Adam Smith

Yes, I know. I've been through a number of these. Perhaps you haven't seen my plethora of posts on this subject here

I'm quoting this out of sequence to the rest of the post because I don't understand what you're saying; it seems somewhat circular. Someone who received a $X credit for future travel has a claim in the amount of $X. That claim can either be satisfied (i) in the normal course, by allowing them to use the $X credit towards future travel, or (ii) with some sort of monetary compensation, which may be less than $X. You can't give something, then take it away, but say that giving it in the first place satisfied the obligation, which is what your wording says.

I think what you were trying to get at is that I'm suggesting that travel credits will be dealt with as per (i), whereas you're concerned they'll be dealt with as per (ii). That's a possibility, but below I'll explain my rationale. (The "TL;DR", as the kids say, is that the liability is likely a lot smaller than most here are thinking and that the costs of trying to cut it down are likely significant).

Part 1 - the amount isn't as big as you think it is

The first part is true - usually vouchers etc would be pretty small.

But I don't think the current magnitude is nearly as big as you (and many others) think it is. Let me walk you through some numbers. At 31/12/19, AC had $2.94B of advance ticket sales outstanding - this is the maximum liability that would exist for what we're talking about here. The actual amount of un-refunded non-refundable tickets sitting at travel credits as of today is going to be a tiny fraction of that. Why?

• AC generally has only about 60-80 days worth of tickets outstanding
• AC will have flown many of the tickets that underpinned that revenue during Q1, while slowing bookings will have significantly cut replenishment
• AC has continued to provide refunds for involuntary cancellations on flights cancelled up to March 19th; also, tickets that are refundable (whether fully refundable like Latitude, or refundable less a penalty like some international tickets) have continued to be refunded
• Some jurisdictions require AC to provide refunds for involuntary cancellations
• Flights have only been cancelled through to the end of April or May in most cases, so anyone holding a ticket for travel after the routes are (currently) scheduled to resume simply has a valid ticket, not a travel credit

So, if AC were to file for insolvency tomorrow, how much in the way of travel credits would be at stake? Any amount stemming from credits issued in the normal before the whole COVID-19 mess, plus travel credits issued between March 19th and today for flights between early/mid-March and end of May.

I can't tell you exactly what the amount would be, but if I had to guess, I'd be thinking $200-400MM. I expect total advance ticket sales on the March 31 balance sheet to be more like $1B than the ~$3B they're typically at. It's a bit of a WAG, but I'm very confident in the direction.

Now, don't get me wrong, when AC is struggling to manage cash in/out today, a few hundred million can be big. The shift to credits over refunds is also probably as much about protecting cash from future sales, so that AC doesn't collect revenue and have to give it right back because it adjusts the schedule, as much as it about the tickets that have already been sold. But when you put that in the context of the $23.4B of liabilities on AC's balance sheet, it doesn't seem so big, does it?

Part 2 - the cost/benefit of trying to haircut the credits in an insolvency may be poor

There are a few reasons why the return on trying to attack the value of the credits in an insolvency may not be worth it.

1. The cash cost to satisfy the obligation is already much lower than its face value
2. Doing so may lead to significantly higher administrative costs in the restructuring, in and of itself
3. It might add time to the process
4. It risks incurring challenges from government/regulatory authorities
5. It's bad PR at a time when bad PR is probably not needed
6. Cost to administer the change could be expensive

1. Cash cost vs face value

Most of AC's costs are not unit-variable costs, i.e. whether you sell one more seat on a flight, the cost of landing fees, pilots, FAs, etc, plus AC's corporate overheard (including airplane rent/financing), is unchanged. Even a decent chunk of the fuel bill is fixed for a given flight. So how much will it actually cost AC to satisfy a travel voucher in the future? 20 cents on the dollar? 30? Plus some of those vouchers would have expired, or been used for tickets worth less than the credits, anyway, so 30% is very generous, I think. Let's go a bit on the high side of my previous estimate of the voucher amount and use $500MM. The historical loss given default for unsecured creditors in North American insolvencies is around 35%, but let's be generous at AC and say that unsecured creditors are looking at a 60% loss. So there's $300MM potentially to be gained from crunching the travel credits.

Let's say again that 30% of the ticket cost is truly variable. What you've actually saved isn't $300MM, it's more like $90MM.

