The credit agreement on AIG's toxic government loan is now out . It is spelled out clearly that the treasury is going to own and control 79.9% of the company. I don't see any way around this. So must we give up our last bit of hope that this massive dilution can be undone?
Let us quote Lady Galadriel from Tolkiens's "The Lord of the Rings".
"Even now there is hope left... But this I will say to you: your quest stands upon the edge of a knife. Stray but a little and it will fail, to the ruin of all. Yet hope remains while all the company is true."
There are a few options left. These are 1) The practical option 2) The political option 3) The legal option
The practical option: a capital injection.
The first of these options is that the shareholders can still try to find an alternative source of capital to inject into the company. If they are able to find say $100B of capital (say from Sovereign Wealth Funds) they might try to buy out the company. Obviously, if they are going to do this, they will need the government to take back their loan money, and give back their 79.9% equity position. So they need to have enough capital so that the government has no worries that AIG will need further cash. Now you need to think of the Fed and Treasury's incentives. They don't really want to be lending AIG money, nor do they want ownership of an insurance company. I think they will feel that the taxpayers would rather get AIG off the government books since this will be the minimum risk position for taxpayers. Taxpayers don't want a high risk, high return opportunity. That is not what the Treasury is for. I think if the shareholders can find such a group willing to invest such a large sum of money, the deal will probably happen. However, I think the chance of this happening is no better than 5%. Even if it does happen, the current shareholders are not likely to get more than 30% of the company. So this is not much better than the current situation. The chance of us getting 100% of the company back through this kind of deal is basically zero.
The political option.
There is a chance that the powerful shareholders of AIG can exert pressure on politicians to act to reverse some of this deal. Remember the Treasury is subservient to Congress and the President. If it turns out that AIG's losses on CDSs are minimal and that we find that its demise was caused by some conspiracy of hedge funds attacking the stock and CDS market to create a panic, there might be some sympathy for AIG shareholders. It would seem somewhat unfair, I think, if AIG comes out of this with massive dilution and other companies like Goldman get saved by some kind of bailout. This might seem kind of arbitrary and there is a chance that politicians will act to correct some of the things that were done. Perhaps they would reduce the government stake from 79.9% to 50%. Again, I think the chances are small, maybe 3% that this will happens.
The legal option
This might be our best option since there are so many ways to go about it. Clearly the shareholders are going to sue a lot of people, the management, the BOD, the Fed, the government, etc. They might even be able to sue certain hedge funds for manipulating the stock. Who knows how this could turn out? I think it is very likely that they will win some judgements. How much this will produce for shareholders is hard to say. The chance of getting the credit agreement pronounced invalid is probably very small but could be maybe 2%.
Overall, I would say there is still maybe a 10% chance of some kind of upside coming out of the various possible ways to undo some (probably not all) of the dilution. This should be factored into the price of the AIG stock. However the most likely situation is that the dilution will stick. So one needs to try to value the company as it is and then divide by 5 to come up with a price for the diluted common stock.
I won't go into detail here abut this. It depends on many things. If this bailout goes through where the government buys up illiquid MBSs, then the CDS marks that we have now will probably reverse. We will end up paying out some cash losses on the CDSs but they may be smaller than it would be if the government stayed out of the housing market completely.
I think it is fairly conservative to say that the CDS and MBS losses will be less than $30B. That is only another $5B mark from last Q which leaves total tangible equity around $60B or $4.40/share. However this is probably not the right way to value AIG. People have estimated the breakup value of AIG from $150B-$180B. Lets use $130B due to the loss of brand value from all of this and the illiquid marketplace. Lets take off another $30B for mortgage related losses and another $10B for interest payments on their toxic government loan. So leaves about $90B or $6.60 per diluted share.
The current price is about $3 and so it seems relatively attractive. However there are still risks to this. How valuable is AIG as a company controlled by the government? How much damage will be done to the brand? Will a credit crunch result in mostly fire-sale prices for their subsidiary assets? Are the CDS losses really greater than we think? All of these worries should keep the price of AIG well below the "rational" value of the company for some time. I think what really needs to be done is that these CDS contracts get unwound. But what price will AIG have to pay to do this? Does the government have the incentive to act in the interests of shareholders or will they act more in the interests of the financial system as a whole? That is a scary question.
Given all of these uncertainties, the stock looks fairly priced at $3.
