|Shares Out. (in M):||3||P/E||0||0|
|Market Cap (in $M):||165||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||0||0|
Worst case scenario, this is a ~10% yield that should be covered nearly 4X over. There’s a double discount here: Canadian preferred shares have been dumped en masse, and investors are overly concerned about the renewal of Aimia’s contract with Air Canada in mid-2020. So you get paid handsomely to wait for these shares to once again trade near par - roughly a double from here. There’s a good chance the contract gets renewed early - perhaps in the next year or so – which would be a great catalyst.
(all amounts in C$ unless noted)
A word on liquidity: the series 1-3 preferred shares together have $165M in market value and trade about $150K per day. I own the Series 2 exclusively, since it has the widest discount to par and it pays a floating interest rate (and since I had to enter a share price, shares out, and symbol, I entered the Series 2 data. But they’re all cheap. If I were more constrained by liquidity, I’d be happy owning all three.
Rate reset preferreds such as Aimia’s Series 1 & 3 began appearing in 2008, when interest rates were falling and everyone thought they’d rebound sooner rather than later. Sold largely to yield-seeking retail investors, they now account for ~60% of the almost $67B Canadian preferred share market. Floating rate preferreds – such as Aimia’s Series 2 – aren’t as common, but obviously offered another way to play this seemingly-inevitable rebound. And of course, rates went on to sink even lower, especially around early 2015 when the retail investors started throwing in the towel. This probably explains the initial swan-dive in the Series 1-3.
But it’s company-specific fear that probably explains why there’s been hardly any rebound. The market is worried about what happens to Aimia when its contract with Air Canada (AC) expires in mid-2020. Aimia grew out of Aeroplan – originally AC’s frequent flyer program – which was spun off from AC in 2005. Today, Aeroplan is a full-blown loyalty “coalition” – in which lots of consumer-focused companies buy points (fka “miles”) to reward their customers. Last year, just over 20% of points were purchased by AC to reward their frequent fliers. 70% were purchased by credit card issuers (CIBC, TD Bank, and Amex), and other ~10% by a hodgepodge of supermarkets, gas stations, etc. But AC still remains hugely important to Aeroplan, since when these customers redeem their points, they spend 80% of them on airfare. AC, along with its low-cost carrier Rouge, provides perhaps 86% of that 80%, while the other Star Alliance airlines provide the rest.
It might seem strange that anyone is freaking out about a contract that doesn’t run out for another 3.7 years, particularly when there’s never been any friction (in public, anyway) between the two sides. And it is strange. But it’s not totally crazy. The CEO of AC has been flagging the upcoming renegotiation as a source of future cost savings. The original contract was signed under some fairly unusual circumstances. BMO’s analyst – perhaps the most bearish guy on Aimia – has gone so far as to say that “there is longer-term existential uncertainty around the Air Canada contract expiry in 2020.”
If you really think the contract won’t be renewed, this idea just isn’t for you. Aimia might survive such an event, but it’s hard to say how the cash flows would change. At best you’d be in for a white-knuckle ride.
But it’s extremely unlikely that AC and Aeroplan part ways. Yes, the new terms won’t be as good (but they’ll be good enough). To understand why, one needs to know some history. The current contract was probably not the product of an arms-length negotiation. I doubt there was a negotiation at all. Instead, this was the result of why I’d call “valuation-multiple arbitrage.” Cerberus – which came to control ACE Aviation Holdings through its 2003 bankruptcy - was looking for ways to pay down some debt at ACE and maximize the value of ACE equity. To do so, they carved out some of AC’s higher quality income streams, including its frequent flyer program. Thus, AC agreed to set aside 8% of its capacity for sale to Aeroplan at cost. These flights were dubbed “ClassicFares” and in the early years they represented nearly all the flight rewards that Aeroplan offered.
It’s all about ClassicFares…
In addition to Aeroplan, Aimia today has lots of other loyalty-marketing operations around the globe. But these cats & dogs basically just about offset corporate overhead, and thus Aeroplan remains the key to the fate of these preferreds.
So we need to estimate much a renewal could ding Aeroplan’s roughly $200M of annual free cash flow. Let’s try to get a sense for how much room there is to renegotiate.. Looking at AC’s financials, it seems likely that variable costs are at least 75% of revenues. See for yourself:
The exact amount looks a bit more like 80% to me, but to avoid quibbling and to be conservative let’s use 75% instead.
So if Aeroplan buys ClassicFares at cost, and cost is at least 75% of market prices, then we know that Aeroplan’s cost for ClassicFares is probably not more than 25% under-market. Since the worst that AC would demand under a new contract is full market prices, the maximum increase over current prices would be 33% (=100%/75%-1).
We can also estimate how much Aeroplan is currently paying. Consolidated “cost of rewards and direct costs” were 1,601.9 in 2015. Star Alliance airlines were 43% of this number, and Aeroplan is the only Aimia coalition affiliated with Star Alliance.
