Buying a very stable high recurring business tied to consumer growth and credit card growth in Brazil, with the ability to get paid 55% of the market cap in cash over 2 years, and then own the business for 4x FCF.
Overview: Mulitplus is the largest loyalty program in Brazil with 2.5 million active members or 6.3 million total members. It was renamed from TAM Fidelidade to Multiplus and spun out of TAM (leading airline in Brazil) in February 2010. As an independent company, the company plans to expand its business into a full blown loyalty program rather than purely the frequent flyer program of TAM. Currently, approximately 25% of its gross billings comes from TAM, ~75% of its gross billings comes from its co-brand credit card and other financial partners and 1% billings from other commercial partners. Over 95% of redemption is for air travel with TAM. Going forward, Mulitplus intends to model its business after Aeroplan in Canada by leveraging its relationship with TAM as an anchor partner and aggressively sign additional issuance (better pricing and diversification of revenues) and redemption partners to expand its network (lower cost of redemption as non-air travel rewards should have lower cost). The key attractiveness of this program to consumers is the ability to aggregate points into one program and redeem those points primarily for highly valued rewards. For example, Multiplus members can redeem a round trip ticket within South America for 20,000 points with no blackout date while a typical roundtrip plane ticket for travel within South America will cost hundreds of BRL.
Tremendous cashflow in next two years. 95% of the net IPO proceeds were used to pre-purchase future air travel rewards from TAM. Although the cash from the IPO is not on Multiplus' balance sheet (650M or 22% of market cap), it's a real asset to Multiplus that will come back in the form of cashflow to the company over the next two years. In addition, all points issued prior to Dec 31, 2009 are TAM's liabilities, not Multiplus'. This is tremendous value to Multiplus. Basically given the average life of a point is 1 yr (they actually expire if not used after 2 yrs), Multiplus basically reaps the benefit of not being responsible for 1 year's worth of cost of redemption while fully benefiting on gross billings. The combination of this and the pre-payment of air travel rewards allows Multiplus to generate 1.9BN BRL of free cash flow in 2010 and 2011 (that's 65%+ of current market cap). While the company is restricted in terms of amount of dividends that can be paid out, management has expressed the interest in returning cash to shareholders through other means (one of which is using the cash to buy back stocks owned by TAM).
Opportunity for significant growth in membership. Multiplus currently has approximately 2.5M active members which represent a 1.3% penetration of the Brazilian population vs. Aeroplan's penetration of 12%. Going forward, Multiplus will focus on increasing membership by (i) improving penetration of membership on TAM flights (<50% of passengers on TAM flights are Multiplus members), (ii) promoting Itau Co-brand credit card (according to the Itau credit card manager, there are currently 300k TAM co-brand credit cards which is very low when compared to LAN Chile co-brand card at 600k in a much smaller country), and (iii) focusing its effort in signing up additional partners. As part of TAM, Multiplus was run as just an airline loyalty program and wasn't as focused on maximizing the value of the business. We believe that Multiplus will become much more aggressive and motivated in expanding its partners network now that it is an independent company
Supportive macro environment in Brazil. Strong consumer credit growth expected in Brazil should benefit Multiplus given its partnership with banks. In addition, inflation and higher interest rates would also benefit the business given the points issued are based on purchase volume and the company's expected large cash balance.
Negative working capital. Multiplus' partners pay Multiplus for the points upfront while redemption happens down the road. This creates an attractive cashflow benefit for the business as the business grows
Operating leverage. Given the business is really a network of issuance and redemption partners, the business itself should have very good operating leverage excluding specific investments to grow network.
Extremely Attractive valuation. Assuming Multiplus just accumulates cash on the balance sheet after making its maximum allowed dividend payment (we actually expect Multiplus to figure out ways to return cash to shareholders as soon as possible), it will have ~1.9BN of cash on balance sheet by 2012. Excluding cash on the balance sheet, Multiplus will be trading at 4x 2012 FCF for a very stable business with significant growth. You are basically getting a great business, almost monopoly, 55% of cash back in two years, and then a business at 4x FCF.
Related party relationship. TAM may do things to benefit itself that may not be ideal for Multiplus. However, we have reasons to believe that it is in TAM's best interest for Multiplus to succeed. TAM owns 69% of Multiplus and will benefit from increased dividend coming out of Multiplus. Also, Multiplus, given its business commands a higher multiple and TAM will benefit from that.
Heavy dependence on TAM. For 2009, it is expected that approximately 25% of gross billings of Multiplus derives from TAM. In addition, over 90% of redemption of Multiplus points are for air travel with TAM. We believe that the value proposition and attractiveness of Multiplus to its customers and members depend heavily on TAM being a viable redemption partner. TAM has the leading market share for both domestic and international travel in Brazil and is the only airline that flies internationally, thereby having a solid positioning in the marketplace. Even if TAM were to lose some market share, the overall Brazilian market growth will still result in strong volume growth.
• Customer concentration. In addition to TAM, 4 of the top 5 banks in Brazil are also major customers of Multiplus, combining for ~75% of Multiplus' gross billings in 9M2009. Loss of any of these banks as a customer or a material decrease in pricing could have a material negative impact on Multiplus' business. However Multiplus already has long term contracts with these banks, and our checks indicate that Multiplus position continues to get stronger given its market share and relationship with TAM (international travel).
Multiplus is a recent IPO and has not yet received attention. Further, on the surface it looks expensive on EBITDA multiple. It requires going through the filings to realize that you will basically get 55% of the company back in cash in 2 years, significantly limiting your downside, and that the stock trades at a ridiculous FCF yield thereafter.