AIM.TO - Aimia

[ulysses02]

however, PLM smelled blood in the water, and all they need is one shareholder to make noise about demanding a vote etc., and then air canada and aeromexico will wind up stealing the pieces... but at least the theft will occur higher than current prices

 

Canadian takeover law requires 2/3 vote for an court-arranged (friendly) offer and 90% tender acceptance for a tender/takeover to completed. This is similar to most other Commonwealth M&A law (UK, Australia etc) i.e. doesn't unfairly overweight or underweight minority or majority investors. In this case, Burgundy and the Mittlemans own ~30% of AIM stock, so Air Canada's offer seems more like a starting bid than a serious tactic that would engender successful shareholder revolt.

 

Aeromexico's (Delta Airlines') offer on the other hand... no idea what they're thinking. In a fantastic scenario, they could withhold dividend payments from PLM for the next 12 years and then force a (discounted) redemptions run large enough to wipe out 2030's accumulated cash & assets, thus wiping out equity in a bankruptcy. So, that would mean they avoid paying an additional $200-$300M in fair value today for what upside/downside?

Upside: get the remaining 49% of PLM for "free" (assuming Aeromexico is PLM's largest creditor in the hypothetical bankruptcy).

Downside: risk damaging the brand (negative publicity of a redemption run) which at that point would be a major contributor to Aeromexico's economics, lawsuits etc.

 

Any other thoughts on the logic of Aeromexico's offer (aside from the "vultures-circling" point that's been made)?

 

 

[sculpin]

The bullish view on Aimia...

 

http://adventuresincapitalism.com/2018/07/27/air-canada-screwed/

 

[Cigarbutt]

Any other thoughts on the logic of Aeromexico's offer (aside from the "vultures-circling" point that's been made)?

 

The loyalty units that are pure frequent flyer programs are usually developed and kept as fully consolidated subsidiaries because they are profit centers. If you look at the airline industry, a significant amount of profit reported is from those programs.

 

Sometimes, like when ACE had to divest their frequent flyer program, which eventually became Aimia (loyalty coalition), financial distress was the factor behind the decision.

 

For Aeromexico (in 2010-2, Delta (with their SkyMiles) was not really in the picture), the frequent flyer program that they had developed did not seem to be particularly profitable and they saw an opportunity in Mexico to develop a loyalty coalition but did not have the expertise, so they needed a partner. They teamed up with Aimia and formed a legal structure that reflected the operating conditions then. The program has been quite successful and is up and running and Aeromexico probably determined that it would be best to try to opportunistically take the program completely in-house. I think they will maintain it and try to grow it but will try to buy back the minority partner whenever possible, paying the least possible, before 2030.

 

I think Aimia reached a good deal when they formed PLM but the only strategic buyer is the majority owner which diminishes their bargaining position in the interim. They could just hold on if they don't need the cash.

 

If you think the long term prospects for Mexico are good (middle class growing, more people flying etc) and realize that, unlike the Canadian market which is unusually crowded in the loyalty coalition space, as far as I know, Club Premier is the predominant loyalty player in its market, the future of this unit looks quite promising.

[StubbleJumper]

Incidentally, in my experience you can't fly without giving your passport number, so there's a unique identifier.

 

 

Nope, not needed for a domestic flight within Canada -- your name is good enough to book the ticket, and then you can show your driver's permit or other government issued photo ID at the gate.  Definitely needed for an international flight.

 

 

SJ

[StubbleJumper]

This is getting yet more interesting.  AIM is trying to negotiate with the One World alliance to find a partner for after AC's departure.  If that can actually be negotiated, that would be progress for program participants, but it still leaves a Canadian frequent flyer program without a domestic airline partner.

 

https://www.bloomberg.com/news/articles/2018-08-02/aimia-in-talks-with-oneworld-as-air-canada-deadline-looms

 

 

Time to bust out the popcorn!