So, 1,601.9 * 43.0% = 688.8 total spent by Aeroplan on flight rewards (all from Star Alliance)
688.8 * ~86% = 592.7 spent on Air Canada/Rouge vs other Star Alliance airlines
592.7 - $180 cost of MarketFare revenue (more on this in a moment) = 412.7 spent on ClassicFares
33% max increase * 412.7 = $137.6M worst-case hit to Aimia’s FCF (approximately)
200 of current annual FCF – 137.6 = 62.4 FCF still available to pay preferred dividends
62.4 / 16.9 of preferred dividends = 3.7x worst-case coverage
But this is very much a hypothetical exercise. There’s no way Aimia is going to pay even close to full retail prices for these seats. Aeroplan’s MarketFare program proves that it can negotiate a discount to market rates for bringing AC a large volume of business. Adding the ClassicFare flights to the mix, that volume of negotiated-rate business will more than triple.
Since the supply of ClassicFares is limited, Aeroplan has long offered flight rewards to members who can’t get a ClassicFare on the flight they want. The first iteration of this was the Avenue program, followed by ClassicPlus in 2006, and finally by MarketFare in 2014. These were a small part of the mix at first, but they’re ~30% of Aeroplan flight rewards today and total ~$180M in annual revenue to AC. While the prices on these are closer to market rates, they’re still at a significant discount, particularly for members who earn lots of points on a regular basis.
Finally, keep in mind that AC doesn’t hold all the cards. One big reason is that the revenue that AC gets from MarketFare flights comes with attractive margins. MarketFare rates were negotiated just a few years ago, when neither party was in any sort of weak bargaining position, thus AC is likely still happy with these prices. It would be hard for AC to replace all of this lost revenue – creating a new coalition requires signing a major credit card issuer, and it’s not clear who that would be. Canada’s top 4 issuers (RBC, CIBC, TD, BMO) have something like 72% of Canada’s general purpose credit card purchase volume (5th place has ~6%), and they’re all pretty tied up as far in terms of loyalty coalitions.
Another big reason is that Aeroplan has developed close relationships with essentially all of AC’s best customers in the process of managing AC’s frequent flyer program. If AC were to take its program back in-house, one can imagine all sort of ways these customers could get upset and take their business to WestJet, Porter, American, et al.
By the way, Aeroplan’s earnings come from more than just the gross profit on ClassicFares: In 2015, It might make some money on MarketFares too, albeit a smaller margin. It definitely makes money on non-airfare rewards, which now attract ~20% of all points spent, and carry gross margins much higher than the margins on airfare overall. It probably makes some money on various travel-related fees (e.g. flight change fees), as well as a tiny profit for managing AC’s frequent flyer program. Last and certainly not least, Aeroplan makes money on the points that members never use, which in theory would be 100% gross margin revenue.
Catalyst – early renewal
Aeroplan has a 6/28/2019 deadline by which it must notify AC if it intends to not renew the CPSA on 6/28/2020. But Aimia has a debt maturity on 5/17/2019, and AC has a veritable “wall” of debt maturing in 2019, so one would expect the renewal discussion to get underway in 2018. From there, it’s not a stretch to think that Aimia might be able to push for a deal in advance of its 1/22/2018 debt maturity, which would allow it to refi at a decent rate and free up cash for its hefty dividends and buybacks. (Aimia’s capital allocation certainly doesn’t suggest any nervousness about Air Canada.)
Starting negotiations early won’t put Aimia in a bad negotiating position, for the simple reason that generates nearly enough free cash flow to pay down all three pieces of debt as they come due. In fact, Aimia is prepared to do just that for the upcoming January 2017 maturity. The CFO will give an update on this issue during the 3Q16 call in November. In addition, there’s also:
excess cash of $130M
a $300m revolver which is nearly untapped
Cardlytics biz is on the block - worth maybe $70m. A sale should be neutral or better to FCF.
48.9% stake in PLM – a Mexican loyalty coalition built around the frequent flyer program of AeroMexico. This business is a gem – grows quickly while throwing of lots of FCF. PLM has been rumored to be worth US$1B, which would put Aimia’s stake at C$650M (note that a sale would reduce FCF by ~$15M - the dividends Aimia receives from PLM). It’s highly likely that PLM will be IPO’d eventually.
But what if Air Canada goes bankrupt again?
AC has been doing well for a while now. Last I checked, adjusted net debt to EBITDAR was below 2.5X. Interest expense + aircraft rental was ~1/3 of EBITDAR. But of course, there could still be trouble if demand drops severely enough. The question is, what then would happen to the current contract?
Thankfully, we can look to history as a guide. In 2009 AC went through an out-of-court restructuring and the contract remained intact. If AC were to actually file, the contract would probably still survive. Management addressed the reasons why at their Analyst Day on 10/1/13 and I’ve pasted their words below. But if you’re short on time, it boils down to:
Canadian bankruptcy law forces debtors to abrogate contracts completely or not at all (unlike Chapter 11 in the U.S., where they can tinker with individual terms).
This contract brings in a critical amount of FCF for AC which it couldn’t fully replace, or at least not quickly. Therefore, it’s unlikely that any judge would allow them to abrogate the contract.
Since AC is the national flag carrier, the government would probably come to the rescue, as they did in 2009.
CEO Rupert Duchesne – “Luckily or unluckily in 2009, we had a chance to put it to the test when Air Canada did get close to filing for bankruptcy. We did an out-of-court refinancing of the airline. We participated. We lent them $150 million at 12.75% coupon, which was I think fair with the risk, if anything. But I think that's very illustrative of the -- at the point that it really gets serious, we are a critical source of cash flow for the airline and being able to make up in a very short period of time for the loss of that would be almost impossible. And therefore, there wasn't the even any discussion at that time of what we going to do and see if we can find somebody else to do this for you. ... Also in a bankruptcy filing there's a whole lot of sort of legal and accounting issues that make it extremely hard for them sort of day off to do without, and we don't book.
