Frequent Flyers For Sale - The Ultimate Reward For Qantas
Sydney Morning Herald
Friday March 21, 2008
One of the great examples of corporate good fortune was the failure of Qantas management and private equity to privatise the airline last year. The debt market tsunami would have taken a devastating toll on a highly geared airline.
So much for plan A. Plan B - to spin out some larger divisions - also has its troubles thanks to the fallout in equity markets. The first cab off the rank is to be the frequent flyer business and Morgan Stanley is already undertaking somework in readiness for a partial float. Qantas boss Geoff Dixon would dearly love to see some of these assets liberated with a view to the "parts" being more fully valued in Qantas's share price. The airline began warming up investment markets a few weeks ago when it broke out the earnings contributions of some parts, including the frequent flyer business. The market has been tantalised by frequent flyer companies since Air Canada freed its loyalty subsidiary Aeroplan - which is now capitalised at more than the airline. This won't be quite the case with Qantas. In the first instance it will retain majority ownership in Qantas Frequent Flyers after the float, and its airline business is in far better shape than Air Canada, which filed for creditor protection in 2003 (although it has since been restructured and revived). Even so, Qantas Frequent Flyers' contribution to Qantas's pre-tax earnings was less than 7 per cent in the half to December, coming in at about $62 million. According to broker estimates, Qantas Frequent Flyers is worth from $1.5 billion to $2 billion - about a quarter of the market capitalisation of the airline. One of the reasons the Aeroplan business is considered more valuable than the airline that once owned it is that the market applies a much larger multiple to the loyalty company's earnings. This is because investors see growth opportunities in these reward programs and they see more reliable and less volatile earnings. However, the half-year earnings from Qantas Frequent Flyers did not demonstrate much growth compared with the main airline, which roughly doubled. And Qantas Frequent Flyers will want to provide some demonstration of stronger growth before it goes into fully-fledged public offer marketing mode. This requires a two-pronged approach. The first is to increase redemptions of miles earned. The second is to increase the ability of loyalty members to earn points. In July we will see the first part of the plan move into action. Qantas will move to the model used by many loyalty programs around the world whereby members can redeem seats much more easily. Rather than restricting frequent flyer seats, any available seats can be used - but at a greater points cost. In other words, you may be able to redeem points for a peak-hour flight between Sydney and Melbourne on Friday night but it will cost a lot of points (just like it would also cost of lot of money). So points will be costed just like airline tickets - according to popularity. The other side of this equation is to enhance the loyalty member's ability to generate points. This means bringing in new partners. The biggest partner will be Qantas, which will offer the most efficient way to earn flying points. Then there will be partner airlines, banks and financial institutions. As well, there will be insurers, car retailers and manufacturers. But there is plenty of scope to enlist more. Aeroplan has 70 commercial partners and more than 150 brands. Qantas Frequent Flyers needs lots more products - preferably ones used by the AB demographic - the same bunch that frequently fly. It then has to effectively market these new partners. Right now you can earn points for buying a Volvo. Qantas also sees an opportunity for members to use points to pay airport fees and taxes. It estimates that redemptions as a percentage of passengers will increase from 10 per cent to 15 per cent. It currently takes frequent flyers an average 2.2 years between earning and redeeming points. The hidden value in all this lies in the fact that Qantas generates profits when members earn points but doesn't recognise the profit until redemption. These unredeemed liabilities sit on the Qantas balance sheet. Macquarie Equities estimates the liability relating to outstanding points redemptions to be about $2.2 billion at June 2007 The beauty of Qantas Frequent Flyers is that its fixed costs don't move up much as the volume of redemptions increases. Its earnings should be less volatile than those of Qantas because its revenue comes from a number of retail, banking and service customers. The risks associated with the earnings are primarily about a fall in overall airline traffic thanks to a general fall in economic activity. And this may have a bearing on when this business moves into the public market. At this stage lift-off is scheduled for the end of the year - providing, of course, that the market conditions are more favourable.
© 2008 Sydney Morning Herald
