President's Club: More good news from AIG and other updates

AIG shares and warrants (AIG.N; $63.58) got a nice lift this week, touching fresh highs, after activist investor Carl Icahn revealed a large stake in the company and started agitating for change. Specifically, the legendary hedge fund manager wants AIG to cut costs and split the company up by separating its life, mortgage and property and casualty businesses. This is a typical Carl Icahn move to surface value and it has worked for him in the past, including with Apple Inc., which he persuaded to borrow money to return more cash to shareholders.

While there’s no guarantee that AIG will split itself up, it’s highly probable that the company will at least trim expenses and improve its margins, and also likely that the pace of divestitures will continue. It’s also possible that the company takes his advice (or that it may have been thinking about doing this already, as others insurers have done this - in fact as we write this the Wall Street Journal is reporting that AIG’s board is considering selling its mortgage insurance unit. While it only delivered 5% of Q2 operating income, it is the fastest growing of all major segments in the first half of the year. The stock is up in after-hours trading.)

Here is Mr. Icahn’s letter to AIG. It’s a convincing read, and he’s not alone. John Paulson, another high-profile investor, believes that the stock could be worth more than $100/share if the company followed this plan. It’s worth noting that Mr. Icahn stresses the importance of continued stock repurchases to make the plan fully effective.

We have been in this name for a couple of years months and have realized a total return in excess of 100% despite numerous analysts moving to a hold or sell at much lower prices.

The stock is still a buy. It trades for a relatively low 12 times earnings and less than book value, and this is usually a winning combination.

Breaking up the company could yield a lot more upside - should it happen - and Mr. Icahn bought his stake recently.

Accord Financial (ACD.TO; $10.60) posted another record quarter of earnings. Adjusted earnings per share were 31 cents in the third quarter, a 15% improvement over last year. For the year so far earnings are up 25%.

CEO Tom Henderson says industry conditions are soft but that the company “is positioned to perform well no matter how the global economy performs.”

It’s comforting to hear that confidence, however given that we’re up 60% on the name we rate Accord a hold for the dividend, which offers a slight 3.7% yield.

Earnings are climbing nicely but that appears to be largely due to lower taxes. The lower tax rate is perfectly legitimate and sustainable but it’s not organic growth.

Convalo (CXV.V; $0.30) confirmed the results it pre-announced, notably third quarter sales of $5.7 million and earnings excluding stock-option expense, interest income and transaction expenses of $870,705.

The company has $25 million of cash and an annualized revenue run rate of more than $30 million.

If one extrapolates from the third-quarter margins, assuming at the same time some modest economies of scale, the company can earn more than $5 million from existing assets. If we assume a conservative multiple of 8 times and add the cash at face value the company is worth $65 million versus a market cap of $61 million.

The multiple should expand as the company grows and diversifies, and to value the cash at face value might be naive considering that when Convalo deploys funds it tends to create a high return on equity. So the stock looks very reasonably priced if not cheap. If the environment for microcaps wasn’t so poor the share price would likely be a higher.

We note that the company wasn’t very “promotional” in its announcement, which is unusual because to build something from nothing to $30 million in annualized, profitable revenue into 2 years is very impressive.

The reason for this modesty is likely that the company wants a large number of warrants to expire worthless to avoid dilution. These are the 50-cent warrants, the exercise deadline of which is now Nov. 17, which effectively means they will expire given that the stock is so far below strike price. This eliminates 43 million shares worth of dilution, and also may be a constructive sign of management confidence given that the warrants would have brought in more than $20 million of capital.

This is a more speculative stock given how young and small the company is, but the risks are mitigated by the facts that the company generates cash and has a big treasury.

Accumulate in the mid-20-cent range if you don’t have a position and like the idea.

Inspira (LND.V; $0.13) also provided financials for the third quarter. Inspira is even earlier-stage than Convalo and isn’t profitable yet and while it also has a sizeable cash balance, it’s on the riskier side and should be at most a small part of your portfolio.

The company announced that it earned EBITDA of $465,798 on revenue of just about $1 million. EBITDA, in our view, is a poor choice of earnings measurement for a lender, since it includes interest income but doesn’t include interest expense, which will always be a big expense for a lender. That said, net income, excluding the hard-to-measure cost of stock options, taxes (the company isn’t taxable yet as it isn’t profitable) and one-time costs was about $200,000, which is attractive on a margin basis at 20% of sales. However, it’s important to note that the company compensates executives largely with options, so to totally exclude option expense gives an exaggerated sense of the earnings power.

The loan book ended the quarter at $40 million, not much higher than the $35 million at the end of the previous quarter. But the company says the book finished September at $50 million, or up 25% in a month, which is encouraging.

In terms of what kind of earnings the company can deliver with its balance sheet once it’s fully deployed and levered, the company says it can build a $500 million loan book by with its fully diluted share count and using 80% debt.

Fully diluted the share count would be 570 million shares, but let’s say 600 million assuming more stock option grants. There would also be $400 million of debt (from a current $31 million). Using these figures and a cocktail napkin we get to the potential for 5 cents a share in earnings. At 10 - 12 times earnings that’s a stock price of 50-60 cents - but that’s admittedly lot of guess work.

The company appears poised to start generating cash within a couple of quarters, so while it’s very early days, the stock is worth owning for the potential upside that seems at this point to compensate for the risks.