American Airlines investors push for sales of frequent-flier plans
Susanna Ray and Hugo Miller, Bloomberg News, The Seattle Times, 11/23/2007
American Airlines, the world's largest carrier, and its U.S. competitors are sitting on frequent-flier plans that may be worth as much as the airlines themselves. Demanding an upgrade on their investment, some shareholders want the programs sold.
American's AAdvantage program, with more than 57 million members, may fetch as much as $5.7 billion, according to a Morgan Stanley estimate. That's about the same as American's market value. Bear Stearns projects United Airlines' Mileage Plus may go for as much as $22.8 billion, more than four times the airline's value. Airlines could boost shares by 20 percent to 27 percent by unloading the units, analyst William Greene at Morgan Stanley said in a report last month.
Investors say selling the mileage plans would help reverse this year's nearly 20 percent drop in airline stocks amid a more than 50 percent rise in jet-fuel prices. While airline executives have resisted giving up exclusive access to their best customers, they are now considering the view of activist shareholders who say it's time to copy the 2005 spinoff of Air Canada's Aeroplan, which has grown to about the same market value as Northwest Airlines.
"Spinning out the mileage programs would be very beneficial to shareholders," said Craig Hall, a Dallas investor who owns the fifth-biggest stake in American and wants American to divest AAdvantage. Hall calls the frequent-flier plans a "hidden asset" not reflected in airline valuations.
Carriers would gain cash from any sale and could still reap profits by keeping stakes while the loyalty plans expand. Released from airlines' control, mileage programs could move outside the air-travel industry, adding retail partners and luring more members.
The five biggest U.S. airlines said in the past month they're reviewing the possible sale of their loyalty units. United, No. 2 by traffic behind American, is developing a profit-and-loss statement for Mileage Plus, though it hasn't yet decided if it will share the information. Delta Air Lines plans increased financial disclosure of SkyMiles next quarter.
Carriers are responding to pressure as airline shares have underperformed the Standard & Poor's 500 Index by 23 percent this year. Reykjavik-based FL Group, which owns 9.1 percent of American, urged American to sell its frequent-flier program in an open letter to American's board in September.
"This has the potential to become a sustainable source of value creation if it's done in the right way," FL CEO Hannes Smarason said in an interview.
Delta said last week it had formed a board committee to review possible mergers after a shareholder, Pardus Capital Management, urged the carrier's management in a letter to combine with United. Pardus owns 7 million shares of Delta and 5.6 million shares of United. While airlines don't provide detailed financial information on their frequent-flier plans, Morgan Stanley's Greene estimates U.S. carriers' plans could be sold for $500 million to $5.7 billion each.
United's plan is worth at least $3 billion, and Northwest's program may fetch as much as $14.6 billion, according to Frank Boroch, an analyst at Bear Stearns. United's market capitalization was $5.14 billion as of Nov. 15, and Northwest's was $4.62 billion.
Boroch and Greene both computed frequent-flier valuations using Aeroplan as a model, because it's the only free-standing airline-mileage business.
Air Canada raised $300 million when it sold a 14.4 percent stake in Aeroplan in June 2005. That valued the Aeroplan Income Fund at about $2 billion. ACE has since pared its holding to 20 percent, and Aeroplan now has a market value of $4.5 billion compared with Air Canada's $2.8 billion.
Airline rewards programs now make money by selling miles to banks or hotels to give to customers. An independent program like Aeroplan would sell points to carriers as well as to banks, retailers and other customers, and then buy airline seats and other rewards at a discount, pocketing the difference.
About 14 to 17 percent of the miles go unclaimed, according to United and Aeroplan, also adding to profit.
Aeroplan's 15 percent profit margin last quarter was more than twice as high as the most profitable of the top five U.S. carriers.
"The extra cost of carrying a frequent-flier passenger is virtually nil, assuming that person isn't displacing a full-fare-paying passenger," said Jay Sorensen, who helped run Midwest Airlines' mileage program and is now an industry consultant.
Creating a separate structure made Aeroplan a better business with more freedom to add partners and grow, said Karl Moore, a professor at McGill University in Montreal who has worked with the mileage plan's executives on business school projects.
"It unleashed an enormous amount of capital that they wouldn't have otherwise had," Moore said.
Still, Aeroplan's success may be difficult to copy in the U.S. Because Air Canada dominates air travel in its home market, Aeroplan can sell points at a premium to Canadian businesses, analysts say. No carrier has similar clout in the U.S.
"Aeroplan is entirely different," said Jeff Misner, chief financial officer of Continental Airlines, the fourth-largest U.S. carrier. "You can't take those multiples and apply them to a frequent-flier program here in the U.S.," he said earlier this month at an investor conference in New York.
Hall, the American investor, disagrees. "If it were spun out, it's like one and one equals three," he said.
While airline managers may be hesitant "from a control perspective," carriers have benefited from previous divestitures, such as when American in 2000 spun off the reservations service now known as Sabre Holdings, Hall said.
Airline executives may yet come around to Hall's viewpoint.
"I admit some people are scared," United CFO Jake Brace said at the New York conference this month. Shedding the plans "is not traditional thinking in the airline industry, and if you just had an airline hat on, you might not do it. But we have to think what would be best for the shareholder."
Bloomberg News reporter Mary Schlangenstein in Dallas contributed to this report.