Majestic Research

Reuters

Frequent-Flier Programs—to Sell or Not?

By Jui Chakravorty Das
Published: July 09, 2008

We’ve heard of airlines selling planes, selling airport gates and even selling regional carriers. But what is a lot less common—and quite a bit more questionable—is the sale of frequent-flier programs.

Air Canada parent ACE Aviation Holdings Inc has done it. Qantas Airways Ltd might do it. And American Airlines parent AMR Corp do it.

As airlines try to cut costs amid skyrocketing fuel prices, divesting frequent-flier programs could be a quick way to get some cash and to please shareholders.

Last week, news about Australian carrier Qantas Airways considering the sale of all or part of its frequent flier business sent the airline’s shares to their biggest gain in more than a year.

“It’s about trying to perform the magic known as unlocking shareholder value,” Bob Mann, president of aviation consultant company RW Mann & Co, said.

Typically, frequent-flier programs are not fully valued when part of an airline. The market often values them at multiples that reflect the money-losing flying part of the business rather than the money-making mileage sale part.

So it could make sense, then, for airlines to sell or spin off those units to generate much-needed cash.

But it’s probably not such a great idea for U.S. carriers.

For starters, frequent-flier programs—which generate revenue by selling air miles to credit card providers and other companies—are profitable units within carriers that are now bleeding billions of dollars because of high fuel costs.

Getting rid of the loyalty program, in many cases, would mean getting rid of what is currently the most lucrative aspect of the business.

Second, the interdependence between the carrier and the loyalty program means the airline has to be confident about a healthy future.

“The airline has to be around and functioning long-term for any of these spin-offs to work,” Mann said.

“Two-thirds of the miles awarded come from credit card companies and other members, but the miles are created for the airline and they have to be redeemed from the airline. If there is a possibility of the airline going bankrupt, this is not going to work,” he said.

Seven small U.S. airlines have filed for bankruptcy or stopped operating this year. Should oil prices not retreat by the end of the summer, some analysts expect several more carriers could file for bankruptcy protection in the fall.

Tough Sell

Also, a sale or spin-off would be tough in current market conditions, when credit lines are tight and a retreat of private equity firms has led to a slide in asset prices. Add to that a dry initial public offering market and it makes for a very tough sell.

“It’s certainly not the most ideal time to be conducting a sale or a spin-off," Matthew Jacob, an airline analyst at Majestic Research, said.

“But that being said, the airlines may be forced to do something to gain some liquidity if the industry continues to struggle.”

After having lost more than $40 billion in the past few years and facing the prospect of losing billions more, U.S. airlines are looking at mergers, forming alliances, grounding planes, cutting capacity and even charging passengers for checking bags.

A spin-off of a loyalty program could be a quick way to get some cash and open up, possibly, a better future for the program business.

Air Canada pioneered the concept about three years ago by spinning off its frequent flier business, creating Groupe Aeroplan Inc.

That company, with nine million members, commands a market value of about C$3.45 billion (US$3.42 billion), more than four times Air Canada’s C$799 million (US$791.08 million).

The frequent-flier business at Qantas, which has about 5 million members, might be worth A$2 billion (US$1.9 billion), JP Morgan analyst Matt Crowe said in March.

That would reflect a price of more than 12 times estimated earnings compared with the 6.4 times at which Qantas currently trades, Crowe said.

American Disadvantage

Imagine, then, the value of AAdvantage—the loyalty program of AMR Corp’s American Airlines, which has 57 million members and serves the largest U.S. carrier.

But analysts say a spin-off would likely not do too much good.

“The U.S. market is a lot more competitive and fragmented. Air Canada was the only large airline of note in Canada. And the same with Qantas in Australia,” Calyon Securities analyst Ray Neidl said.

Indeed, U.S. carriers, despite needing cash, have not taken this path yet.

Last year, FL Group, an Icelandic investment firm that was one of AMR Corp’s single largest investors, tried to get the company to spin off its AAdvantage program to “unlock value.”

Following AMR’s decision to put its regional carrier American Eagle on the block instead, FL Group cut its stake in the carrier to 1.1 percent from 9.1 percent.

Some analysts estimate American’s AAdvantage to be worth roughly $5 billion, even if each member were valued at one-fourth the value of each Aeroplan member because of the large number of inactive members in AAdvantage’s database.

“It does not matter how profitable they are or how much of a one-time cash payment the airline gets for it,” Neidl said.

“For the long-term health of the airline, the loyalty program, which is their best way to connect with their customers, should stay with the airline, especially in the U.S. market, which is extremely competitive.”

Jacob said even though such spin-offs might not succeed for either the airline or the program in the U.S. market, we might still see such transactions.

“Desperate times call for desperate measures,” he said.