Points International Ltd. PTSEF
February 06, 2008 - 9:20am EST by
2008 2009
Price: 2.50 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 390 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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Every now and then, an internet company comes seemingly out of nowhere and, before many people have even heard of it, develops a market cap or acquisition value in the billions. I believe that Points International might be another such company although, like any company with that kind of potential, the stock is clearly overpriced on the last twelve month’s numbers.
Trading Miles for Dollars:  PTSEF has developed a central marketplace (www.points.com)  for the exchange of loyalty points (e.g., frequent flyer miles), letting the public trade points between one program and another, buy additional points, or spend points like cash with various vendors, including Wal-Mart, Amazon, and iTunes.  By providing an easy way for the public to monetize their points balances, PTSEF provides a new source of near-cash to consumers, which should attract some notice as the economy slows.  At the same time, when consumers use their points, this enables the program sponsor to immediately eliminate from their balance sheet the liability those points represent.  Since consumers will gladly trade in points at a discount from the sponsor’s balance sheet value to get things they actually want, that differential, minus the cut for PTSEF, flows directly into the sponsor’s operating income.  To further encourage consumers to use their otherwise stranded points, PTSEF recently started a peer-to-peer exchange through which one can trade points of various programs with other individuals, at exchange rates they negotiate themselves.
PTSEF is already the dominant processor in the rewards points field, exclusively handling the operations of 13 of the 25 largest loyalty programs, including 7 of the top 10.  Any loyalty program that allows members spend points with many popular vendors,  and even use them with competitors, will be viewed by the public as a more valuable perk than a traditional program, that is useful with only that sponsor.  Creating consumer preference for one’s business is the whole point of having a loyalty program, and only PTSEF, as an independent middleman, can facilitate that. This gives an incentive for those program sponsors not yet using PTSEF to join up to allow their members access to this marketplace.  In other words, there is a “network effect” at work, or perhaps one could say this is potentially a natural monopoly.  The loyalty program market is surprisingly huge, with The Economist estimating the value of unredeemed points outstanding worldwide in the neighborhood of $700 billion.  That may be high, but discount it by 90% and it still represents a market that is massive relative to PTSEF’s $390M fully diluted market cap.
Services to Businesses:  PTSEF began business about eight years ago as a provider of transaction processing services to rewards programs.  CEO Rob MacLean started with the company then, having previously been in charge of Air Canada’s very successful program.  PTSEF is based in Toronto and numbers are recorded in Canadian dollars, although by far most of its business comes from the US.  In addition to the PTSEF symbol in the US, it trades as PTS in Toronto.  Trading tends to be a bit more active in the US than in Toronto.
Services in which PTSEF is paid by the rewards programs themselves, rather than individual consumers, represent about 85% of PTSEF’s revenues.  PTSEF has developed a robust technology that debits and credits points in real time across multiple platforms.  It facilitates consumers redeeming, buying, transferring or gifting points and manages accounts.  Some of its larger airline partners now include Alaska, American, British, Delta, Lufthansa, Northwest, US Air and Virgin Atlantic.  Some non-airline rewards programs whose programs are operated by PTSEF include American Express Membership Rewards, and a variety of hotel chains, such as the Priority Club (Holiday Inn, Intercontinental, Crowne Plaza, etc.), Trip Rewards (Ramada, Travelodge, etc.) and the Starwood program.  If you go into any of those sites, and try to do something with your point balance, your transaction is actually being handled by PTSEF. 
The only alternative to using PTSEF is if a rewards program operator does all the processing internally, since there are no other third parties in this business.  This requires investments in technology and people that usually would be better spent on the operator’s core business.  Even if a given operator develops a high quality proprietary system internally, it is unlikely to take on any outside customers to spread the costs, since Airline X would never want Airline Y to have access to its loyalty program member database.  PTSEF is not in the airline, hotel, or any other competitive business, and is therefore trusted with that information. 
The total membership in PTSEF partners’ programs is over 300 million, representing perhaps 50+ million individuals, since many people are members of multiple loyalty programs.  PTSEF is typically paid a mix of fixed sums based primarily upon the number of members and the level of services, and varying commissions to handle specific member transactions.  Clients have contracts that last varying number of years, and so far almost all have been renewed, except in cases where the client dropped its rewards program or was acquired (often by another PTSEF client).
A factor that is starting to have a positive impact on PTSEF’s sales and earnings is the growth in what PTSEF calls its principal model.  With the ability to study the results of various offers and promotions over the years over its entire customer base, PTSEF believes it has insight into what will work to induce people to make use of their otherwise idle points balances, and to buy more miles to use as currency.  Rather than waiting for its corporate client to think up and implement these offers, and earn a small fee for handling the transactions, PTSEF is now going to clients with specific proposals in which it will purchase miles wholesale at a discount and, in effect, resell them at a premium by offering consumers attractive deals.  While this does entail a small amount of risk on PTSEF’s part, it generates new business and offers substantially higher margins.
Services to Consumers: In addition to doing transactions with consumers who use the websites of its corporate partners, PTSEF operates the www.points.com website.  This offers a convenient central place for members of that site (about 1.8 million) to keep track of points in all their programs.  Through the site members can trade points from one program to another, or use their points to book travel packages through Travelocity involving transport, hotels and car rental.  They can also turn their points into credits that can be used with hundreds of different merchants, such as Amazon, Home Depot, Starbucks, Circuit City, Best Buy, Macy’s, Sears, Avis, Target, and numerous restaurants.  I recommend bouncing around the site to see all it offers.  Or join—it costs nothing.
