We have just read Bruce Berkowitz's semi annual letter and was more than glad to see him discussing about the long-dated warrants that we have mentioned in previous posts.
Here is the snapshot of the returns that he is projecting for the different warrants:
Source: http://www.fairholmefunds.com
Both AIG and BAC warrants are high up on the list, offering returns of 752% and 592% respectively.
We have used even more conservative growth rate than his suggested 10% growth in book value through the years. What is interesting here is that Hartford warrants have almost the similar returns as AIG warrants. We will probably do some work on it.
On investing in the warrants, we always have people asking us how come then with such returns, well known value managers are not putting their money in the warrants but instead in the common stocks?
The reason is they can't. There is simply not enough volume of warrants out there in the market for them to buy. Bruce himself already holds close to 25mil of the 75 mil outstanding AIG warrants. That is almost 1/3 of the entire float!
But for retail investors, that is a different case altogether. We can instead buy in to these warrants and hold on till expiry and chances are, you will be getting a huge paycheck at the end!
Nice. I believe his cost basis on the warrants is roughly $8 for AIG and roughly $4 for BAC. Wish he would mention the exact amounts in his letter, but nonetheless it's nice seeing him mention them. Note: he did have to sell out of about 3% of his AIG common but that was due to redemptions.
ReplyDeleteabsolutely, a storied franchise that is traded in the market at half its book value. Don't think we will ever see this kind of opportunity again.
ReplyDeleteBruce will get his revenge pretty soon on all the naysayers!
Assuming his cost basis is $8 on AIG and $4 on BAC, his theoretical return implies that the price of the AIG warrants would be $68 and the BAC warrants $27.
ReplyDeleteValue Ground, do you think Berkowitz was using current market prices or his cost basis when calculating theoretical returns? I would assume his cost basis as this letter was to his shareholders and they would only be concerned with the theoretical return of their invested money.
ReplyDeleteAlso, do you agree that his cost basis is $8 on the AIG warrants and $4 on the BAC warrants?
Thanks
Using his projected CAGR in BV of 10%, and pb of 1, it would seem that he is using fairholm fund cost per warrant to calculate his returns for AIG. We believe his cost is in the range of $7.5 - $8.
ReplyDeleteLikewise for BAC warrants, if assuming so, his cost would be in the range of $3.5 - $4.
So, let's take the average of those ranges: $7.75 AIG and $3.75 BAC. Using his theoretical returns he expects a warrant price at expiration of $66.03 AIG ($7.75 * 8.52) and $25.95 BAC ($3.75 * 6.92). Does that seem reasonable?
ReplyDeleteIn fact, we would say, its a very conservative price to begin with.
ReplyDeleteRemember, both AIG and BAC got a good number of years to grow and return back to normalized earnings before the expire date.
And as huge storied franchises, AIG is still today's one of the largest insurance company in the world, BAC one of the largest bank in America, we would really not expect them to trade at price to book of 1.
AIG could easily go pass $100, and bac above $40.
I agree, especially when you consider the history of P/B for both companies. Well above 1.2 (oftentimes north of 2.0) for both for nearly their entire respective histories prior to the most recent financial crisis. Just some of the reasons that AIG warrants and BAC warrants are my two largest holdings. Thanks for your feedback, VG.
ReplyDeleteCongratulations! you are on your road to riches!
ReplyDeleteI was glad to find your site because our portfolio allocations are very similar and your analysis and approach validate my own. The only investments I own are GOOG, BRKB AIG.W and BAC.WA. At today's prices, would you invest new dollars in AIG, HIG or BAC warrants. I try to add to these position with each paycheck given the likely returns. Thanks,
ReplyDeleteYou have a great portfolio over there!
ReplyDeleteThough we will not normally consider tech investments, Google is an undeniable great company we have seen.
At the moment, AIG warrants have run up pretty much over the recent months, such that we believe BAC warrants offer a higher upside at current price of about $3.6.
With new dollars, we would choose to load up more on bac warrants A for now.
We are also considering a small investment in Citi warrant A, tremendous upside opportunity!
You might wish to take a look.
My take on the Citi warrants is that the strike price is too high, making the risk/reward calculation less attractive than the other TARP warrants and most likely the Citi common itself. Have you done much work on the Hartford warrants?
ReplyDeleteWe looked at Hartford warrants too, and you will find that Berkowitz projected returns is pretty high. Nothing interests us though as the upside we calculated is way below, for example, BAC warrants. It could be because Berkowtiz is using his fund's cost price as the base for calculation, which is extremely low when he bought it.
ReplyDeleteKeep in mind that you need to own 10 Citi warrants for every share you want the right to convert. Each warrant represents 1/10 of a share. If they were 1-for-1 warrants-for-shares I might be a buyer, but 10-for-1 makes it a poor play, in my opinion. Here's the prospectus which explains it: http://www.sec.gov/Archives/edgar/data/831001/000095012311005624/y89178b5e424b5.htm
ReplyDeleteHere are my thoughts on HIG. AIG and BAC will not fail. If they fail, the entire world economy and capitalism fail. They are far too important. HIG could fail and it would hurt, but their failure would not crush the economy nor the world permanently. Couple that with the excellent and reasonable returns that are likely to be seen with the "too big to fail" AIG and BAC warrants, and you're likely to come to the conclusion that those two companies should be owned instead of HIG.
ReplyDeleteThat is incorrect Mark, each citi warrant allows the right for conversion to 1 common stock of Citi. The strike price and warrant price has already been adjusted for the stock combination.
ReplyDeleteVG, scroll down to the 3rd page of the PDF at the link below. You'll see the explanation that even with the high strike each warrant only converts to 1/10th of a share...
ReplyDeletehttp://www.citigroup.com/citi/press/2011/110509a.pdf
Warrant share number prior to adjustment:
ReplyDeleteone share of common stock
Exercise price prior to adjustment:
$17.85
Warrant share number after adjustment:
1/10th of one share of common stock
Exercise price after adjustment:
$178.50
The adjustment was a double-whammy (strike rises, conversion ratio drops) and many mistakenly believe the adjustments moved in tandem. Probably one of the major reasons Berkowitz doesn't own Citi warrants.
Hi Mark,
ReplyDeleteGreat thanks for pointing out, we went back to recheck and found out you are right. The warrant price has not been adjusted, and the conversion would now be 10-1.
You save us from making a foolish bet on citi warrants!
You're welcome! And thanks to you for your great blog and information on AIG and BAC.
ReplyDelete