over 40% year-to-date, so investors seem to like what they see. Experts like Jim Cramer have been touting AIG for a while. Take this post from May[8] after a roughly $5 billion secondary offering of AIG stock by the Treasury, including the quote:

“With AIG, you’re getting your hands on the greatest and most improbable turnaround story I’ve ever seen. Under the phenomenal leadership of CEO Robert Benmosche, AIG has gone from an overleveraged, highly complicated financial company into a leaner, slimmed down play on life insurance, property and casualty insurance and mortgage guarantee insurance.”

Dilution is a risk with a secondary offering this large, but according to analyst reports,  management at AIG wants to suck a large amount of that stock up itself — buying $5 billion of the $18 billion sale. That will help prevent a glut of new shares driving down prices.

This is Treasury’s fifth sale of AIG stock in a little more than a year, and the latest offering at the beginning of August went quite well.[9] AIG stock price not only held firm after the 164 million share offering but actually climbed. The market seems to be receptive to previous moves, so that bodes well for the next installment.

Cons

The biggest risk as I see it is the funny accounting on behalf of the government. Consider that while AIG is profitable, a big reason for that profitability comes from huge tax breaks. AIG didn’t pay a dime in 2011 corporate taxes[10] and in fact got money back from the IRS! And when you look at its landmark Q4 filing at the end of 2011 that pushed the company back to profitability, it involved a staggering $17.7 billion tax benefit from the government[11]!

We can debate the virtue of allowing companies to write off the pain and get a pass from the IRS when they restructure or record losses … it’s a feature of the tax code and has been for ages. But absent the discussion on taxes, it’s important to realize that the “profitability” of AIG these days is very much dependent on a favorable filing with the IRS. That’s not encouraging for investors.

Despite this recent asset sale, taxpayers aren’t off the hook completely just yet. AIG is currently 53%-owned by the government, and the stock offering would reduce that to just 20%. AIG CEO Benmosche claims the government will be out of the insurer by 2013, but there’s still plenty of potential for meddling or share dilution if the government decides to cut and run at a bad time..

While three pillars of property, life insurance/annuities and mortgage insurance drive the AIG train, there’s still some overhang from the complicated mess of the old AIG. Take the airplane leasing business ILFC, which AIG still owns. AIG filed to take it public last year, but the IPO plan has languished amid weak markets (thanks Facebook[12]).

Previous offerings were a fraction of the size of this Treasury sale — with 164 million shares floated in August and some 500 million on the docket this time to reach that $18 billion price tag advertised on Sunday, depending on the price agreed upon for the secondary offering.

It’s also worth noting that while some secondary offerings for AIG went well, others flopped. Consider that in May, the stock was trading over $34 and then the Treasury announced a secondary offering[13]. Shares fell to around $27 about a month later. The stock has fought back lately, but those kind of declines are still worth noting.

Verdict

AIG is like any turnaround story: There’s no way to know for sure whether this will be a winner or a loser because so many moving parts are involved. These secondary offerings make for big news events, but the broader reshaping of this company has been a grueling multi-year affair, and we still have a few more years to go before we’ll see what American International Group will become.

For myself, I’m not inclined to stick around and find out. My investment strategy rarely involves buying fixer-uppers, and I would rather own the best house in a bad neighborhood — say, the strongest materials stock despite secular weakness in the sector — than a ramshackle company that’s either a big profit center or a big money pit.

If you like fixer-uppers, AIG isn’t all that bad a story. It has the backstop of the government still, and the insurance business is a stable, reliable one if AIG can emerge successful on the other side.

But know what you’re getting into. This is a risky gambit that you have to buy and sit on for years and have the guts to see it through.

I’m inclined to seek opportunity elsewhere, both to reduce my risk and to put my money to work in the meantime instead of parking it in AIG until the turnaround is complete or the bust is clear.

But if you like a little adventure and you don’t mind the risks, take a look at this stock.

Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.”[14] Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.

Endnotes:
  1. we learned: http://online.wsj.com/article/SB10000872396390443779404577642023069906372.html
  2. GM: http://studio-5.financialcontent.com/investplace/quote?Symbol=GM
  3. BAC: http://studio-5.financialcontent.com/investplace/quote?Symbol=BAC
  4. C: http://studio-5.financialcontent.com/investplace/quote?Symbol=C
  5. a $15.5 billion deal : http://www.huffingtonpost.com/2010/03/08/aig-alico-sale-profitabe-_n_489655.html
  6. MET: http://studio-5.financialcontent.com/investplace/quote?Symbol=MET
  7. PRU: http://studio-5.financialcontent.com/investplace/quote?Symbol=PRU
  8. Take this post from May: http://www.cnbc.com/id/47330390/Cramer_Another_Reason_to_Buy_AIG
  9. went quite well.: http://www.insurancejournal.com/news/national/2012/08/07/258456.htm
  10. AIG didn’t pay a dime in 2011 corporate taxes: http://investorplace.com/2012/08/7-companies-paying-their-ceos-more-than-the-taxman/2/http:/investorplace.com/2012/08/7-companies-paying-their-ceos-more-than-the-taxman/
  11. a staggering $17.7 billion tax benefit from the government: http://investorplace.com/2012/03/dont-fall-for-the-lies-about-aig-profits/
  12. thanks Facebook: http://investorplace.com/ipo-playbook/dissecting-nasdaqs-botched-facebook-ipo/
  13. the Treasury announced a secondary offering: http://marketday.nbcnews.com/_news/2012/05/07/11579616-treasury-rakes-in-58-billion-in-aig-offering?lite
  14. “The Frugal Investor’s Guide to Finding Great Stocks.”: http://www.amazon.com/dp/B007KB9CSI/ref=rdr_kindle_ext_tmb

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