AIG (NYSE:AIG): Downgraded to Underperform at Bernstein

Bernstein Research is taking down their rating on AIG (NYSE:AIG):

We are downgrading AIG to Underperform from Market-Perform. Our target price of $10 and earnings estimates remain unchanged. There are no changes to our thinking since our Q2 earnings writeup on August 10. Therefore, the downgrade is strictly a reaction to the big run up in AIG's stock price.

Using our 3-part valuation model, we can examine why we think AIG's current stock price allows very little chance for uncertainty, and fails to corporate considerable downside risk potential.

− AIG's Q2 end book value per share to holders of common equity, after all Government stakes and support are eliminated, was $21.80. We are using an estimated year-end book value per share of $14.30 as our starting assumption for other calculations. This amount included an announced charge of $5bn for Q3 as AIG accelerates amortization of its remaining $13.8bn of prepaid commitment fee (essentially a non-cash equity injection from the Government as part of its support). ˇ

− However, if one were to completely eliminate the prepaid commitment fee now, plus goodwill of $6.4bn, AIG would already have negative tangible common book per share of ($7.10). There could be other sources of writedown as well (e.g. deferred tax assets that cannot be applied to future earnings).

− But given that AIG is being supported with other preferred equity, its current negative common equity ignores potential positive optionality from potential operating earnings, capital gains, and asset sales. Our "upside" scenario captures this, and current registers a midpoint value of about $36 per share. But this scenario is highly uncertain: even our midpoint estimate assumes that a lot has to go right in the future. The midpoint corresponds to an average price/book ratio on the insurance subsidiaries of about 1.05x "normal" book (i.e. assuming cleaned-up assets). This is comparable to where "cleaner" names like TRV and ACE are trading. On $21.80 per share, AIG is trading at nearly 2.1x book, almost comparable to PGR.

− Finally, AIG's current stock price gives virtually no weight to the possibility that the common equity is worth zero. Both the base and upside scenarios show the possibility of zero in any sensitivity analysis, and we are explicitly using a 50% probability of this event. While we would acknowledge that the prospects for AIG employees and insurance operating units appears considerably better than they did 9 months ago, the same cannot automatically be said for common shareholders. We still think the political risk is considerable, with a very real possibility that the Government reduces support once AIG is no longer deemed a systemic risk.

Action: It is just a quick heads-up for early birds. AIG is currently trading at $44 in the pre-mkt, which should be good for a short before the rest of the crowd wakes up. Would like to get out by 8 am to reduce the risk of getting caught by yet another squeeze.