- Nationalisation and confidence

Nationalisation and confidence – AIG

Written by Wilfred Ling

Wednesday, 18 March 2009

For the past few days, we have seen how the US government has been furious over bonuses paid to AIG employees amounting to US$165 million. Here are a few of my comments:

A company can be nationalized in a few ways. It can either be fully owned by the government or majority owned through equity stake. In the case of AIG, the US government owns more than 80% in equity stake. As a major shareholder, it now has controlling power on how the company is run. Since the majority owner is a not-for-profit shareholder but a government, the company can no longer run like a private company. It has to things that is for the public good. This is especially so when it has received huge amount of bailout money from taxpayers’ money. This is a good example to show what it really means for a company to be nationalized – it can no longer run like a private enterprise and it has to do things that satisfy the public. However, AIG continues to run like a private enterprise paying itself huge bonuses. The hostile relationship between the company and the majority shareholder will only decrease the confidence level of its existing and potential customers. Existing customers would only bring their business to someone else while potential customers will not consider doing business with AIG. If this is the case, how is the company going to survive in the future when its customers have lost confidence? Actually, the company itself is already dead. There are two reasons why I say this:

First reason is this: If it wasn’t for the government, the company would have gone bankrupt. In bankruptcy, there are two possible outcomes: The company could go into liquidation or it could go into reorganization. For liquidation, all its assets are sold and the proceeds are distributed to creditors starting from the most senior creditors to the least. There will be some prioritization in the manner how the proceeds of the assets are distributed. For reorganization, prioritization may not happen. It does not mean that senior creditors will recover most of their money. But after the reorganization, the outcome is a new functional company. In the case of AIG, the government is determined not to allow the company to fail. However, it is also expecting the company to sell its assets to repay the treasury. So we have a situation in which a company is not bankrupt but is trying to liquidate its assets. Unfortunately, some of its assets have no buyer due to the poor market sentiment and due to the buyers not able to get favorable financing. If it does manage to sell, it will be selling at an unfavorable price due to the poor market situation. To me, if the company is being pressured to sell its assets to repay, than it isn’t much difference from a bankrupted entity making liquidation. Well, at least for a bankrupt entity, it has a choice of whether to liquidate or reorganize.
Two years ago, AIG share price was 72.46 but today is 0.96 cents. The large losses is due to both major share dilution when the US government bailout the company and also due to lost of investors’ confidence. The drop is –98.7% for an equity investor. What is the difference between –98.7% and –100% lost? The difference is only 1.32%. For 0.96 to rise back to 72.46 will require a return of 7448%! Let’s say a person is willing to wait for 20 years, it will require a return of 24% per annum of return! As it can be seen, this is an impossible task. Therefore, such an investor will just consider the equity stake to be a total lost. The market is quite efficient. It has already declared that the company is dead by giving the investor a return of nearly –100%.

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