(And keep in mind that since the amount of credits at stake here is a small fraction of AC’s revenue last year – $17.2B of passenger revenues – and people would be using these credits spread across thousands of different flights over the course of 24 months, it’s not like eliminating a bunch of these credits will allow AC to cancel any flights, so we really are looking at incremental fuel, some food and beverage, and not much else in terms of true costs to satisfy these tickets)

2. Higher administrative costs

Insolvencies are expensive. Large, complex ones require armies of lawyers and financial advisors. And everyone's advisors get paid by the debtor (i.e. AC would not only pay for its own lawyers and financial advisors, but the bondholders', the aircraft financiers', the lawyers representing voucher-holders, etc). In 2016, I worked on a large restructuring with a much smaller and simpler balance sheet than AC's (albeit more jurisdictional complexity), and the fees on that were around US$10MM a month.

Adding another set of lawyers and financial advisors to the mix would add another set of fees, and would also increase the fees of the advisors that would already be working on the deal, because the advisors spend a lot of time interacting with one another. The more of them they are, the more interactions - it's a very expensive version of network effects.

It could easily cost $1MM or more, per month, in extra advisory fees to try to grind on the travel credits.

3. Lengthen the process

Adding another group of creditors can potentially add a bunch of time to the process - the fewer people sitting down at the table, the less time it takes to hash out an agreement. And it's kind of exponential.

More time = more cost (see point 2).

If the expectation was that a CCAA was going to take 6 months at $10MM/month in fees, and going after the travel credits adds $2MM per month in fees and 1 month to the process, your fee budget has now gone from $60MM total to $84MM total. That's $24MM of those $90MM of savings up in smoke.

Time is also money in and of itself. Whatever firms sign up to back this restructuring probably don't want to see their money tied up on a company that's operating under the straitjacket of insolvency for too long, they want the company to get back to business and earning a return on their capital. Every day their DIP financing (debtor in possession, basically the bridge financing they provide while the company is in CCAA) is being used, their clock is running to make money for their investors.

4. Government/regulatory issues

Governments have so far not been going after AC too hard for issuing credits instead of refunds, but if people found out that their $1,000 flight is now a $500 credit for future travel, when the airline probably should have given them a full refund in the first place, do you think some government might take action? Feds, through legislation? Or the CTA? How about Quebec's very aggressive consumer protection agency? If any of them try to intervene in the process, see points 2 and 3.

Or they may simply legislate that involuntary cancellations must allow customers to get a full refund and that this obligation takes precedence over other claims in an insolvency. Having to pay out 100% of the amount in cash would certainly be worse than simply letting people use up the travel credits and only cost you 30% of that amount in cash costs, wouldn’t it?

5. Bad PR

People are heavily motivated by price when buying air tickets, but it's not the only factor. How many bookings would it cost AC to piss people off by not only not refunding them, but then haircutting their travel credits on top of that? Or think about it another way, how much money would AC have to spend on advertising to offset those lost ticket sales? This is one more hassle that a company coming out of a restructuring probably doesn't need.

6. Difficult to implement

This amount of hundreds of millions of dollars is spread across thousands, or tens of thousands, of tickets. It's already hard for AC to even keep track of the credits. Do you really think they have the technical wherewithal to apply a haircut to the value of unused credits? Gift cards, I might believe they could do that, but I'm sure that programming a way to cut the value of all these tickets - without touching the value of tickets that remain valid, in case those need to be exchanged or refunded - would cost AC millions of dollars and take months.

Bottom line

Putting this problem in context is key. That 2016 restructuring I referred to earlier, with substantially less debt than AC, we elected to exclude (i.e. leave alone) a couple hundred million dollars of claims from suppliers because, in the context of the other liabilities (in the $5-10 billion range), it wasn't worth the time and cost to try to reduce them. And on that deal, creditors were taking a ~60-80% haircut. And in that case, we were only dealing with items 2, 3, and 4 from part 2 of my analysis above.

I’m not saying that someone won’t look at this and think about it, but the way I see it going is that the investment bank or consulting firm that’s acting as some creditor's financial advisor will run some numbers on this, much as I’ve done above (but with real data as opposed to my guesstimates), and weigh the other cons, and come to the conclusion that it’s simply not worthwhile.

Ergo, I think that it is likely that travel credits will survive in an insolvency.

Yes. Or even if airlines avoid insolvency, having to spend time and money litigating this issue.