 

 

SJ

[wabuffo]

I think the banks (credit card partners) are the ones who will either make or break this deal (TD/CIBC).  They have a lot to lose if there is no agreement.  I would not be surprised if they kick in something in order to raise the offer from the Air Canada consortium.

 

Leaking the OneWorld negotiations is a good negotiating tactic but its not relevant to what happens next.  I'm expecting an extension in negotiations and a raised offer but WDIK.

 

wabuffo

[SnarkyPuppy]

https://www.newswire.ca/news-releases/update-on-discussions-with-current-partners-regarding-conditional-acquisition-of-aeroplan-business-689938021.html

 

-Original offer upped to $325mm.

-Amia countering with $450mm. 

 

Seems low considering Mittleman valuing it at $1bn in SOTP

 

[wabuffo]

Seems low considering Mittleman valuing it at $1bn in SOTP

 

It depends on the other terms of the deal and how they handle the transition as it will affect cash flows during the transition back to AC and its consortium through 2020.  As of now though, they have no deal - unless the negotiations get extended.

 

AIM releases its Q2 earnings tomorrow am.  I'm sure we'll hear more on the current state of play from the new CEO on the CC.

 

wabuffo

 

 

[Cigarbutt]

Case study in the making.

IMO the divorce is official and AC will come back to the table only if they can offer less.

 

This investment rests now on the risk/reward of the transformation with AC lining up as a competitor.

 

 

The last Q2 results:

 

PLM continues to do very well

 

Q1:

Numbers for the core Aeroplan coalition program:

 

Accumulation activity (YoY variance, %):  2017    Q1:5,4  Q2:1,2  Q3:2,0  Q4:(0,9)      2018    Q1:(2,8)    Q2:(4,9)

Redemption activity  (YoY variance, %):  2017    Q1:3,9  Q2:1,8  Q3:4,7  Q4:9,9        2018    Q1:9,6      Q2:7,7

 

Can Aimia survive?

Aimia assumes decreasing redemption pressure going forward which appears to be optimistic.

They present their data rather well and one can reasonably make cash flow scenarios.

I would say they are likely to survive.

 

Can Aimia thrive (post June 2020)?

Interestingly, I find the new team more competent and that increases both the reward and risk profile.

Too hard for me and it will take a while to find out.

I see too many falling knifes.

 

This investment has definitely made it out of my circle. Good luck to the longs (common and preferred).

[StubbleJumper]

Case study in the making.

IMO the divorce is official and AC will come back to the table only if they can offer less.

 

This investment rests now on the risk/reward of the transformation with AC lining up as a competitor.

 

 

The last Q2 results:

 

PLM continues to do very well

 

Q1:

Numbers for the core Aeroplan coalition program:

 

Accumulation activity (YoY variance, %):  2017    Q1:5,4  Q2:1,2  Q3:2,0  Q4:(0,9)      2018    Q1:(2,8)    Q2:(4,9)

Redemption activity  (YoY variance, %):  2017    Q1:3,9  Q2:1,8  Q3:4,7  Q4:9,9        2018    Q1:9,6      Q2:7,7

 

Can Aimia survive?

Aimia assumes decreasing redemption pressure going forward which appears to be optimistic.

They present their data rather well and one can reasonably make cash flow scenarios.

I would say they are likely to survive.

 

Can Aimia thrive (post June 2020)?

Interestingly, I find the new team more competent and that increases both the reward and risk profile.

Too hard for me and it will take a while to find out.

I see too many falling knifes.

 

This investment has definitely made it out of my circle. Good luck to the longs (common and preferred).

 

 

 

A few observations:

 

 

1) Cash and debt are dreadfully similar.  AIM must repay its notes next year, and I have already questioned the likelihood of its revolver being renewed.  If that actual cash debt needs to be repaid and new debt cannot be floated, they'll have about CAD$200 of cash available.

