Piles of Miles
United, seeking more just-in-case cash, taps Mileage Plus to reassure lenders
Like an overcautious squirrel gathering nuts for the long winter, U.S. airlines continue to stockpile more and more cash… just in case. Just in case the current traffic recovery stalls. Just in case international travel restrictions remain in place for many more months. Just in case the economy gets even worse. Just in case it’s years before corporations start buying premium seats again. Just in case there’s a much-feared second wave of Covid-19 in the fall.
Last week, United announced the industry’s biggest borrowing binge yet: A plan to raise another $5b from investors, on top of the $2.8b it borrowed from banks this spring, and another $1.5b it needs to repay Washington as part of the latter’s payroll support program. The airline, in April, also issued $1.1b in new shares. What’s most interesting about United’s latest mustering of more capital, however, is not how much it wants to borrow. It’s the collateral it’s using.
In a first for U.S. airlines, United is turning to its loyalty plan to reassure prospective investors. If the airline fails to repay, worry not. Lenders would then have access to the valuable assets of Mileage Plus. That should be a lot more reassuring, United assumes, than the basket of aging planes it offered as collateral in a $2.3b attempted bond sale that flopped last month.
In marketing the new offer, United unveiled a treasure trove of details about Mileage Plus, the first time any U.S. airline has opened up about the finances of its loyalty plan. Not that it was any secret that these plans are giant profit contributors. But now the world knows just how giant.
Mileage Plus, United disclosed, currently has more than 100m members, generating $5.3b in cash sales last year (12% of the company’s total revenue). More impressively still, the program produced more than a quarter of the airline’s total 2019 operating profit (excluding depreciation and amortization). Its operating margin excluding depreciation and amortization was a lofty 34%. Membership has grown about 9% annually since 2017. Revenue from members, which account for more than half of the airline’s total flying revenues, has grown 10% annually. In the past three years, revenue from non-members has grown at just half that rate. Premier status members, meanwhile, spend 14 times more than non-premier members. Premier status members with a United-branded credit card spend 25 times more.
Of the $5b-plus in cash Mileage Plus generated last year, 29% was an inter-company transfer from United, registered when members earn miles by flying the airline, or flying with a partner airline. When this happens, United “buys” the miles from Mileage Plus for a penny per mile, plus some formula-determined margin. Members can also buy miles directly from Mileage Plus, which is also included in the 29% figure. More interesting though, is the other 71% of cash Mileage Plus generates by selling miles to third parties. Chief among them is JP Morgan Chase, which offers popular credit card products in a joint agreement with United and Visa.
The three companies recently updated and extended their contract, which was previously not as lucrative for United as the co-branded credit deals that American and Delta had with their partners. The new United-Chase-Visa arrangement now runs through 2029, requiring monthly purchases of miles, at a margin of at least 20%. As a general rule, United charges third parties two cents a mile. When a customer redeems miles for a seat on a flight, another inter-company accounting transaction occurs: Mileage Plus buys the seat from United, paying one cent a mile. The plan’s core profit is thus the difference between the two cents a mile it’s getting from third parties, and the one cent a mile it’s transferring to the airline.
But doesn’t United stand to lose money if someone redeems miles for a seat that a paying traveler might have otherwise paid for? Airlines call this displacement. What about people who redeem miles that would otherwise readily pay money for that same seat? This is called dilution. Fortunately, carriers have sophisticated revenue management software to mitigate these risks, carefully controlling how many award seats are available, and requiring more mileage for seats deemed more valuable. The broader point of these programs, of course, is fostering customer loyalty, so that people who spend the most money with the airline receive the most benefits. That means more miles, yes, but often more importantly, it means perks like seat upgrades, airport lounge access, and so on.
Generating billions in mileage sales to third parties, fostering loyalty… no wonder these plans are so valuable. They’re all the more so, in fact, in the age of big data, supplying the personal information to enable more customized and personalized sales and service. The risk of course, is if United ultimately can’t repay the $5b. It would then lose this incredibly valuable asset. In times of distress, airlines like Air Canada, Virgin Australia, and several carriers in Latin America felt it necessary to sell ownership stakes in their loyalty plan. All wished they never did, and ultimately repurchased full control. The point is, losing full control of a loyalty plan is something no airline ever wants to experience.
