PART II –
The golden goose isn’t your ticket or bag fee—it’s the credit card you use to collect frequent flier miles.
By Justin Bachman
Does your wallet contain an airline-branded credit card? If so, your daily Starbucks visits, iTunes selections, and dining habits serve a critical role in keeping the U.S. airline industry fat and happy.
Delta Air Lines Inc., the world’s second-largest carrier, said it expects that its American Express partnership will yield $4 billion in revenue per year by 2021, rising by more than $300 million annually until then. Those sums translate to a very high margin of profit, Delta executives have acknowledged, but they’ve decline to specify further. At an investor presentation on March 29, Alaska Air Group Inc. said its Mileage Plan relationship with Bank of America will account for $900 million in annual cash flow, once the airline has fully combined with Virgin America Inc.
So while there’s agreement from some CEOs that more transparency is needed, that’s about as far as it goes.
American, Delta, and United declined to comment, as did a spokesman for Barclays Plc, which issues cards for American, JetBlue Airways Corp., and Frontier Airlines Holdings Inc. A spokeswoman for Bank of America said she didn’t “have anything to add.”
Cash pouring in from the big banks isn’t 100 percent profit—airlines are still on the hook for seats obtained with those miles, as well as merchandise offered in their catalogs. Fly the family to Bali on reward tickets or cash in miles for a new laptop, and the airline incurs a redemption cost. The loyalty programs’ outstanding mileage balances also count as a liability under accounting rules, giving airlines a powerful incentive to prod you to use them.
But redemption expense is largely incidental to these bank partnerships, given the wide spread between what a bank pays an airline for a mile and its future cost to the airline. At American, which has the largest program, Stifel estimates a mile’s sale price is about three times its cost at redemption. (Naturally, any miles that are canceled, expire, or are otherwise never redeemed flow to airline coffers at a 100 percent margin.) “Fundamentally, airlines are selling miles to credit card companies for much more than they will cost the airline when those miles are redeemed—and they are doing it hundreds of billions of times a year,” Stifel wrote in a February client note.
It’s difficult to quantify how much investors focus on the value of loyalty programs when assessing an airline’s prospects. Stifel’s “sum-of-the-parts” valuation approach may overlook one aspect of how airline loyalty programs operate: They are intimately tied to the core business, since most members prefer to use their miles for air travel, said Seth Kaplan, a managing partner at industry journal Airline Weekly. For the purpose of valuation, that might lower a loyalty program’s value if an airline wants to spin it off.
“It’s still highly dependent on the airline,” Kaplan said. “So would somebody pay retail for that company or … would they apply some kind of discount to it?”
Some airlines periodically devalue their miles, causing consumers to howl but boosting financial returns. However, overly aggressive devaluation could dent the market value of an airline’s loyalty plan.
Several carriers have sold their miles programs, mostly in times of financial distress. Air Canada’s then-parent company did so in 2008. In that transaction, it jettisoned its remaining stake in Aeroplan three years after spinning off its program. Earlier this month, Air Canada’s chief executive said the airline expects to gain more favorable financial terms with Aimia Inc., the program’s Montreal-based owner, when the current contract ends in 2020.
For his part, DeNardi doesn’t believe the U.S. airlines should spin off their loyalty programs.
He points to the loyalty program disclosure United made for 2002 through 2005 during its bankruptcy, calling it a “perfect” model for how airlines could report this income. While United was unprofitable at the time, the mileage program, United Loyalty Services, posted margins as high as 45 percent. United ended those disclosures in 2006 when it emerged from court protection.
Airlines have been reluctant to reveal more details about these figures, which usually run through their “other” income lines, because the bank deals typically carry confidentiality clauses. Moreover, carriers aren’t keen to show competitors detailed information about their loyalty profits. The banks, however, probably have a good sense of what their rivals are paying, DeNardi said.
“If I know that the margin on this business is 60 percent or 70 percent, with a very limited level of disclosure, then [JPMorgan Chase Bank, N.A.] and Citi and AmEx—the guys negotiating these agreements—they must know what the margin is,” he said.
The banks are making out pretty well in these partnerships, too. AmEx said in securities filings that Delta SkyMiles, its “largest airline co-brand portfolio,” accounted for approximately 7 percent of its worldwide billed business in 2016. The loyalty program is also responsible for approximately 20 percent of worldwide card-member loans as of Dec. 31.
If airlines do come around to DeNardi’s call for greater transparency, maybe as a way to boost share prices, which one will take the plunge first?
Said DeNardi: “Given the sheer size of American’s program and the fact that Doug [Parker] gets paid all in stock, he’s pretty well incentivized to have the stock adequately reflect the valuations.”