 

2) The Burn-to-earn ratio of Aeroplan has turned unfavourable.  You have noted that the company inexplicably forecasts that this will stop in Q3 and subsequent quarters, but I don't quite understand how.  Some program participants are heading for the exits and burning their miles, while the credit card companies have significantly reduced their promotional credit card sign-up campaigns.  The trend is not good, and I don't understand why it would get better in Q3, especially since a large portion of the credit cards are issued by two of the banks making an offer to buy Aeroplan -- presumably any new promotional campaign would be contingent on a successful bid.

 

Is the burn-to-earn ratio near the tipping point where AIM goes cash-flow negative?  If they can't arrive at a deal with the AC consortium, this looks like a real dog.

 

 

SJ

[bizaro86]

They've announced they're going with Porter post 2020, which I think takes a deal with AC off the table.

 

Porter has very few vacation type destinations, and nor presence in the west. This feels like a mistake to me...

[StubbleJumper]

They've announced they're going with Porter post 2020, which I think takes a deal with AC off the table.

 

Porter has very few vacation type destinations, and nor presence in the west. This feels like a mistake to me...

 

 

My sense is also that this is a mistake.  If your only flying activity is Billy Bishop to Trudeau airport, you might be happy with this arrangement, but everybody else will need to join AC's new FF program. 

 

Perhaps there's some weasel language in their deal with Porter than will enable them to continue negotiating with the AC consortium?

 

 

SJ

[bizaro86]

If they're just using Porter to try and leverage a better deal from AC that's one thing, although that isn't what it sounded like to me. Of course, who knows what the actual contract says.

 

I think the AC deal on the table is better than a standalone Aeroplan with Porter as the main partner.

[wabuffo]

If that actual cash debt needs to be repaid and new debt cannot be floated, they'll have about CAD$200 of cash available.

 

The business is still generating cash every Q and they have many levers they can pull.  In addition to the cash on hand of $248m, they have $260m of bonds, and/or they can sell their stake in CDLX worth $70m.  Plus the business will generate $120m-$150m in cash between now and end of Q2, 2019.  As long as they continue to strand the preferreds, they will be fine while they work through the transition into the post-Air Canada world in 2020.

 

Is the burn-to-earn ratio near the tipping point where AIM goes cash-flow negative? 

 

I think these loyalty programs are really sticky.  Most of the points/billings come from credit card spend (TD/CIBC/AMEX) and as long as these cards are the consumers' primary credit card - they're kind of on autopilot and people don't think about the points or switching their cards.  It's the banks that have the most to lose here, if Air Canada doesn't make a deal with AIM and selects new bank partners for its new frequent flyer program.  Even then, there's a lot of inertia before people will switch cards. 

 

Look at the Air Miles fiasco a few years ago when the Air Miles program started to cancel points.  There was a two-quarter "run on the bank" but after Air Miles reversed its policy, everything went back to normal and Air Miles has seen no impact on its business.  As long as AIMIA doesn't cancel points outright by putting a time limit on using them, their liability will be very stable and its a Blue Chips stamps kind of liability with very high breakage over time.

 

If they can't arrive at a deal with the AC consortium, this looks like a real dog.

 

Well, if you listen to today's CC, you'll understand that AC's offer of $250m was a gross cash offer, and after onerous deal conditions were factored in, the net cash to AIM was a lot lower.  That's the part we don't have details on.  The cash part is the tip of the iceberg and the factors like working capital adjustments, mileage liability assumptions, breakage, which employees go with the deal, who assumes pension obligations for transferred employees, whether redemption contingency cash is transferred to AC or stays with AIMIA can swing the economics from cash positive to cash negative (ie, AIM has to pay AC to take Aeroplan).

 

I think AIM is fine because I think it will cost AC and the banks more than it will cost AIM if the deal breaks as their profit pools are bigger.  But that's what makes a market.

 

I do think the new CEO is terrific and "gets it".  Unfortunately, it looks like he's getting pressured hard by the lenders and the preferred holders who are absolutely panicking.  He also apparently is getting a lot of grief from major shareholders about the "lowball" $450m offer in the p-r.