The advice we received is that we don't think any bankruptcy judge in Canada would allow the airline to abrogate the contracts in such a way that gave cash flow risk to the airline. Frankly, if it did happen, our view is that we've actually got a fairly strong argument for the airline not to do anything. Because if we were to take that customer base and that revenue flow and provide it immediately to their competitors, WestJet, OneWorld Alliance, et cetera, et cetera, it will be a crippling blow to them. So I think what you'll see happen is have a fairly logical argument with them about is the price we're paying for Classic seats compensating you fairly for the opportunity cost of those seats? And we've done that work fairly regularly and the answer to that is yes. Are we paying you a fair price for the MarketFare rewards? And we've just done that deal so you could argue that in a moderate time, like we're in today, the answer to that obviously is yes at this point. And therefore, is there any incentive for anybody really to do anything? I think the answer is no. There are much more important things to worry about in the restructuring than a contract that is net cash flow positive to you in a much higher degree than if you did it yourself, which is what this is.
So we were lucky to be able to prove that in 2009, and our position now having done – just done this new deal with the card partners is much stronger than it was even in 2009 because the total revenue pile coming from these because of the breakage reduction we're talking about a moment ago and the increased price being paid by the bank means that the net cash flow in favor of the airline is even higher than it was in 2009 and will continue to grow as we get closer to the renewal of that relationship and the increased price being paid by the bank means that the net cash flow in favor of the airline is even higher than it was in 2009 and will continue to grow as we get closer to the renewal of that relationship.”
Former CFO David Adams – “Yes, just 2 other data points to that: one is Air Canada is a little bit different than many other airlines because it is a national flag carrier. And when it was put to the test in 2009, the Canadian government through EDC came to -- participated in the out-of-court refinancing and bridge loan. So the international gates are viewed as a national asset. And so notwithstanding WestJet's growth in the Canadian marketplace, I still believe that when push comes to shove, the Canadian government will be there with the financial support. So in a disaster scenario, we shouldn't be thinking about would the airline evaporate because there's a very, very low probability to that outcome. And for those of you, because we're here in London, just a finer point of Canadian bankruptcy law, we're not Chapter 11, right? So don't think of us that we are U.S. Chapter 11. And the difference is, is that in the U.S. you can actually cherry-pick contracts, I mean you get a judge to abrogate certain terms or conditions. In Canada, you have to abrogate the agreement in total. So it's either you keep the agreement out or you have to abrogate it completely. So when you talk about the risk of renegotiation, risk of cash flows, it's much higher in that circumstance than it would be under Chapter 11.”
By the way, Aimia’s equity was previously written up on VIC by castor13 in 2011 (under the old name of “Groupe Aeroplan”) as well as by Ragnar0307 in 2013. I’m not sure if the equity is cheap today, but in any case, I think the preferred shares offer at least as much upside with less risk.
Also, note that Aimia is one of those rare small-caps where IR (Karen Keyes) can answer most if not all of your questions. Not that you shouldn’t talk to the CEO/CFO, but you might want to try her first.
 AC CEO Calin Rovinescu at a conference on 12/2/15 - “10 years ago, Air Canada spun out its loyalty program to create shareholder value at that point in time. With that came a fairly expensive commercial contract. And we will be restructuring that contract in 2020 with Aeroplan, and that will create value at that point in time.” At AC’s 2Q16 call on 6/29/16 - “there's no question the expectation will be that, anything that is a below market, the term will be brought to market [upon renewal of the CPSA]”
 CEO Rupert Duchesne on the 6/27/13 analyst call – “So in the worst-case outcome where we wouldn't reach agreement with Air Canada in 2020, which is I said, I think it's extremely unlikely, we would have a hugely successful and economically viable program even without them. And frankly, it would be a program that would have been -- would be a great interest to other participants in the travel business.”
 ACE was the holdco which owned AC at the time.
 There is some evidence that AC had thought about eventually spinning-off Aeroplan prior to the 2003 bankruptcy, but in any event, I think it’s obvious that AC never would have agreed to these terms in an arms-length deal.
 CEO Rupert Duchesne at Analyst Day on 10/1/13 - “when we did the spinoff, we very carefully analyzed the real cost of the airline of providing those 8% of seats and we pay that pretty precisely. "
 Technically, there’s some circularity here, as ClassicFares are a component of AC’s revenue. But we can overlook this since they’re probably not much over 3% of the total, and since our final estimate of the worst case scenario suggests a big margins of safety.
 For what it’s worth, Aeroplan’s own margins on ClassicFare seats seem to be close to 20%. Since 2004, the program has offered seats at prices closer to market levels for those times when ClassicFare flights aren’t available. In recent years, these have grown to ~30% of flights, but in the early years of 2002-2007 these were likely just a small portion of total flights, meaning that the Aeroplan’s gross margin on ClassicFare flights was probably close to its overall gross margin on airfare. The latter margin never went much higher than 20%. But it’s possible that Aeroplan was passing some of its savings on to coalition partners (e.g. CIBC) during that time, so this number might understate the true gap between ClassicFare and market prices.