One new merchant, as of last week, is the iTunes store.  I have a couple young nieces, and as far as I can tell, their craving for more tunes is constant.  Should the word get out that iTunes gift cards can be bought with otherwise idle frequent flyer miles rather than cash, this could push many a parent into signing up for points.com membership.
A new program at the website, still in beta, is “GPX”, which stands for Global Points Exchange.  This allows members to trade with each other, exchange points between programs at rates they negotiate.  As with the swap trades at official company rates, PTSEF gets approximately 15% of the value of the GPX trade in fees.  I wouldn’t be surprised if that fee gets cut if, as I expect, PTSEF eventually determines that a lower fee would stimulate enough extra trades to increase its total take.
With only a few percent of all those who hold of rewards points being registered www.points.com, one can fairly say that PTSEF has not done a good job of raising public awareness of the site and the benefits of free registration.  One would think that loyalty program operators, interested in getting the unused points liabilities off their balance sheets at a discount, would promote the points.com website, but that doesn’t appear to have happened yet.  Nor have the merchants reminded people that there is a way they can buy things without having to make their credit card balances worse, provided they join points.com and spend their points instead.  I have no reason to think that the company will get any better at marketing, but I believe that the value of the service to consumers is so high that some combination of word of mouth and mention by bloggers and consumer reporters will eventually spread the word.  One word from Apple to cash strapped teens, that their cash strapped parents with extra miles can still keep them in tunes, would do the trick.
Why Both Sides of a Transaction Gain: The arithmetic on cross platform transfers is interesting.  You may have miles in your account at an airline that, realistically, you are unlikely to use any time soon or ever.  They do you no good, and your not spending them does the airline no good, since they sit on its balance sheet as a liability, let’s say for this example at about ¾ of a cent per mile, which is what the airline estimates it will cost to fly you somewhere if you were to use them.  Suppose you discover through your membership in www.points.com that you can spend them on something you actually want at one of the merchants mentioned above, but they will only be valued at ½ of one cent.  Will that bother you?  Probably not, because they can buy you what you want now, as opposed to sitting there until you care to use them with the usual Frequent Flyer problem--the airline will fly you to someplace you don’t want to go, at a time you don’t want to go there.  The ½ cent is viewed as found money, and you don’t really care what the airline values it on its books.  At the same time, the airline will be happy to pay ½ cent plus a fee to PTSEF to get rid of the ¾ cent obligation; it is cheaper, the difference goes into operating income, and it makes you, the consumer, more willing to fly that airline, because you know that its rewards program can get you things you want.
To summarize, there are tens of billions of dollars worth of rewards points sitting on the liability side of corporate balance sheets.  Some unknown but probably large percent of those miles are held by individuals who would be delighted to use them somewhere other than the program in which the points reside, and will accept a much lower value per point to do so.  This is good for the consumers, good for the corporations, and PTSEF is the middleman. That is a powerful position.  As the economy weakens, the ability of consumers to buy things without having to use either their cash or their credit is a concept that is right for the times, and could spread virally.
Revenues Take Off:  PTSEF’s numbers have been rising rapidly.  Sales in the September quarter were C$7.1M vs. C$2.8M.  The company’s guidance was for sales to jump to the C$14M to C$17M  range in Q4, giving it C$31M to C$34M for the 2007 year vs. $12M in 2006.  The most recent guidance for 2008 had sales in the C$65M-C$75M range, hardly a brave forecast since Q4 2007 was already pretty close to that pace.  Guidance for 2007 started out at a good 40% below what appears to be the final number, so $85M or above seems plausible for 2008.  Fully diluted market cap is about 4.6 times that sales estimate; hardly cheap, but not crazy for an internet company with a dominant position in its field and such rapid growth.
There most likely was a small positive EBITDA in 2007 and there should be a much larger one in 2008, with perhaps a nickel or so in EPS in 2008, again, not enough by itself to impress most VIC members.  But, like an online brokerage firm or other transaction based internet companies, there is a large fixed element to PTSEF’s cost structure; transactions are handled entirely by computer, thus the marginal cost of each trade is close to zero and the impact on profits of a surge in popularity would be impressive.
The biggest risk to its business would be another 9/11 type terrorist incident that puts a halt to travel, since that is the primary way people gain rewards points, and also how they spend them, although decreasingly so as PTSEF adds more traditional retailers as vendor partners.  Recessions are bad for airline and hotel business.
On the other hand, consumers don’t have to add to their points balances for PTSEF to do well.  Rather, consumers in the aggregate have large points assets that, because of PTSEF, they can now tap to spend.  Given the squeeze on consumer finances of late, I don’t believe this will go unnoticed for much longer.
The balance sheet is fine, and the business is not capital intensive.  IAC/Interactive Corp. (IACI $24.55) provided early financing and owns about 19% of PTSEF’s equity in the form of a convertible preferred.  There is a complex battle for the control of that company, and it is conceivable, although unlikely, that this could somehow put PTSEF into play.  The stock is volatile; PTSEF was under $2 in October, over $4 in December, and back under $2 two weeks ago.  I can’t guess whether the next half point will be up or down.  I think that, given conditions in the economy, and the tremendous value PTSEF provides to both consumers and their corporate rewards program partners, that there is a plausible chance that in the next year www.points.com and PTSEF could go from being relatively unknown to very popular.


For consumers, a value proposition that fits the times. The word spreads that, using PTSEF's points.com website, one can use otherwise idle rewards program points to spend as cash.
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