 

wabuffo

[wabuffo]

My sense is also that this is a mistake.  If your only flying activity is Billy Bishop to Trudeau airport, you might be happy with this arrangement, but everybody else will need to join AC's new FF program. 

That's not what AIM is doing.  After 2020, they can and will buy seats on any airline -- including Air Canada.  That's why they are negotiating with OneWorld as well (American, British Airways, etc).  They're setting up for the post 2020 agreement termination. 

 

Yes, the frequent flyers may switch, but only a few have loyalty credit cards and they make only 17-18% of gross billings.  The key is frequent spenders (TD/CIBC/AMEX loyalty card users) who just want to fly when they want to fly.  AIMIA would still 'buy' seats on Air Canada at market rates (less a volume discount).  But AIM's buying power via credit cards would be 3x-4x AC's frequent flyer program and would lead to AIMIA steering flyers to OneWorld airlines/Porter.  These airlines would add capacity to Canadian cities since 8-10% of AC seat's belong to AIM today.  That's a lot of new planes on Canadian routes and a nightmare scenario for Air Canada.

 

If this threat becomes credible enough, Air Canada will have to come back to the table.

 

wabuffo

[StubbleJumper]

If that actual cash debt needs to be repaid and new debt cannot be floated, they'll have about CAD$200 of cash available.

 

The business is still generating cash every Q and they have many levers they can pull.  In addition to the cash on hand of $248m, they have $260m of bonds, and/or they can sell their stake in CDLX worth $70m.  Plus the business will generate $120m-$150m in cash between now and end of Q2, 2019.  As long as they continue to strand the preferreds, they will be fine while they work through the transition into the post-Air Canada world in 2020.

 

 

Ignore the bonds and instead think in aggregate.  Total cash and investments is $531m and total cash debt is $329.8m (the notes and revolver) and all cash debt is due within two years if it cannot be extended/renewed.  Hence, they have at the moment about $200m in cash available on the balance sheet if you are a pessimist like me and believe that they will not be able to float new notes or renew their revolver.

 

The cash flow thing is interesting.  FCF for the quarter was ~$20m.  If you are brave, you might run-rate that over a year, but as I questioned, how much more deterioration in the burn-to-earn ratio would be required to drive FCF to zero (or negative)?  So far, the burn-to-earn for the past three quarters has been pretty grim.  I'm not sure that I would rush to pencil in $120-150m of cash generation between now and the end of Q2 2019.

 

 

Is the burn-to-earn ratio near the tipping point where AIM goes cash-flow negative? 

 

I think these loyalty programs are really sticky.  Most of the points/billings come from credit card spend (TD/CIBC/AMEX) and as long as these cards are the consumers' primary credit card - they're kind of on autopilot and people don't think about the points or switching their cards.  It's the banks that have the most to lose here, if Air Canada doesn't make a deal with AIM and selects new bank partners for its new frequent flyer program.  Even then, there's a lot of inertia before people will switch cards. 

 

Look at the Air Miles fiasco a few years ago when the Air Miles program started to cancel points.  There was a two-quarter "run on the bank" but after Air Miles reversed its policy, everything went back to normal and Air Miles has seen no impact on its business.  As long as AIMIA doesn't cancel points outright by putting a time limit on using them, their liability will be very stable and its a Blue Chips stamps kind of liability with very high breakage over time.

 

 

Yes, cards are a big deal and represent a large chunk of the billings.  But, card use was down 4% year-over-year.  If AC launches its own Star Alliance based program and cuts a deal with, say Scotiabank or the Royal Bank for a credit card program, how many people will switch cards?  I agree that the autopilot concept plays heavily here and most people will continue to use their Aeroplan cc, but some percentage of users will walk.  So, card use is already down 4% Y-o-Y, what happens if 10% of current card users switch to the new program (this is getting to my question of cashflow tipping point of the burn-to-earn ratio)?  What if it's more than 10 percent?  Just for rough justice, 10% would represent what, about, $20m/quarter of billings and FCF for the quarter was about $20m?

