Air Canada is selling a stake in their reward program. Will other airlines follow suit?

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January 28, 2003
Air Canada Selling Stake in Customer Reward Plan
BY BERNARD SIMON


ORONTO, Jan. 27 � Demonstrating that frequent-flier programs are as valuable to cash-hungry airlines as to their points-hungry passengers, Air Canada said today that it would raise $161 million (United States) through the sale of a 35 percent stake in its Aeroplan loyalty program.

The buyer is the Onex Corporation of Toronto, a diversified Canadian investment group, which has interests in electronic parts manufacturing, auto parts and sugar, and stakes in the Loews Cineplex chain of movie theaters.

Airlines in the United States may follow Air Canada's example. Frequent-flier programs "are very attractive companies," said Glenn Engel, an analyst with Goldman, Sachs in New York. Mr. Engel said that the profit margins of programs like Mileage Plus from United Airlines were typically around 20 percent.

Randy Peterson, editor and publisher of InsideFlyer, an industry newsletter based in Colorado Springs, said several United States airlines had examined the feasibility of spinning off their frequent-flier programs toward the end of the stock market boom in the late 1990's. But with profits from their core airline operations running high at the time, there was less pressure to bring in outside investors.

When frequent-flier programs were introduced in the mid-1980's, they were seen as a financial burden, with unused points reflected as a contingent liability.

The programs, however, have become increasingly profitable as miles have been sold to a widening array of partners eager to find a way to encourage customer loyalty. The trend started with travel-related businesses like hotels and car rental companies but now includes credit card companies, retailers, telephone companies and home loan providers.

"They're no longer frequent-flier programs; they're frequent-buyer programs," said Tim Winship, editor and publisher of FrequentFlier.com, an industry newsletter. Mr. Winship estimates that the partners pay an average of about 2 cents a mile, but that the cost to the airline is negligible.

"Consumers don't see the profitability part of it," Mr. Winship said. As an example of the profitability of the frequent-flier plans, Mr. Engel noted that Bank One, a leading bankruptcy financier for United Airlines, operates the airline's frequent-flier mileage credit card.

"Bank One would not have lent money to United if it didn't have the frequent-flier card," Mr. Engel said.

United makes up about 10 percent of Bank One's credit card receivables, and analysts have estimated that the relationship contributes 20 to 25 cents a share to Bank One's annual earnings. The United program has 40 million members.

At Air Canada, Calin Rovinescu, the airline's executive vice president for corporate development and strategy, said during a conference call today that the deal with Onex would enable Air Canada to keep control of Aeroplan while providing an outside partner to help expand the program's horizons.

"The airline business will not be able to provide the capital to grow businesses that are not airline businesses," Mr. Rovinescu said. Air Canada, which is based in Montreal, has $7.9 billion in debt. After reporting two consecutive profitable quarters last year, the airline said earlier this month that it expected to report operating losses in the fourth quarter and for 2002 as a whole.

Aeroplan has about six million members. Almost two-thirds of its $394 million in total revenue last year came from partners other than Air Canada. The deal with Onex "is intended to build a loyalty business, not just a frequent-flier program," Mr. Rovinescu said. "The future of Aeroplan lies in growing its partner network," especially in the retail sector.

An Onex official, referring to a growing imbalance between demand for redemption of frequent-flier miles and the availability of seats, said the deal included a commitment by Air Canada to make more airline seats available to Aeroplan.

But Rupert Duchesne, Aeroplan's chief executive, said that one in four or five Aeroplan customers now want to redeem miles for "high-end experiences" other than air travel, including golf and ski vacations.

The biggest frequent-flier program is American Airlines' AAdvantage, with 45 million members and 1,300 participating companies.

Gus Whitcomb, a spokesman for American Airlines' parent company, the AMR Corporation in Fort Worth, said that spinning off the program "is not on our agenda right now." But he said that Air Canada's move "further demonstrates that airlines are having to look at every facet of our business."

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Well, Carlson has managed programs for NW and KLM, as well as Radisson's frequent stay program, so the idea that a FF program must be a division of the airline that offers it is becoming as anachronistic as airlines keeping their res systems in house. [As AA discovered when it took SABRE public, while holding onto the controlling stake.]

As Air Canada was well aware, given the bleak stockmarket and market cap that airlines have, their true values are being ignored. AC has a market cap of about US$300 million. Yet its Aeroplan division alone was generating positive cash and thus on standard evaluations of 7 to 10 times cashflow, was worth US$650 to US$700 million.

ONEX clearly recognized this and siezed the day by offering AC cash it needed, while maintaining control in the airline's hands. Talk had been that AC, which spun Aeroplan off from being a division within the marketing department, to a full standalone subsidiary company, would do an IPO. But of course, this is no time for an airline to go to the capital markets.

ONEX also sees in FF programs -- and other airline's current plights -- the same opportunities it saw when it bought SKY CHEFS from AA. In partnership with LH, ONEX grew SKYCHEFS into the premier airline catering company, increased profits and cash flow, but also made the local managers quite wealthy.

I would not be surprised to see UA selling a similar stake in Mileage Plus to ONEX or someone else [Carlson might be considered a conflict of interest holding both NW/KL and UA]. These raise interesting possibilities for the future.

Americans might not know, but when the movie theatre business tanked two years ago, ONEX scooped up several major chains, including CINEPLEX, and has now reorganized these holdings into a fairly strong, fiscally healthy business.

Time will tell.

BTW, there are lots of threads on this over on the AC Forum, so those who want to read some more newspaper reports and analysis.

Also interesting to note that Onex parterned with AMR a few years ago in a hostel takeover bid for AC that failed. Now they get a portion of the FF plan for considerably less.

So who will make changes to the program in the future, AC or Onex?

Well, AC still has control of the company and all but one seat on the board. As is now the case, AC Marketing designs elite benefits, designates promos and route bonuses, etc. This aspect is unlikely to change, just other Aeroplan activities may increase.