But United is betting that the risks of not having enough liquidity are greater. It will certainly have a lot of the latter, expecting roughly $17b in available cash or cash-like assets by the end of next quarter. That includes the $5b it hopes to get through this latest Mileage Plus-secured borrowing, plus another $4.5b it can borrow from Washington if needed. It also has an undrawn $2b bank credit line. It would take a lot more than even Covid-19, in other words, to put United at risk of another bankruptcy in the near-term.
But will it ultimately be able to repay roughly $9b worth of newly borrowed money over the coming decade? Interest rates are helpfully low. And for now, demand for air travel is recovering faster than expected. United said last week that domestic demand is steadily improving, with even some unspecified international routes showing signs of life. Ticket cancellation rates are down about 70% from their April highs. Since the end of May, net bookings (new bookings minus cancellations), have been positive. Load factor was just 16% in April and 35% in May. June should see an increase to about 50%. July’s figure should rise to 55%. Even in July though, passenger ticket revenues will likely be down as much as 88% y/y, on about 75% less ASM capacity. Other U.S. airlines are reviving capacity much faster, even excluding international routes.
United’s cargo revenues though, are up sharply y/y, supporting the international flying it’s still doing. Including cargo, total revenues for all of Q2 will be down about 88% y/y, keeping in mind that this includes the awful month of April. Mileage Plus is itself continuing to sell miles, expecting $300m to $350m in revenue net of redemptions this quarter. In fact, during April and May, the program’s cash flow improved y/y thanks to a sharp drop off in members redeeming miles for seats. In addition, as members cancelled trips they booked with miles, United transferred back cash to Mileage Plus. It’s just bookkeeping, yes. But in the event of a default, lenders would be able to seize that cash. Dangling another enticement, United noted that during the 2008-09 recession, the airline’s revenue declined 19% while Mileage Plus revenue only declined 2%.
United’s overall cash burn, meanwhile, should drop to about $30m a day in the third quarter. Like the rest of the industry, it’s slashing operating costs and capital costs. And it’s preparing for the critical day Oct. 1, when government funding for payroll expires. With everyone expecting corporate demand, premium demand, and intercontinental demand to still be largely dormant by then, all airlines are in the process of heavy downsizing. United, unfortunately, depends more on these three market segments than any of its peers. Even before the crisis, CEO Scott Kirby felt his airline was underweighted in domestic markets, the result of excessive cutting during its years in bankruptcy (late 2002 to early 2006). Last week, Reuters reported that United is now sweetening its offer to front-line workers who elect to leave the company voluntarily. To avoid involuntary job cuts this fall, it needs “a lot more people to sign up.”
Speaking via video with the Global Business Travel Association (GBTA), Kirby said the airline is acting conservatively with respect to restarting flights, suggesting rivals might be taking too much risk in restoring service prematurely. United, he said, can restart flights within 30 to 60 days when demand truly merits. He spoke, incidentally, before JetBlue’s declaration of war on United’s Newark hub (see Routes section). Kirby sees a second wave of Covid as a risk for airlines this fall. Only when there’s a vaccine will the industry return to 100% normalcy. He himself will start hitting the skies this week, meeting with employees at airports, and so on.
In a separate interview with Cranky Flier’s Brett Snyder, United’s network and alliance chief Patrick Quayle spoke of heavy pent-up demand visible in forward bookings. United is keeping planes and crews active and ready to return on short notice. And while the airline needs to rethink its network to reflect new realities, its hubs in America’s largest cities (i.e. New York, Chicago, San Francisco, Los Angeles, Houston, Washington) remain a major strength.
But what’s the future of its large Asian franchise? How about London, Tokyo, and Frankfurt, its three largest overseas markets? Unlike Delta and to a lesser extent American, United helpfully doesn’t hold ownership stakes in its partners, other than modest positions in South America’s Avianca and Azul. Back home, it’s the smallest of the Big Three in Florida, where demand is already returning. It is possible of course, that the corporate intercontinental premium demand that United depends on returns sooner than expected. It’s not too far-fetched to envision the second half of 2021 characterized by robust global demand growth, fueled by vaccine protection, massive government economic stimulus, cheap fuel, and raging pent-up demand. United is certainly not betting on that. On the contrary, it’s insuring itself against things getting even worse than they are now. Hence the latest round of heavy borrowing, this time backed by the company’s crown jewel: Mileage Plus. Just in case.