 

Interestingly enough, non-AC and non-card retail partners registered a 16% reduction in their billings.  Maybe some of this was Esso?  Maybe there was a lack of retail promotions?  But in any case AC was the only partner that registered an increase in billings of 1%.  Add it all up, and miles accumulated are down 5% year over year and AC hasn't even launched its new program yet.

 

So far the "run on the bank" has lasted three quarters and doesn't look like it's slowing yet.  I guess time will tell whether it abates or gets worse.

 

 

 

If they can't arrive at a deal with the AC consortium, this looks like a real dog.

 

Well, if you listen to today's CC, you'll understand that AC's offer of $250m was a gross cash offer, and after onerous deal conditions were factored in, the net cash to AIM was a lot lower.  That's the part we don't have details on.  The cash part is the tip of the iceberg and the factors like working capital adjustments, mileage liability assumptions, breakage, which employees go with the deal, who assumes pension obligations for transferred employees, whether redemption contingency cash is transferred to AC or stays with AIMIA can swing the economics from cash positive to cash negative (ie, AIM has to pay AC to take Aeroplan).

 

I think AIM is fine because I think it will cost AC and the banks more than it will cost AIM if the deal breaks as their profit pools are bigger.  But that's what makes a market.

 

I do think the new CEO is terrific and "gets it".  Unfortunately, it looks like he's getting pressured hard by the lenders and the preferred holders who are absolutely panicking.  He also apparently is getting a lot of grief from major shareholders about the "lowball" $450m offer in the p-r.

 

wabuffo

 

 

Yes, there's probably a lot going on here that outsiders cannot know.  Certainly with this history, nobody would accuse AC of engaging AIM in good faith!  My poorly informed impression of the new CEO is also that he's a major improvement, but AIM probably needed him about four or five years ago.  Time will tell, but my sense is that this will not work out well for AIM shareholders

[Cigarbutt]

Well, if you listen to today's CC, you'll understand that AC's offer of $250m was a gross cash offer, and after onerous deal conditions were factored in, the net cash to AIM was a lot lower.  That's the part we don't have details on.  The cash part is the tip of the iceberg and the factors like working capital adjustments, mileage liability assumptions, breakage, which employees go with the deal, who assumes pension obligations for transferred employees, whether redemption contingency cash is transferred to AC or stays with AIMIA can swing the economics from cash positive to cash negative (ie, AIM has to pay AC to take Aeroplan).

 

One of recent working assumptions I held was that the unsolicited offer (even the bonified one) would result in a negative cash flow event for Aimia which says a lot about the perception of Aimia's value from AC's point of view.

 

BTW wabuffo, your measured assessment of Aimia's real and potential strengths is appreciated (but I share SJ's doubts).

 

Thinking out loud here, given that:

 

-the banks and credit card company were explicitly supporting the offer

-the last counter-proposal by Aimia is miles apart from recently reported appraisals for Aeroplan by Mr. Mittleman

-definite termination of the previous arrangement results in uncertain outcomes for both.

 

Last fall, when I was holding preferreds, I wrote to Aimia's Board to suggest a compromise by setting up a joint venture. I wonder if a similar arrangement now would allow a compromise between bruised egos. They could setup a joint venture with Aeroplan A+L, with AC being majority partner (51%) and plan a gradual buyout over time contingent on reaching financial targets. AC could contribute about 200M. This would allow sharing the pain of the digestion of the excess redemption liabilities that AIM has accumulated on their books and allow sharing of the unimpaired cashflows going forward.

 

If it's not too late, time may be running out though.

[wabuffo]

SJ, CB - I agree the sentiment and news flow is about as ugly as it gets -- but that's what makes this situation so interesting. 

 

My view is that the only thing that changes once the CPSA ends in 2020, is that Air Canada stops buying miles from Aeroplan, and Aeroplan no longer gets the Classic Fare cheap seats from AC (but can still buy the Market Fare seats like other volume buyers do).