 After interest expense but before preferred and common dividends
 This depends on the price that coalition partners pay for points, which could be less than the market value of the airfare it can buy
 CEO Rupert Duchesne at CIBC conference on 9/21/16 – “we would hope that we would get an Air Canada deal done long before we get to the end maturity on any of this debt.”
 CEO Rupert Duchesne at CIBC conference on 9/21/16
 Adjusted for aircraft leases
Good chance they renew the contract with Air Canada in 2017.
|Subject||Re: classic fare assumptions|
|Entry||10/07/2016 04:49 PM|
thanks bdad. and I appreciate the question since I've been pondering this myself. not surprisingly, the company is loathe to give any detail on the contract that isn't already in the public domain, so we've got to rely on our own logic here.
Suppose for a moment that Aeroplan had just 50 members instead of ~5 million. In that case, the incremental cost to AC would be little more than a Diet Coke and bag of peanuts for each ClassicFare sold (assuming, of course, that these folks don't all want the exact same flights). But we're talking about 8% of AC's capacity on every route every month (source: 10/1/13 analyst day). I'm not sure that means 8% on every single flight, but clearly AC can't sell ClassicFares on only those seats that were likely to otherwise be empty. So I think the true cost to AC has got to include some allocation of fixed costs. (Not all of them, though - I left their IT costs out of the equation, for example)
My guess is that the cost number is reset frequently - likely even more than once a year. If nothing else, there's probably an adjustment for fuel costs, which were nearly 18% of rev in 2015. Empirically you can look at Aeroplan's cost per mile redeemed for airfare and see that it does vary over time (they don't give out this number but you can estimate it ... you can have my #s if you like) it gets a bit complicated since the % of non-ClassicFare flights has changed over time and that definitely impacts cost per mile, but I think this % has steadily increased over the years, whereas cost per mile ebbs and flows.
By the way, I'll admit there's a lot of steps in coming up with my worst case scenario, and more steps mean more chances to be wrong. If the end result were that pfd dividends were just barely covered I'd be concerned, but it's 3.7x ... i.e. room to be wrong.
|Subject||Re: Air Canada, Value Proposition|
|Entry||10/07/2016 05:41 PM|
1) I wouldn't be shocked to find that the pref dividends were still fairly well covered in the event of a divorce. but the market would freak out and it could take a while to reach a deal(s) with other airlines. I haven't yet checked how well an alliance with WestJet and AlaskaAir could replicate the flight options that members currently have with AC. Crudely speaking, their combined revenues in 2015 were C$11.3B vs AC's C$13.9B, so maybe, maybe they could come close to replicating the current options. but either way I'm sure some Aeroplan members would feel like they got bait-and-switched. also, I'm not sure what a divorce would do to Aeroplan's contracts with CIBC, TD, and Amex which together are 70% of Aeroplan's revenues. The Amex contract expires 2018, so clearly they could drop out. The CIBC and TD contracts expire 2023, but for all I know there could be a contractual "out" in the event that Aeroplan fails to renew with AC.
2) don't know. I'll ask.
3) Regarding interchange fees, the decrease wound up being only ~10%, to an average rate of 1.50% - still plenty of room to pay Aeroplan. I agree completely that the credit card landscape has gotten more competitive, but mgmt seems to have navigated this issue fairly well. Competition started to increase no less than ~3 years ago, causing Aeroplan to make some major changes to the program - basically making the rewards much more attractive. in the process, they got CIBC and TD to agree to a 15% price increase to help fund part of this (granted, it cost them some business with CIBC, but that in turn led to them signing TD - overall a big win for Aeroplan). Essentially, they took a big hit to margins in order to boost revenues. Now that rewards are better, breakage has declined to about 11%, which is the lowest breakage rate I've seen for any loyalty program that involves air travel. In other words, they're pretty lean and mean these days, as opposed to over-earning and about to get steamrolled by competitors.
by the way, the interchange drama caused TD to pause its marketing for the TD Aeroplan card in 2015, but now they're back at it and avg spend per card is rising once again
thanks for pointing out that slide. to your point, when AC gets asked about Aeroplan, the CEO usually prefaces his comments with "we have a great relationship with them..."
|Subject||Spread per Mile, Burn vs. Earn Ratio and Asset Sales|
|Entry||10/11/2016 07:05 PM|
Thanks for the write-up, very well-done and very helpful. I agree with you that Air Canada bringing the loyalty program in-house is highly unlikely and agree that the Air Canada renewal terms will not be overly punitive. Putting the Air Canada contract aside, I do see other pressures on free cash flow: 1) a declining spread per mile and 2) redemptions of previously issued miles.
The spread per mile in 2013 (prior to TD distributing Aeroplan credit cards) was ~35%. Today the spread per mile is only ~20%. I believe there is a scenario where the spread per mile continues to decline as Aimia will need to incur greater reward costs in order to maintain the competitiveness of the Aeroplan program. This is driven by the “spend vs. lend” environment. Today, banks are giving away “spend” economics through aggressive reward or cash-back programs in order to attract wealthier consumers / obtain attractive credit card “lend” economics (see American Express).
In addition to a declining spread per mile, I estimate Aeroplan has ~130.5 billion unredeemed miles outstanding, equivalent to a liability of ~C$1.4 billion. If Aeroplan members begin redeeming these miles and miles redeemed approach or exceed miles issued (i.e. the “burn/earn” ratio increases), free cash flow will significantly decline.
