Tom A's Stock Picks

AIG - in the crosshairs

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In my Wednesday post, I mentioned that AIG was on "the list" of high-demand securities. That observation proved to be correct, as AIG tanked Friday and its CDS spreads went into orbit. For those who are not familiar with how the operation works, there is a primer on the front page of the Money and Investing section of the WSJ today, headlined "Uncaged Bears Hit Lehman Stock Hard." Their analysis yields 4 steps:

"1. Hedge funds short shares of companies like Lehman, Merrill Lynch and AIG.

2. The funds buy up credit default swaps on the compnaies, sending those prices higher.

3. Investors worried that the CDS market is signaling bad news sell the stock

4. Hedge funds book profits on their short sales as share prices fall."

Other signs of this type of operation include biased and one-sided news coverage and blogs - the rule is, the writer finds the largest possible negative number by reading the company's financial statements and press releases and then presents it without any of its related context. For AIG, the number would be the 26 billion in mark to market losses on their insured portfolio of Super Senior CDOs. Another number would be the 12 or 13 billion of collateral AIG might need to post in the event of a downgrade by S&P or Moody's.

TV journalists, in an effort to prove they are where it's at, echo the negative, out of context numbers.

I have ample experience investing in front of operations of this kind, inadvertently earned while owning shares of Ambac (ABK) and MBIA (MBI). Both victims survived, and my portfolio survived, by dint of averaging in at the bottom. Now, with that experience in mind, I am starting to enlarge my very small position in AIG, in accordance with a set of tactics I have developed for cases of this kind. The steps:

1) Important - find strong support for the necessary thesis - that the victim can survive the attack.

2) Determine the total amount of money you are willing to risk

3) Develop a metric for the company's value - you need this as a starting point.

a) Tangible Book Value per Share, or other estimates of book value per share

b) Smart money or prior capital raise entry points

i.) example, Warburg Pincus invested in MBI at 31 per share

ii.) ecxample, MBI raised additional capital at 12.75 per share

4) Make more or less equal dollar investments of 10% of your max at the following points:

1/2 your metric
1/3 your metric
1/4 your metric
1/5 your metric
etc.

5) Sell in due course when sanity returns to the market

For AIG, I had previously prepared a loss estimate for the Super Senior CDOs, using disclosures on their website and an elaborate 11 page Excel workbook. I got losses of 4 billion, not the 26 billion mark to market. As far as posting collateral due to a downgrade, MBI and ABK both went through that exercise and survived. So, I think AIG can survive the attack.

I am willing to risk 7% of my portfolio, or 70,000 for my Marketocracy account.

Instiutional investors participated in a capital raise earlier this year at 38. So, my first entry point would be at 19, 1/'2 of this metric. The next buy point would be at 12.66 (1/3 of the metric), then would come 9.50, etc. In actual practice I bought 500 shares in my SLOport at 14.03, roughly 7,000. I was busy on my personal portfolio, and missed the next buy point under 12.66. There is no need for numerical precision, but it is definitely important to start small so you have enough cash to keep buying at the scary points.

This is a crazy sounding system. But bear in mind it is an insane market. As an example, my last SLOport buy on ABK was at 1.26, 1/12 of the adjusted book value, 15.75 at the time.

A similar approach to WM in my personal portfolio netted a pre-market buy at 1.75, which was 1/5 of where the smart money (TPG) came in at 8.75. On WM the survival thesis is not really all that strong, so I elected to exit on the rumor (of course it was unfounded) that JPM would buy them out, selling as high as 3.23, day-trading.

I personally prefer a more conservative, value strategy, rather than dancing around picking up shares in front of these manipulative operations. I have written to my senators and congressmen and the SEC complaining about the manipulation inherent in CDS, options, and naked short-selling, to no avail. The SEC is absolutely determined to keep their head in the sand. While I personally regret the devastation of wide swaths of our economy by these anit-social acts, I believe the best way to earn money unde present market conditions, is to buy the shares of companies that are being attacked but will survive the ordeal.

PS. 9/17/08

Slight problem here, the Treasury comes in and takes 80% of the company. This strategy will not work in this market - even solvent companies can be beaten down to zero, the government completes the job.