The billionaire activists pushing for a breakup of bailed-out insurer AIG (AIG) - Get Report will be in the right place at the right time if the company uses proceeds from some of its stake in a Chinese joint venture to repurchase more of its own stock.
Both Carl Icahn and John Paulson have been urging the company, which has struggled to regain its footing after a near failure during the financial crisis, to split into three leaner segments: property and casualty, mortgages, and life insurance. The sale of a $752 billion piece of AIG's stake in a joint venture with Property Insurance Co. of China, announced this week, is a far cry from that but could boost this year's buyback to about $10 billion.
"We are focusing AIG's capital in our core markets and enhancing our financial flexibility," CEO Peter D. Hancock said in a statement. "We continue to greatly value our strategic partnership" with China's largest insurer, he said.
The Chinese offering, being marketed primarily to institutional investors, represents about a third of AIG's Hong Kong-traded shares in the venture and is expected to close by Thursday, according to the statement. AIG will still hold about 5.7% of the venture afterward.
"The sale would be a one-time cash flow for them, and they'll probably try to return as much cash to investors as they can," Brett Horn, an analyst with Morningstar said in a phone interview. "They definitely have a preference for share repurchases."
A repurchase of around $750 million, if the sale closes this year, would translate into about a 1% buyback of AIG's entire market capitalization, or an increase in year-end earnings per share of up to 5 cents, according to Josh Stirling of Bernstein.
AIG had already repurchased about $8.7 billion of its own stock by the end of October, and the primary restraint for further buybacks has been caution over a potential credit-rating downgrade, not the regulations imposed by the company's designation as a "systematically important financial institution," CEO Peter Hancock said on a November earnings call.
"The rating agencies are the critical binding constraint that governs our buyback pace," Hancock said. "And the longer they get comfortable with the stability of our operating model and our ability to execute on it, the more and more they will give us capacity to use capital more efficiently than we have in the past."
The SIFI label, introduced by the Financial Stability Board in 2011, is applied to finance companies large enough that their failure would threaten the broader U.S. economy. It's a component of the government's effort to avoid a repetition of the 2008 financial crisis when the failure of Lehman Brothers investment bank froze global credit markets, and taxpayers funneled roughly $182 billion into AIG to keep it afloat.
Breaking up the company, according to Icahn, would help eliminate that designation and free the remaining businesses to invest their capital more profitably.
"AIG is worth more dead than alive," Bernstein's Stirling wrote in a report this month. "If the company sold itself off in a series of digestible and thus competitive transactions, strong competition among strategic bidders would ensure AIG benefits from the winning bidders' cost, capital and tax synergies."
Far more valuable than the sale of the Chinese unit is that management appears on board to return capital to shareholders and committed to shaping a smaller, more agile company, Stirling said. Because the sprawling corporation has been "unmanageable" since the financial crisis, it has pulled in only a 10% return on equity, versus about 12% to 15% from its peers, he said.
AIG also sold portions of its stake in the China venture earlier this year, and this week's move may be driven by more favorable market conditions since the summer, Stirling said.
"The most important thing to understand is that AIG is kind of a broken company and they need to fix their businesses," Stirling said. "So the balancing act here for management will be to try and keep the stock price moving up through buybacks, because they really haven't been improving margins."