In a scenario where I have the spread per mile declining to ~15% and the burn/earn ratio increasing to ~100%, I see free cash flow approaching zero.
Where I could get comfortable with Aimia’s preferred shares is if there is anyway for the preferred holders to capture the value from the other Aeroplan assets, such as PLM and Cardlytics. If somehow we could ensure that in a downside scenario pref holders would see some of the proceeds from these potential asset sales, I think this could be a very investible idea. So my questions are as follows:
1. Do you have any insight into why the spread per mile will not further decrease?
2. Insights on why the burn vs. earn ratio will not increase above management’s ~89% target (i.e. 1 – the 11% breakage assumption)?
3. Insight that pref holders will be able to benefit from the potential monetization of PLM and Cardlytics (i.e. all proceeds won’t simply be dividend to equity holders)?
|Subject||Re: Re: Spread per Mile, Burn vs. Earn Ratio and Asset Sales|
|Entry||10/11/2016 09:41 PM|
Thanks for that anecdote Katana.
1. I don't have any insight as to what might trigger an increase in redemptions but surely this is an elephant in the room. If people simply use the points they are entitled to, the business is a zero.
2. I know you addressed the question to mpk, but from my understanding Aimia is liable and Air Canada is only on the hook if they make some sort of agreement with Aimia. Clearly this is not great for existing Aeroplan members like yourself who have banked a significant number of miles and come 2020 might not be able to redeem. Again, I'm with mpk and see Air Canada renewing with Aimia.
|Subject||Re: Re: Spread per Mile, Burn vs. Earn Ratio and Asset Sales|
|Entry||10/13/2016 10:59 AM|
Thanks mpk. Completely agree with the reward mix being a driver of costs and that this mix has been stable. However, I still worry that longer term these margins continue to compress. There are cash back cards today that offer 2-4 percent back, far exceeding the the 1.2 percent dollar equivalent offered by most Aeroplan cards.
I'm still thinking through a burn vs. earn scenario where redemptions start upticking but do acknowledge the historical average has been closer to 85 percent.
I think based on all the facts, one conclusion is that the bonds appear very well covered in a worst case (I.e. even if Air Canada leaves). This won't make us rich but these bonds appear very attractive versus shorter dated ig/hy alternatives.
|Subject||Re: Re: Re: Spread per Mile, Burn vs. Earn Ratio and Asset Sales|
|Entry||10/13/2016 01:11 PM|
afgtt- I can't say you're wrong about future margin compression. sounds like you've done more work on the credit card industry than I. for what it's worth, spend (the "earn") has been increasing recently from TD, which paused its marketing of their aeroplan card in 2015 during the uncertainty about interchange reform. (In retrospect, I should have mentioned that the dive in these preferreds was likely due, in part, to the 2015 declines YoY in points earned) now they're back to normal levels of promotion.
You might take a look at row 39 in my spreadsheet - it's currently hidden. this is the total points actually burned by Aeroplan, combining points issued before 1992 as well as those issued after (today it's all post-1992 points being burned). compare this to points earned to get the burn/earn ratio. it's fluctuated within the same band for a long time. perhaps it's possible to get the 1984 - 1991 data as well ... you might try asking both Aimia and AC.
|Entry||11/09/2016 05:54 PM|
good quarter for Aimia, with pretty much every metric at Aeroplan moving in the right direction. Gross and cash margins widened by ~5% yoy due mainly to a drop in airfare costs, but mgmt cautioned that the drop was due to pretty unusual flight patterns on Star Alliance partner flights (i.e. international flights) and costs should return to previous quarter levels. [cash margins = (gross billings - cost of rewards)/gross billings]. PLM also continues to do quite well (recall that Aimia owns just under 50% of this JV ... basically a higher growth version of the Aeroplan loyalty coalition in Mexico).
not surprisingly, they're paying off the 2017 sr notes with cash on hand.
mgmt noted that the Cardlytics biz continues to grow but won't be ready to be sold in the near-term.
on the negative side, the Amex relationship was extended but only for a year. While total Aeroplan gross billings were up due to both price and volume, Amex gross billings declined modestly yet again.
Interestingly, when asked about Amex, mgmt commented that the extension of this contract by one year "also means that we have a bit more time to focus on the renewal of Air Canada as well." Call me crazy but that comment reinforces my belief that Aimia wants to renew the deal with Air Canada way, way ahead mid-2020. And early renewal would remove the market's big worry about this company.
|Entry||02/26/2017 06:26 PM|
decent 4q16 and 2017 outlook from Aimia. At Aeroplan, gross billings were up yoy on flat volume and a ~2% increase in price. Gross billings from Air Canada were up 5% yoy. Cost per mile redeemed up ~1% due to higher mix of airfare vs other rewards (margins on airfare are a bit lower) as Air Canada has been growing its capacity.
I estimate Aeroplan SG&A was up a bit too, but hard to say since the company no longer discloses the exact number. In any case, not too worried as company-wide opex came down by ~$17m in constant currency in 2016 (excluding temporary transition costs of outsourcing their IT to HP). Headcount down ~7% in the year. Mgmt said the decline in opex will continue in 2017 but didn't commit to a target. Also said capex will continue to decline.
Total $ paid to AC for Market Fare flights rose a couple % (~$180m to ~$185m) in the year.