 

The Aeroplan program will then transform into an Air Miles type of program but with some airline alliances (OneWorld, Porter, Westjet?).  The Air Miles program is a very illustrative example -- it has twice the number of members (11m vs Aeroplan's 5.5m) and generates $200m EBITDA -- which points to a $100m EBITDA for Aeroplan post-AC split.

 

The question is will the existing deferred revenue/mileage liabilities blow-up in a bank run such that Aeroplan never gets to that future state?

 

I think these types of liabilities are not very well understood and are quite sticky.  Look at Buffett's experience with Blue Chip Stamps -- the liabilities lasted for decades after stamp issuance stopped cold.  I think, worst case, there may be a slightly elevated burn-vs-earn ratio but not life-threatening.  I also think there will be elevated breakage for structural reasons (eg some AC frequent flyers stranding a high percentage of miles in Aeroplan as they some switch to AC's new frequent flyer program, etc).

 

The bigger question is what will the banks do.  These loyalty programs are incredibly important to their credit card franchises so perhaps they take them in-house.  But I don't think they want the unredeemed points liabilities on their balance sheets as it negatively impacts their capital ratios -- so there is a role to play for Aeroplan, Loyalty One/Air Miles businesses since they hold the deferred revenue liabilities on behalf of the airlines and banks which don't want them.

 

I also think that Air Canada has to fish or cut bait here -- they can't solicit new partners for their in-house program if they look like they might buyback the Aeroplan program.  What banks will waste their time investing resources to start up new cards if they think AC will pull the rug out from them with a sudden acquisition of the Aeroplan program.

 

We'll see - high risk/high reward for sure.  BTW - I agree with your POV that previous mgmt really messed up a great business in such a way that limits the new CEO's degrees of freedom.

 

Thanks for your viewpoints!  Much appreciated.

 

wabuffo

[bizaro86]

Airmiles has twice as many members, but also way more partners. They have great partners in gas, grocery, pharmacy, liquor, hardware etc.

 

The business also has significant scale benefits. Of you were a retailer, you would prefer the program with more members, as you get more benefits. As a consumer, it makes sense to consolidate points where you can earn them lots of places.

 

I think half of the Air Miles EBITDA has to be a best case scenario for a program with half the number of members and nowhere near the number of partners.

[wabuffo]

The business also has significant scale benefits. Of you were a retailer, you would prefer the program with more members, as you get more benefits. As a consumer, it makes sense to consolidate points where you can earn them lots of places.

 

Hard to argue with your point.  But I think Aeroplan will still focus largely on airline seats while slowly expanding its offerings with retailers once the all-clear signal is obvious to all.  For some reason, consumers have this attraction with airline ticket redemptions (even though few do the calculations on a cents per mile basis which shows that they are often not the best deal -- ie, you can get lower fares paying cash/credit).  It makes it a great business because the average float is long-tail (24-36 months) with high breakage (10-20%).

 

The Porter CEO was on BNN explaining the deal with Aeroplan.  Porter will be offering a set % of seats to Aeroplan on a fixed-cost basis (similar to Air Canada's Classic Fares).  Aeroplan was responsible for purchasing 2 million seats on AC flights last year.  This is a huge boost for Porter if they get even a small fraction of that business.  Expect Porter to announce new routes to Florida and the US plus add planes to meet the demand as the incremental load factors add scale.

 

I'm sure the negotiations with OneWorld (primarily American Airlines and British Airways) are to also offer similar fixed cost basis terms to Aeroplan.  I wonder why WestJet isn't also talking to Aeroplan - perhaps they are waiting to see what comes from the negotiations with AC.

 

I think Air Canada has made a huge mistake and will take over 5 years to get to 5m+ members, if not longer.  Meanwhile they have invited competitors to add capacity on their turf while their business loses some of the seats Aeroplan used to buy.

