SAN FRANCISCO (MarketWatch) -- After making millions of dollars betting against subprime mortgages, Steve Eisman of hedge-fund firm FrontPoint Partners is advising investors to short shares of American International Group Inc., according to a recent presentation.
AIG AIG, -1.20% owes roughly $111 billion, even after proceeds from sales of "crown jewels" like Alico and AIA, Eisman wrote in the presentation, a copy of which was obtained by MarketWatch Thursday.
AIG's remaining businesses, which include property- and casualty-insurer Chartis and its domestic life and retirement unit, may be worth about $88 billion, Eisman estimated, while noting there's a lot of uncertainty about this valuation.
That leaves a loss of $23 billion, or $36 a share, for common stock holders of AIG, Eisman calculated.
"AIG has no common shareholder equity remaining on its balance sheet," the hedge-fund manager wrote in the presentation. "It would likely be insolvent if not for government support, in our opinion."
In a better-case scenario, AIG's remaining businesses could be worth $116 billion, Eisman estimated. That would leave equity holders with a gain of roughly $7 billion, or $7 a share, he said, while pointing out that this isn't likely.
AIG shares closed at $37.59 on Thursday, down 5.3% from Wednesday's close. The stock hit a low of $6.60 in March 2009 and has more than tripled since then.
Eisman joined FrontPoint in 2004 to head a new financial-services hedge fund at the firm. Morgan Stanley MS, -2.64% acquired FrontPoint in October 2006, as the housing market was peaking.
By the end of 2007, Eisman's hedge fund had doubled in size to $1.5 billion after bets against subprime mortgages paid off handsomely. He's featured in a new book called "The Big Short" by business writer Michael Lewis, which chronicles the exploits of several hedge-fund managers who made billions of dollars anticipating the housing meltdown and financial crisis.
The U.S. government currently owns 79.9% of AIG's common stock after saving the insurer from bankruptcy at the height of the financial crisis.
There's also about $46 billion of AIG preferred stock that the government owns through the Treasury Department, Eisman noted in his presentation.
The most likely scenario is that the government converts its $46 billion of preferred securities to common stock. Based on an AIG share price of $37, that would create about 1.24 billion new AIG shares, diluting current equity holders, Eisman estimated. Further dilution could happen if the government exercises warrants it was given in return for bailing AIG out, he said.
If AIG is able to generate $2 billion of earnings, assuming a 0% tax rate, the insurer could make $1.15 a share. At a multiple of nine times earnings, that would produce a share price of $10, Eisman's presentation pointed out.
Once the government converts its preferred securities to common stock, it could sell the shares to the public over time, he said, adding that this may be the best chance for the government to reduce losses from the AIG bailout.
If there's an "orderly liquidation" of AIG, Eisman's sum-of-the-parts valuation suggests the government and shareholders would be left with losses, he calculated.
Another alternative would be for the government to leave AIG in its current condition. "Over a very long period of time AIG earnings allow it to rebuild capital to buy out capital," Eisman wrote. That could take "a very long time."
The analysis in the FrontPoint presentation rests in part on the valuation of some of AIG's remaining businesses, including Chartis and the domestic life and retirement unit.
Eisman valued Chartis at about $35 billion. That's a discount to the insurance unit's book value and at the low end of the valuation range for rivals. He said a discount is needed, partly because there are concerns about the adequacy of Chartis reserves. Read more about Chartis.
AIG's domestic life and retirement unit is worth about $13 billion, Eisman estimated. That's based on forecast 2010 earnings of roughly $1.5 billion.
A multiple of nine times that profit results in a $13.2 billion value, he calculated, while noting that rivals MetLife Inc. MET, -2.36% and Principal Financial Group Inc. PFG, +1.29% trade at about 10 times earnings.
However, AIG's domestic life and retirement business generated an operating profit of $1 billion in the fourth quarter of 2009. On an annualized basis, that's $4 billion. After taxes of about 35%, that would be $2.6 billion a year. At a multiple of nine times earnings, this business could be worth more than $23 billion.
Swing to gain?
Eisman's analysis also partly depends on AIG's debt levels and how difficult or easy it will be for the insurer to pay the money back.
In one part of the FrontPoint presentation, he lists $17.9 billion of junior subordinated debt and hybrid securities. Some of that may include about $5.9 billion of mandatory convertible debt. This will automatically convert to common equity in stages through 2011, reducing AIG's debt load.
Eisman also lists $17 billion of matched notes and $4.7 billion of commercial paper issued under a program run by the Federal Reserve Bank of New York. This debt is backed by assets. So AIG could sell those asset and repay the debt.
The debt conversion in 2011 and the repayment of this other debt through asset sales could reduce AIG's debt by about $28 billion. Meanwhile, a higher valuation for its domestic life and retirement businesses could boost AIG's balance sheet by about $10 billion.
That $38 billion swing would change Eisman's estimate of what's left for shareholders, theoretically moving it from a loss of $23 billion to a $15 billion gain.
However, the fourth-quarter earnings of MetLife MET, -2.36% were also strong. Annualizing that result would leave the insurer trading at a lower price-to-earnings multiple. That argues against a much higher valuation for AIG's Domestic Life & Retirement unit.