As expected, they paid off their Jan'17 bond with cash on hand, but they generated so much cash toward year-end that the current level of excess cash ($100-130m) is roughly where it was when I posted this idea.
Adjusted FCF was $206m in 2016. Mgmt defines this as cash from ops less capex, adjusted to exclude one-offs like severance payment and one-time lump sum payments to/from credit card issuers related to long-term contracts. Guidance for 2017 FCF is $220m (ex one-offs that is ... I don't expect any significant one-time expenses aside from perhaps severance related to opex reduction). That $220m is simply the $206m in 2016 plus $14m savings on interest expense from the paydown of debt. Given guidance of higher gross billings, lower opex, lower capex, and rising dividends from PLM I suppose this forecast could be conservative. Or perhaps it's assuming sales of some FCF+ businesses ... they currently have assets with ~$150m in revenue on the block.
PLM by the way continues to do well. Growth in gross billings varies year to year but the trend seems to be ~15% annually, while paying out most (all?) FCF in dividends.
|Subject||Re: Re: 4Q16|
|Entry||02/27/2017 05:28 PM|
I wasn't that impressed with CIBC's analysis. too high level and reliant on too many major assumptions. i prefer a more bottom-up approach starting with an estimate of the discount on Classic Fare seats. CIBC cites some numbers that are just plain wrong - e.g. Aeroplan does not buy 1.9m seats on AC annually ... some of those are on other Star Alliance partner flights. Also, they mention Scotia Bank as a potential financial partner if AC wanted to bring the program in house. I'm not sure how reasonable that is, given that Scotia's share of credit card purchases in Canada is small compared to that of either CIBC or TD, and even more so vs CIBC+TD+Amex who are all tied to Aeroplan. So I stand by my analysis and have a full position now.
Regarding a Rona/TA style outcome, I guess I need to look at how the rules on exchange offers for those issues compares to those of the Aimia prefs, as well as the compositions of the respective shareholder bases. Any chance you've done that regarding TA? It's nice to see that the TA offer got rejected and Lowe's only managed to scam $1 off the $25 par value from Rona pref holders.
|Subject||the dance begins...|
|Entry||04/28/2017 01:53 PM|
|Subject||Re: Re: the dance begins...|
|Entry||05/08/2017 12:57 PM|
definitely think it's the latter
|Subject||Re: Re: Re: Re: Re: AC intention to not renew|
|Entry||05/11/2017 06:13 PM|
Well today sucked. My apologies to anyone who invested based on this writeup. That said, it's far from clear to me how much of today's paper loss is really a permanent impairment of capital.
First let's take a quick look at the numbers. Aimia gave us a couple useful datapoints today. One is that Classic Fares represent ~50% of the flight rewards redeemed on Aeroplan in 2016. The other is that Classic Fares represent 1/3 of the $682M that Aeroplan spent on airfare in 2016.
We also know that about 30% of flight rewards are Market Fares (4Q15 presentation). Thus, 1 - 50% - 30% = 20% of fares are on other Star Alliance partner flights (i had assumed 14%). The cost to Aeroplan for Market Fare flights in 2016 was $185M. Finally, Aeroplan issued 1.9M flights to members in 2016. From all this we can deduce:
No surprise that flights on other Star Alliance partners are much more expensive - given AC's extensive routes in Canada and the US, almost all of these are probably international flights to some other country. As such, comparing the average cost of these flights to the rest is probably not apples-to-apples. But comparing the costs of Market Fares vs Classic Fares probably makes sense. And there we can see that Classic Fares seem to be priced at a roughly 26% discount to Market Fares, which is pretty close to my assumption in the writeup (239/325 - 1 = 26%).
In their press release today, AC said that it "intends to continue to offer Aimia redemption seats for Aeroplan members after June 2020, with pricing competitive with other third-party rewards programs." In other words, at rates similar to current Market Fare rates. So all else equal (more on that in a second!), if Aimia took them up on that offer and paid Market Fare rates across the board, that would mean an extra $81M (1/(1-26%) - 1 = 36% increase. $227M * 36% = $81M).
Somewhat surprisingly, management reiterated their guidance for $220M in free cash flow in 2017. An $81M hit to $220M would still leave plenty of room to pay the $17M of dividends on the preferred shares. Of course other things won't be exactly equal, but I think this little excercise helps frame the issue a bit. For a sanity check, note that the analyst at GMP Securities today estimated EBITDA post-June 2020 at $150-200M. With ~$260M of consolidated 2017E EBITDA, that's a hit of $60-110M. The analyst at RBC estimated a hit of $75M to post-June 2020 EBITDA. I don't yet know how they arrived at those numbers, but it seems we're all roughly as crazy.
As for what won't be equal:
Unless AC comes back to the table (more on this soon), Aimia needs to either find new airline partners fast (likely WestJet plus a US carrier - perhaps Alaskan Air or American Airlines) or take Air Canada up on their offer discussed above. Clearly the former is preferable to the latter, not only because the latter would be more expensive, but also because AC's seat availability will gradually decrease as they allocate to their own FF program. By laying out the post June 2020 future for the Aeroplan program, Aimia would hopefully avoid the "run on the bank" as hkup881 talked about, as members wouldn't feel compelled to use up all their miles in the next 3.1 years. (Note that as a last resort, Aeroplan could always re-write the rules on redemption any way they please, but at the long-run cost of pissing off members.)