 

What is $100m EBITDA on a steady-state basis on 153m common shares outstanding worth?  What is 48.9% of PLM's growth rate in EBITDA going to be by 2020 (currently $100m CAD run-rate)?

 

Again - thanks for the critical view points.  It's very good feedback.  I'm sorry for taking up so much air-time and I'll go back to lurking. 

 

wabuffo

[bizaro86]

One big risk here is timing and shrinkage. Even if they get to 100 MM EBITDA, they could be free cash flow negative for a long time.

 

If the program is 1/2 the size going forward as it is now in terms of earning (which seems possible based on losing the AC mileage issuance and some cc customers), they will burn cash as the deferred revenue balance decreases.

 

If there is no free cash flow for the next 5-7 years, the NPV could be low.

[StubbleJumper]

One big risk here is timing and shrinkage. Even if they get to 100 MM EBITDA, they could be free cash flow negative for a long time.

 

If the program is 1/2 the size going forward as it is now in terms of earning (which seems possible based on losing the AC mileage issuance and some cc customers), they will burn cash as the deferred revenue balance decreases.

 

If there is no free cash flow for the next 5-7 years, the NPV could be low.

 

 

If there is no FCF for the next 5-7 years, chances are that AIM will be insolvent.  Assuming that they cannot renew their existing debt or float new debt, they only have about CAD$200m of cash available.  They cannot run negative FCF for very long with that amount of cash.  Under that scenario, they'd be selling assets or declaring insolvency.

 

And, I don't think that's a crazy idea.  We know that revenue from Aeroplan must come down.  They will lose AC's billings and replace a small fraction of it by having at least some billings from Porter.  Will Porter's billings be one-quarter of AC's?  They don't have many domestic routes, they have no transatlatic/transpacific, precious few US routes and virtually no market share for the routes they do have.  AC was 18% of AIM's gross billings in Q2.  So would that 18% be vapourized and replaced by 5% from Porter?  That would mean you'd vapourize ~$54m of quarterly revenue from AC and replace it by perhaps ~$16m from Porter?  That kind of magnitude would cut the top line by ~$38m.  FCF for Q2 was $20m, so if you cut the top line by ~$38m, does FCF disappear entirely?  And, as I posited a few posts ago, if you lose 10% of your credit card users under the assumption that they migrate to AC's new program, that might cost you another ~$20m of billings per quarter, which does what to the FCF?  As far as I'm concerned, unless AIM is able to reduce its cost of redemptions, they stand a strong chance of going FCF negative for several quarters.

 

 

SJ

[wabuffo]

As far as I'm concerned, unless AIM is able to reduce its cost of redemptions, they stand a strong chance of going FCF negative for several quarters.

 

I'm not concerned.  You've already seen slightly elevated burn-to-earn ratios and it's still cash flow positive after the Air Canada cancellation notice from last year.

 

The deferred revenue is recognized at full gross billing cash value but the direct cash cost of the liability is a lot lower.  For every $1 of gross billings coming in (and sitting on the balance sheet as a deferred liability), the direct costs of redeeming the points for each $1 of billings is 59-cents.  So the way I think about it is -- at the end of Q2, the b/s deferred revenue liability of $2.9B is really a cash liability of $1.7B to to meet redemptions dollar-for-dollar with zero breakage.

 

But it's actually even lower than that because you first have to assume 13% breakage off the top, then take 59% of the after-breakage gross billing value.  And I'm willing to bet the breakage in all of these transitions will be a lot higher than the 13% of a steady state situation.  But let's go with 20% (it used be 18% when Aimia used to have an expiry date on points).  So $2.9B gross x .8 x .59 = $1.3B of actually cash liability against two years worth of gross billings ($2.6B).  Even if I completely eliminate AC's contribution and cut credit card gross billings, I don't think this is going to be a problem.

 

This is a business that reports accounting losses but positive free cash flow and generates float as it does.  The deferred revenue on the balance sheet is an accounting value -- but not a cash liquidation value.  It confuses everyone -- including the analysts and rating agencies.

