Under financial pressure from the pandemic, many airlines are turning to their loyalty programs as collateral for loan programs. They are discovering that these programs are often worth more than their market capitalizations. But experience suggests that the relationship between the programs and the airlines is symbiotic and that airlines should retain control of them in order for the value to be fully realized.
Airlines are no strangers to the debt financing markets — aircraft, gates, and other assets have historically been used as collateral for debt structures. But in 2020, for the first time in history, U.S. carriers collateralized the future cash flows of their loyalty programs to raise billions in loans.
United was the first to make the move, raising $6.8 billion in June, but Spirit and Delta quickly followed suit with $850 million and $9 billion respectively. And in March of 2021, American Airlines set a new record for the largest ever financing transaction in aviation history with a total of $10 billion backed by the intellectual property and cash flows associated with the AAdvantage program.
These deals (and the increased level of reporting on programs) have pulled the curtain on the remarkable values that are attached to airline loyalty programs. AAdvantage and MileagePlus, according to their projected enterprise values, are significantly more valuable than the respective airlines (American and United) as measured by their market capitalizations at the time.
What’s going on? Why are we only seeing this now? The answer, of course, is pressure from the pandemic, which has cast a spotlight on a hitherto underused asset.
Loyalty as a Lifeline
When the bottom fell out of air travel, loyalty programs stood out for their resilience. Although people had stopped flying, they continued to spend with program partners, specifically the co-branded credit cards. Accrual from non-air sources (activities other than flying) now account for more than half of all miles earned in major programs. This type of spending has proven to provide a natural hedge during downturns.
Luc Bondar, President of MileagePlus at United Airlines, sees a recurring pattern. In a recent interview we conducted as part of an event for the Center for Aviation, Bondar said, “We have this great proof point where the aviation sector has been dramatically suppressed for acute periods of time and the loyalty program, while feeling it, has failed far less and has been able to ride above the fray.” Because of diversification in spend, he noted, loyalty programs have had stable, resilient, and predictable cash flows, and steady EBITDA margins on the business.
As the crisis sent passenger numbers plummeting, finding sources of liquidity became mission critical, said Bondar. Traditional sources of liquidity include pre-selling of miles to partners, and equity carve-outs of the loyalty program.
United evaluated these traditional ways of leveraging the loyalty program. “We sat down and challenged ourselves to come up with a more creative approach, recognizing that we sit on this incredible business and yet would never fully leverage that value out in the marketplace,” said Bondar. In an innovative turn of events, United came up with a new structure that, whilst maintaining full ownership of its program, managed to unlock access to capital at favorable terms.
At What Price?
The numbers are certainly impressive. At $24 billion and $22 billion, respectively, the disclosed pro-forma valuations of AAdvantage and MileagePlus exceeded the airlines’ own market capitalizations at the time ($6.5 billion and $10 billion as of July 1, 2020). The very notion seems inconceivable — yet when American and United leveraged their programs for financing, they both projected just that.
Perhaps the most telling proof point is the rate at which the airlines were able to secure financing through collateralizing their loyalty programs. Using the loyalty programs instead of the airlines as collateral has paid handsome dividends, with risk discounts between 2% and 3.5%. This demonstrates that even though the two businesses (airline and program) are clearly intertwined, investors consider the loyalty programs as less risky businesses compared to airlines.
As the market is now waking up to the underlying value of loyalty programs, they are likely to attract a lot more attention from management and boards as well as from investors.
Loyalty to What?
The new financing structure deployed by United and others provides a new dimension to the existing debate of whether or not airlines should spin-off their loyalty programs. Both opponents and proponents of equity carve outs point to the Air Canada experience in this context.
Created in 1984, Aeroplan was spun out by Air Canada as a standalone business in 2002. From 2005 to 2008, Air Canada’s parent company ACE progressively sold Aeroplan, leaving Air Canada with zero equity in the program but with a 15-year agreement in place stipulating the commercial arrangements between the two (including access to awards seats).
In 2017, a few years before the term of the agreement was to run out, Air Canada announced its intent to not renew it, and following extensive negotiations, Air Canada bought the program back again for C$517 million, as well as assuming the outstanding liability. Given that Aeroplan generated more than C$3 billion in cumulative profits (adjusted EBITDA) over the period 2005–2017, the transaction value prima facie may appear low, but more than anything it illustrates the leverage of the airline as being the key provider of preferential access to rewards seats. Without preferential access to seats, the program will struggle.
Going Forward
Focusing just on the ownership structure, or the survival chances of the program or airline on their own, does not do justice to the proven ability to generate value by these programs. As Bondar told us, “I think it’s somewhat academic to have the debate around what’s the value and whether it is really worth that much. MileagePlus wouldn’t have the same value without this relationship with United. The reality is, it is worth that much as part…of a cohesive relationship with the airline. Together we’re able to generate this incredible value that the program represents.”
With the new focus on loyalty programs, airlines would be well-advised to consider how the loyalty program can play more than its current part — in a sustainable and equitable way.