Adding to the urgency, Aeroplan's contract with Amex (16% of gross billings) is up within a year. Thankfully the contracts with TD and CIBC (52% of Aeroplan gross billings) run through 2024.
Finally, Aeroplan does earn some fees for managing AC's FF program, but I doubt the profit (if any) on this amounts to more than $10M and is probably much less. Moreover, mgmt is now guiding to (as Fenkell mentioned) $70M in cost cuts by 2019, with some of that to be realized in 2018. And no, that's not related to the cost of serving AC, as it's coming before June 2020.
Capital allocation & AC:
Mgmt is drawing $200m on their revolver (which matures in 2020) to help pay off the Jan 2018 notes early, which saves a tiny bit of interest expense. Somewhat surprisingly, they kept the dividend intact and renewed the common share buyback program. When asked about buying back preferred shares, they basically said no comment. Finally, they're considering accelerating the existing program of asset sales. Biggest potential sale is their stake in PLM, though I'm not sure they could sell before AeroMexico agreed to an IPO. In any case, PLM is doing great and the US$ 1 billion estimate IPO value (mentioned in my writeup) puts AC's stake at roughly C$ 650M.
Part of me thinks they might be crazy for not suspending common dividends and buybacks and instead buying back preferreds or just hoarding cash. And they might be crazy. But I also think this might just be posturing as mgmt gave a lot of hints on the call that the dance with AC might not be over. For one thing, AC has apparently not yet served legally-required notice of intent not to renew - but they did tell their customers today that they won't renew - so I'm not counting on this. AC claims an NPV of $2 billion can be captured by going it alone, and pledged to provide details on Sept. 19th, so perhaps something good could happen before then. Frankly I can't imagine how they get to a $2 billion figure given the costs to set up all the systems to replace what Aeroplan does for them, and given that ~$81M delta between Classic and Market Fares. Also, keep in mind that if Aeroplan can line up some decent new Airlline partners (and mgmt did say repeatedly that they've planned for such an event), they could change redemption rules to incentivize members to redeem their miles on WestJet or whomever vs AC, which could mean as much as ~$400m in lost revenue to AC, not to mention the potential for pissing off AC's best customers.
Lastly, I do appreciate the discussion here, especially hkup881's insights into the loyalty industry. If anyone would like to see my model, let me know and I'll post a link.
|Subject||Re: Re: Re: Re: Re: Re: AC intention to not renew|
|Entry||05/12/2017 12:10 PM|
So AC has served their legal notice that they do not intend to renew. I'd therefore advise them to halt the dividend after paying the one they just declared.
And a clarification:
when I said that Aimia needs to find a new airline partner(s), I should have said this is for two reasons, not one. The "run on the bank" risk is real, but with just over 3 years to go on the current contract they should have time to line up something that preserves the value of Aeroplan miles in the minds of consumers. The bigger risk - I believe - is that Aeroplan card holders start to shift their spending to the other cards in their wallet, causing gross billings to drop overall and particularly with Amex, should such a trend cause them to not renew their one-year contract.
|Subject||Re: Re: Re: Re: Re: Re: Re: AC intention to not renew|
|Entry||05/12/2017 12:39 PM|
one more thought: after mulling it over, I just don't see how Calvin Rovinescu gets to a $2 billion NPV over 15 years from this move, unless one or more of the following are true:
a) Aimia will fail to line up a decent contract with a new airline partner(s) and thus continue buying AC flights at whatever terms he dictates (maybe, but I doubt it)
b) AC can create its own full-blown loyalty coalition (which I don't think will be easy)
... and perhaps even sell miles to coalition partners at higher prices than Aimia was getting. I've heard anectodes of US airlines with their own internal loyalty coalitions who supposedly are able to charge a really high spread between the price they get from coalition partners for miles and their cost to provide the flights. I'm talking about a spread way higher than what Aimia gets. Said airlines don't typically disclose such metrics so who knows. In any event, Aimia deliberately lowered their own spread a few years ago as Aeroplan members were starting to really hate Aeroplan. Main complaint was lousy availability of seats ... Aimia fixed this at a cost to its gross margins, but in so doing prevented a decline in gross billings. It was the right move. Not sure how AC could extract higher prices than could Aimia.
The biggest $ savings for AC that I can imagine is more than offset by potential loss of $ from flights redeemed with miles earned with other coaliton partners e.g. TD, CIBC, gas stations and other frequent-purchase retailers. These likely account for well over $400M a year in revenue to AC, often for seats that would have gone unsold.
Not saying he's crazy. Just sayin' I don't get it. Sept. 19th will be interesting.
|Entry||05/16/2017 12:14 AM|
I did some diligence and spoke with industry folks. This seems to me quite dire. The general situation that was described to me is that the core aeroplan member is a frequent flyer and often a business traveler. They are in the aeroplan program for one reason - to get great deals on air canada flights. These people are not looking to exchange their points into a toaster oven...they want flights, and quite specifically flights on air canada. I think something like 85 or 90% of redemptions from the aeroplan program are on air canada/star alliance. There is no substitute. Westjet is with Rbc and things are going quite well there....there are no other options. You may have noticed a $3.2b liabilitity on aimia's balance sheet. Some portion of this will be turning into negative cash flow in the very near future....not all of it, but a good chunk.
A few things are going to happen
- the card issuers are going to see new card accounts grind to a halt (who is going to be running out to sign up for a new aeroplan card right now)?
