Airline executives have hinted in recent years that frequent flyer programmes, particularly in the US, are profitable. It took a global pandemic to reveal just how profitable.
A quartet of US carriers — American Airlines, United, Spirit and most recently Delta — have put up their customer loyalty schemes as collateral for large quantities of new debt needed to see them through the crisis. Others may soon do the same.
Documents sent to creditors contain a trove of information on the size, margins and valuations of the programmes, from American’s AAdvantage to United’s MileagePlus and Delta’s SkyMiles, with hundreds of millions of members between them.
“The profitability and the size of these loyalty programmes, it’s the only reason American Airlines isn’t in bankruptcy right now,” said Stifel analyst Joseph DeNardi. “It’s the only reason United isn’t bankrupt, or on the verge.”
Airline frequent flyer programmes began in the 1980s as a marketing tool to inspire brand loyalty among travellers, and have evolved into a lucrative source of cash. Airlines sell miles to banks, who then use them as credit card rewards, attracting the affluent consumers they want as cardholders.
In essence, airlines have two businesses: the first flies people between destinations, and the second peddles those people to banks for a fee.
Valuations recently put on the loyalty schemes have exceeded the market capitalisations for the airlines themselves — implying that investors value the business of flying passengers at less than zero.
MileagePlus was valued at just under $22bn in bond documents, while United’s stock market capitalisation is just $10.6bn. Appraisers pegged American Airlines’ programme at a valuation between $18bn and $30bn, versus its equity market cap of less than $7bn.
Delta Air Lines did not offer a valuation but in January, On Point Loyalty, a consultancy specialising in frequent flyer programmes, independently valued SkyMiles at almost $26bn, making it the most valuable programme of its kind in the world. Delta’s market cap totals $20.7bn.
Strong financial figures underpin the hefty valuations. Pro forma financials for Delta’s SkyMiles show gross revenue of $5.7bn and net income of $2.5bn in 2019, for a profit margin of 42 per cent. At United the loyalty programme earned $1.8bn before interest, taxes, depreciation and amortisation last year, for a 34 per cent profit margin. It was responsible for roughly a quarter of the Chicago-based company’s profits.
Loyalty programmes are especially profitable in the US, where fees on credit card transactions are not capped like in Europe, giving card issuers more money — and more incentive — to pay up for miles.
The programmes are also growing. Delta told investors last year that it expected to double revenue from American Express by 2023 to almost $7bn.
For contrast, the entire 2019 revenue of the UK-based European budget airline easyJet was less than $8bn.
If the card programme is worth more, then the core airline operation is worth less
Mr DeNardi estimated that in 2019, depending on the company, loyalty programmes contributed between 30 per cent and 50 per cent of profits for US airlines. “They’re manufacturing these miles for about a penny, and they’re selling them to their credit card partners for two pennies,” he said.
With demand for air travel still low because of Covid-19, Mr DeNardi said, this kind of fundraising is a tempting option for most in the industry. “Whether they say it or not, they’re all looking at it,” he said. “Some with more urgency than others.”
Not everyone is convinced the valuations put on the frequent flyer schemes stack up, however. Some appear “surprisingly high”, said S&P Global analyst Philip Baggaley, who pointed out loyalty programmes only generate profits when “there is an airline, with its planes and other assets, flying to provide rewards to those who want to use their miles”.
The possibility of airline bankruptcy looms over discussions about valuations. Historically, the programme either disappears if an airline ceases operations, or it is bought by another airline, like how Delta bought Pan Am’s programme along with other assets in 1991. Only rarely does a programme manage to survive the airline to become a standalone business. The best known case, Mr de Boer said, is when Jet Airways’ programme became InterMiles last year.
Another question is what the revelations about the profitability of loyalty programmes mean for airline valuations when normal flying operations resume.
Some industry experts say airline stock prices could rise thanks to greater transparency on an appealing, steady and increasing revenue stream.
Traditionally, airline fortunes rise and fall with the wider economy, and the companies’ fleets present huge, profit-devouring fixed costs unless they are operating at close to full capacity. Loyalty programmes represent the opposite, with their steady growth, scalability and lack of assets, Mr de Boer said.
That attracts a different type of investor, he said, one more interested in dividends than profiting from a changing stock price. Those investors “are willing to pay a lot more per dollar of profit for a loyalty business than they are for an airline business . . . They consider it a lot more stable.”
Savanthi Syth, an analyst at Raymond James, said that when airlines are flying normal schedules again, “equity investors will probably recognise some value, at least in terms of a higher floor when valuing the downside case, even if not a direct application of a multiple on the segment”.
Still, the loyalty business always has been embedded in airlines’ overall financials. “It’s a zero-sum game,” said Vertical Research Partners analyst Darryl Genovesi. “If the card programme is worth more, then the core airline operation is worth less.”
Mr DeNardi is among the analysts who believe loyalty programmes would justify a higher stock price, were it not for the pandemic. With the industry now awash with capital from debt and equity fundraising, he is worried airlines may aggressively compete for market share, holding down profits even when passengers return to the skies.
“We finally know what United’s loyalty programme is worth,” he said. “But we have no idea what the airline is worth because nobody’s flying.”
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