American International Group Inc. (AIG) - Get Report 's sale of its insurance unit United Guaranty to Arch Capital for $3.4 billion under pressure from billionaire raider-turned-activist Carl Icahn will help the mega-insurer meet - and expand - its goal of returning about $25 billion in capital to shareholders through stock buybacks and dividends through 2017, analysts say.
"When the activists joined the company they set up a shareholder rewards program and a new strategic plan that included billions in buybacks that was unprecedented in the insurance industry," said Josh Esterov, analyst at CreditSights in New York. "The sale of United Guaranty will generate $2.2 to $2.5 billion in cash, which will help them meet their buyback goals. Every time they reach their authorization limit they expand the authorization. They are likely to continue to repurchase shares and at this point it looks like AIG is on track to return about $25 billion through 2017."
Specifically, AIG sold the unit to Bermuda-based insurer Arch Capital (ACGL) - Get Report , which will pay $2.2 billion in cash, $250 million in perpetual preferred stock and $975 million in convertible preferred stock, according to a press statement issued late Monday.
The sale also comes after Icahn in February brought to an end a three month public director election battle with a settlement that installed two dissident directors onto the mega-insurer's board, including hedge fund mogul John Paulson of Paulson & Co. The possibility of further agitations likely drove AIG to put the mortgage insurance unit onto its list of non-core assets and helped drive the sale. However, on Tuesday, Icahn told Bloomberg TV that he and AIG CEO Peter Hancock are on the same page with the future of the company. "And you know, Peter Hancock and I don't see eye to eye on everything but I really think he and I see eye to eye on what they should be doing at AIG," Icahn said.
Icahn had sought to have AIG break itself into three parts to shed an unwanted designation by regulators in Washington that subjects it to onerous regulatory burdens. Specifically, Icahn has argued that his goal of a break up into three separate businesses -- life, property & casualty and mortgage insurance -- would convince a council of regulators in Washington to drop a "Systemically Important Financial System" or SIFI categorization. The designation subjects the insurance giant to a variety of tougher capital and liquidity restrictions, many of which have yet to be introduced by regulators.
Esterov noted that the sale of United Guaranty will not eliminate AIG's SIFI designation and all the regulatory costs associated with the higher level of oversight that comes with the categorization. He points out that the unit is their smallest of the three reporting divisions AIG had prior to the announcement of the new strategic plan, representing about 2% of their revenue and slightly less than 10% of operating earnings for the first half of 2016. AIG's massive property & casualty unit and its large life insurance business would need to be split, he notes, for there to be more serious discussion about a repeal of SIFI designation. "I'm not sure they would have aggressively pursued this sale and the $25 billion buyback plan had they not been pressured by the activists," Esterov said.
The sale of the entire mortgage guarantee unit, suggests that Icahn's team was likely pressing behind-the-scenes for a sale of the whole mortgage business -- and that it still may press down the road for a break up of the life insurance and P&C division. The sale may be enough to appease Icahn and Paulson and convince them not to launch a director-election proxy contest.
So far, AIG has completed $7.9B billion in share buybacks and dividends as of Aug. 2 for 2016 so far. AIG would likely have had to pursue other strategic moves to achieve the $25 billion distribution goal had it not sold United Guaranty, such as shifting more assets away from hedge funds or hiking leverage.
The sale is a much simpler approach for the unit than the otherwise contemplated two-part approach AIG had been working on. If a sale wasn't completed, AIG had planned to conduct an IPO for 19.9% of United Guaranty followed by a possible full separation of the business. "This certainly made more sense than a piecemeal IPO of the mortgage insurer followed by a move to sell the rest of the business," Esterov said.
One analyst familiar with AIG noted that AIG's $25 billion capital distribution plan only considered an IPO of 20% of the Mortgage Guaranty unit. He noted that the sale of the whole unit adds about $2.7 billion - the remaining 80% sale value -- to the buyback plan. Should AIG meet its return on equity goals, he added, it could increase the distribution even beyond the $25 billion authorization for 2016-2017. "It's definitely a positive for AIG's buyback authorization," he said.
Charles Sebaski, analyst at BMO Capital Markets Corp. in New York, said the sale gives AIG a much higher probability of achieving their $25 billion capital distribution plan. However, he notes that as a result of the sale AIG is giving up value of the 19.9% unit IPO as well as the earnings on the business for the coming years. Nevertheless, Sebaski contends that it may have been challenging for AIG to achieve its buyback and dividend goal without the sale, especially if there was a large catastrophic loss charge next year. "Now they don't have to worry as much about whether the wind blows or ground shakes or low lands flood," Sebaski said.