- some portion of aeroplan members will shift their spend to other cards or switch to another card altogether
- redemption activity will tick up and breakage will go down. Not a run on the bank i dont think, but keep in mind this is absolutely everywhere in the news in canada....on the margin, people are going to look to gobble up those miles and make sure they get used. Of course you will say aeroplan can just change the value of the points to disincentivize ppl to redeem out....but we all know that is really the end, because you just p*ss off your already angry customer, which will drive further behavior noted in points 1&2 above.
the dynamics noted above shall all lead to negative cash flow, perhaps enormously negative cash flow.
Anyhow, please tell me where Im wrong and why I havent wasted 48 hours or research time, Im all ears!
one wild card idea that i heard is that air canada is using this as a ploy to acquire aimia at a discount. If that is the case, id love to own air canda stock and i wouldnt want to be at the same poker table as those guys. I doubt that is what is going on though...
|Subject||Re: Re: Re: Cooked goose|
|Entry||05/16/2017 04:37 PM|
hkup and fenkel, you guys make some good points. the only one i do not understand is the "600mm in cash flow over the next three years". where does that come from? the agreement with air canada extends for 3 years, but part of the point i was making is I would expect the cash flow of the business to immediately go down drastically, likely to zero or to negative- because spend on aeroplan cards will definitely go down immediately (hard to know how much) and redemptions will increase. this is another way of saying their deferred points liability will start going down immediately (not in 3 years) and will be a large consumer of cash. for the frequent flyer, why would that person continue to use the aeroplan card - seems like they will migrate their spend away quite quickly.
I understand that the other businesses have value, but it is hard to understand the relevance of aeroplan without air canada, and they will need to work off the liability in some form as aeroplan winds down
|Entry||05/16/2017 06:10 PM|
... for use in your own analysis of "how cooked is this goose?"
A) -$78M = incremental cash flow loss from no longer managing AC's FF program. This is takes all the miles earned by members for flying on AC and calculates how many of these miles are redeemed for flights on AC, for flights on other Star Alliance airlines, and for non-airfare rewards. I estimate the costs of these to Aeroplan in 2016 were roughly $110m, $33m, $26m respectively, or ~$170m total. Meanwhile, Aeroplan received $248m in gross bilings from AC. 170-248=-78m
B) -$61M = cost of paying Market Fare rates on all Classic Fares purchased with miles not earned by flying AC. Keep in mind that when AC offered to continue making seats available for Aeroplan members post June 2020, they weren't doing so out of kindness. Aeroplan paid $434m to AC in 2016 for flights earned outside of AC's FF program. This would be nearly $500m if all of it had been priced at Market Fare rates.
C) +$70M = Aimia's targeted cost savings in 2019
Clearly there are big uncertainties regarding what other Airlines Aeroplan can partner with, and how soon, and how Aeroplan card useage will change, and how TD, CIBC, and Amex will change their promotion levels for Aeroplan cards.
One way to look at it might be to say that if I'm right about A, B, and C, then just prior to June 2020, runrate Aimia free cash flows would have to drop from around $220m today to ~$86m before coverage drops below 1.0x on the preferred dividends. (Bonds should be paid off by that point, thus no interest expense.)
Again, that's: 86m runrate FCF prior to june 2020 - 78m - 61m + 70m = 17m post-june 2020 FCF = 17m preferred dividends
|Subject||Re: Re: some numbers|
|Entry||05/17/2017 11:21 AM|
hkup- yes, I agree there is probably some SG&A that goes away. Hard to say how much so I just ignored it, which would be erring on the side of conservatism.
I've got to think that the $70m doesn't include cost to process ACFF customers. That would be an egregious error.
|Subject||Re: Re: some numbers|
|Entry||05/17/2017 11:31 AM|
Fenkell- yeah, I suppose that's not too bad given that AC chose the nuclear option. thanks.
As for the equity, I guess I'd want to see the CEOs of Aimia and WestJet having drinks at a bar, laughing their asses off and slapping each other on the back.
(ok, that's exaggerating a little, but I do think the analysis required on the preferreds is a good deal simpler than it is for the equity, and i've got a strong preference for simple.)
|Subject||Re: Re: Re: Re: some numbers|
|Entry||05/17/2017 04:52 PM|
they're cumulative, so mgmt can't pay dividends to the common until preferreds are all caught up on their dividends. I suppose mgmt could suspend all dividends while they gobble up common shares, but to what end? Eventually shareholders are going to want dividends as Aimia has not proven itself capable of being a growth story.
|Subject||Re: Re: Re: Re: Re: Cooked goose|
|Entry||05/17/2017 05:18 PM|
On thing I dont understand is that you suggest the deferred liability on the balance sheet is not a real liability because the vast majority is already broken. I think the liability on the balance sheet is already net of the company's estimate of breakage, in other words the liability reflects the actual amount of miles that the company expects people to really redeem over time. take a look at note 16 in the annual financial statements, which is followed by:
Aimia may be required to provide rewards to members for unexpired Loyalty Units accounted for as Breakage on the
Loyalty Units issued to date for which the revenue has been recognized or deferred and for which no liability has
been recorded. The potential redemption cost for such Loyalty Units is estimated to be $860.6 million at
December 31, 2016.
In other words the $3.2b is already net of the amount that the company estimates is broken and shall never be redeemed.