What are Frequent Flyer Programs Really Worth?

by on November 5, 2005 at 6:48 am in Economics | Permalink

Not entirely fair, but I’ve often said that several major airlines have been kept in the air purely to support their underlying credit card business. (I say not entirely fair because some carriers have been kept afloat so that GE Capital doesn’t have to write down the value of its aircraft leases .pdf. ;).

  1. When United entered bankruptcy, BankOne (since acquired by JP Morgan Chase) provided $500 million in debtor-in-possession financing. The bank needed the airline to survive because their most profitable credit card product is the United Visa. JP Morgan has now stepped up as a major provider of United’s bankruptcy exit financing.

  2. American Express pre-paid the purchase of $500 million worth of Skymiles to try to keep Delta out of bankruptcy. Again, an airline was kept afloat because it was needed to sustain a credit card business.

  3. American Express required that Delta make its first action in bankruptcy a request to the Court to reaffirm its frequent flyer obligations, just as United had done in its first bankruptcy action.

  4. The Alaska Airlines Visa from Bank of America will be good for $225 million in revenue to the airline in 2005. Revenue is growing at 28% a year. That's an incredible figure for an airline that lost $15.3 million in 2004 and made $13.5 million in 2003. The sale of Mileage Plan miles to Bank of America dwarfs both figures.

  5. Juniper bank is contributing $455 million to the merger of America West and USAirways in exchange for the right to issue its frequent flyer credit card. This was a huge blow to Bank of America, which had been issuing cards for both airlines, and BofA is taking the deal to court.

Frequent flyer programs clearly drive not just consumer spending decisions, but also serious revenue. Can it really be that frequent flyer programs have tremendous economic value when the airlines they’re attached to are losing billions of dollars?

The market certainly thinks so. When Air Canada exited bankruptcy it spun off its own loyalty program into a separate, publicly traded entity. Based on the price paid for a 12.5% stake in June 2005, Aeroplan has a market value of CAD$2 billion.

These programs have their own independent revenue streams. Airlines sell miles, and then buy seats redeemed with those miles (or merchandise, etc.) at a discount, earning money on the spread. The sale of miles alone currently generates US$3 billion in revenue annually.

According to the cover story of July’s Inside Flyer magazine, Air Canada isn’t the first airline to spin off its frequent flyer program, although it’s the first to become publicly traded. United spun off Mileage Plus into a wholly-owned subsidiary in 2002 in a $1.4 billion transaction.

    In 2003, ULS accounted for 5 percent of UAL’s 2003 revenues. In 2004, United recognized more than $400 million in revenues related to ULS, which would not reflect the entire business revenue of ULS for that year. In 2000, revenue for third-party mileage sales reached $220 million during the first six months alone.

    But American AAdvantage is clearly the king of frequent flyer programs, with annual revenue related to third-party sales of miles exceeding $1 billion annually.

United’s Mileage Plus program is estimated to be worth between $2.5 billion and $15 billion. (The $15 billion estimate is hugely flawed. It takes the per-member market value of the Air Canada Aeroplan program and multiplies that by the number of United Mileage Plus members. But US consumers participate in more frequent flyer programs than Canadian consumers do, so Mileage Plus occupies far less mindspace than Aeroplan.)

United’s bankruptcy is likely the reason that Mileage Plus has not yet been brought public. Air Canada was ready to spin off Aeroplan a couple of years back but put those plans on hold when it entered bankruptcy. The questionable status of the underlying airline would have been a drag on the value of its frequent flyer program. With United’s exit from bankruptcy I expect an IPO of Mileage Plus to follow (within two years).

While airlines lose money, their loyalty programs are engines of wealth creation that have yet to be fully exploited. I don’t have a fully formed method of valuing these operations, but I do expect the market to develop one.

A not unreasonable point is that these programs are tied directly to airlines with questionable futures. I’m not sure that matters for their viability as going concerns. A frequent flyer program redeeming miles for 5 – 10 million seats per year would be the single largest customer of any airline. It’s not unreasonable to believe that they could negotiate major discounts with another carrier or group of carriers, and continue to both sell miles and redeem them for flights at a profit. That will certainly take some business vision, but could go a long way in supporting market valuations in the billions.

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