Searching among the market's nooks and crannies often uncovers golden opportunities ignored by the masses. Sometimes, though, value is hidden in plain sight. Today we'll take a closer look at American International Group (NYS: AIG) .
A steal: AIG
The noticeable issue with AIG is its largest shareholder ... the U.S. gummint, which owns 77% of the company. Yes, the beleaguered insurance giant, once the darling of the investment world, is still a ward of the state three years after a financial panic that cost its shareholders most of their wealth.
The same division inspired AIG's rise and its fall: AIG Financial Products (AIG FP). Throughout the '00s, AIG FP sold billions in credit default swaps on junky asset-backed securities (ABS), a move which looked shrewd as real estate prices moved ever upward and investor spirits were ever buoyant. The company viewed the CDS premiums almost as free money: Banks like Goldman Sachs were willing to pay small amounts to FP in order to insure against massive losses in their ABS portfolios, losses AIG thought would never come. Little did the FP managers know how much they'd end up owing Goldman and its ilk.
When the day of reckoning arrived, AIG was caught with its undergarments down and needed an $85 billion emergency loan from the government, for which it took most of the equity in the company as compensation. The stock rightly cracked and has remained in the crevice since.
But that's the past. The company no longer owes the government money and has rapidly shrunk its FP division, with exposure to derivatives contracts down almost 90% from its peak in 2008. Through restructuring, AIG has created one global property/casualty insurance group under the name Chartis alongside its massive SunAmerica life insurance unit, as well as a hodgepodge of other assets including cash, deferred tax assets, and stakes in foreign insurance companies and an aircraft-leasing operation.
As for the government ownership stake, that will dissipate over time as it periodically sells stock. While the selling does create a certain overhang for the stock, this is technical only: It has no effect on AIG's fundamental value.
Most important, AIG is cheap. At last count, AIG showed $55 in book value per share, which now includes the value of its deferred tax assets. (Those will come in handy once AIG's earnings power begins to shine through under the new structure, and will make its target return on equity of 10% or greater much easier to achieve.)
With AIG's share price under $30 per share, AIG trades for nearly half of book value. What's a more appropriate multiple? Some of its smaller competitors trade at far higher prices. Auto and home insurance giant Allstate (NYS: ALL) trades for nearly 80% of book value, and it seems it's on the low end. Allstate is largely a personal lines insurer with very little exposure to commercial insurance or life insurance in the vein of SunAmerica.
Chubb (NYS: CB) , a broader P&C operation with operations in auto, home, workers' comp, and commercial insurance, trades for over 120% of its book value. While Chubb does not have a life component either, and its recent underwriting has been better than that of Chartis, it's fair to say that Chubb is not worth more than twice AIG -- especially given AIG's size, global brand recognition, and long history.
The Berkowitz connection
The largest AIG shareholder outside of the government is Fairholme Capital Management, run by Bruce Berkowitz, with an estimated $6.1 billion in assets under management at the end of 2011. His firm runs the Fairholme Fund, a mutual fund, as well as separately managed accounts.
Berkowitz is a rare bird in the mutual fund world, prone to heavy concentration and often long-term holding periods. It's been a double-edged sword; Berkowitz was named "Domestic-Stock Fund Manager of the Decade" by Morningstar last year, but a rough 2011 has caused him to suffer massive outflows.
Berkowitz's unusual approach has led him into a substantial concentration in financial stocks, beginning in 2010 with the purchase of Citigroup (NYS: C) , which was among the quickest of the large banks to rebuild its capital levels after its 2008 collapse and government bailout, and continuing into 2011 with purchases of Bank of America, Jefferies Group, MBIA, and CIT Group, among others.
But his largest position, by far, is AIG. Does that tell you something?
Sizing up the situation
Keep in mind that size is the enemy of returns. Successful investing brings the money manager more assets, and before you know it, the billions limit the universe of investable stocks. If you've got Berkowitz's $6 billion-plus under management, buying the kind of $100 million market-cap stocks that I and the Motley Fool Special Ops team prefer doesn't move the needle on your returns. But even large companies can occasionally be mispriced if the popular sentiment is against them. I believe that, like Berkowitz, we have an opportunity to be bold and bet against the herd with AIG.
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At the time thisarticle was published Tom Jacobs is the advisor of Motley Fool Special Ops, a special situations and opportunistic value service that is self-insured. You can email him and follow him on Twitter @TomJacobsInvest. Tom owns no shares of companies mentioned in this commentary. The Motley Fool owns shares of Bank of America and Citigroup.Motley Fool newsletter serviceshave recommended buying shares of The Goldman Sachs Group and Morningstar. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.
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