 

Plus - Aimia can silently gate redemptions and/or devalue the rewards if they have to (which I don't think they will).  As long as they don't make the same mistake that Air Miles did (ie, set a hard deadline for miles going to zero), they will not have a run on the bank/cash flow problem.  People tend to forget about their miles and rarely remember the redemption grids.  But tell them that they will lose their points at a certain date and you will invite a run.  The whole loyalty industry learned from the Air Miles fiasco.  Aeroplan which had a time limit also removed it as well.

 

I think they can and will pay down debt and continue to strand the preferreds.  At that point, they will be free to execute their non-AC Aeroplan strategy.  But they will have to communicate what they are doing with all stakeholders (members, banks, creditors, etc) and execute well.  The new CEO gives me more confidence than previous mgmt but his window is closing since Aimia should've been doing this years ago.

 

We'll see I guess.  I could be very wrong about this situation.

 

wabuffo

[bizaro86]

 

This is a business that reports accounting losses but positive free cash flow and generates float as it does.  The deferred revenue on the balance sheet is an accounting value -- but not a cash liquidation value.  It confuses everyone -- including the analysts and rating agencies.

 

 

The problem is, they've generated a lot of float in the past, which they spent on dividends, buybacks, and exec comp.

 

If the business shrinks, that becomes net negative cash flow as they have to redeem more miles than they issue in any given year.

[StubbleJumper]

As far as I'm concerned, unless AIM is able to reduce its cost of redemptions, they stand a strong chance of going FCF negative for several quarters.

 

I'm not concerned.  You've already seen slightly elevated burn-to-earn ratios and it's still cash flow positive after the Air Canada cancellation notice from last year.

 

The deferred revenue is recognized at full gross billing cash value but the direct cash cost of the liability is a lot lower.  For every $1 of gross billings coming in (and sitting on the balance sheet as a deferred liability), the direct costs of redeeming the points for each $1 of billings is 59-cents.  So the way I think about it is -- at the end of Q2, the b/s deferred revenue liability of $2.9B is really a cash liability of $1.7B to to meet redemptions dollar-for-dollar with zero breakage.

 

But it's actually even lower than that because you first have to assume 13% breakage off the top, then take 59% of the after-breakage gross billing value.  And I'm willing to bet the breakage in all of these transitions will be a lot higher than the 13% of a steady state situation.  But let's go with 20% (it used be 18% when Aimia used to have an expiry date on points).  So $2.9B gross x .8 x .59 = $1.3B of actually cash liability against two years worth of gross billings ($2.6B).  Even if I completely eliminate AC's contribution and cut credit card gross billings, I don't think this is going to be a problem.

 

 

Okay, so let's follow that logic.  If the current quarter FCF is $20m, and if you lose $38m/quarter in billings as a result of switching from AC to Porter, and if you lose 10% of your credit card users who decide to migrate to AC's plan which would cost you another ~$20m/quarter in billings, what happens to your FCF?  So, might it be the lost quarterly revenue of $58m less the associated cash redemption costs of ($38m + $20m) x .8 x.59 = ~$31m reduction in FCF?  So, assuming that your cash cost structure is correct, the loss of revenue from AC flights and from a potential modest decline in CC usage would be enough to put AIM's quarterly FCF negative to the tune of $20m - $31m = -$11m?  And that's just the result of lost revenue.  It doesn't even hypothesize that a bunch of people might rush to redeem their existing miles (ie, the run on the bank theory).

 

 

This is a business that reports accounting losses but positive free cash flow and generates float as it does.  The deferred revenue on the balance sheet is an accounting value -- but not a cash liquidation value.  It confuses everyone -- including the analysts and rating agencies.

 

Plus - Aimia can silently gate redemptions and/or devalue the rewards if they have to (which I don't think they will).  As long as they don't make the same mistake that Air Miles did (ie, set a hard deadline for miles going to zero), they will not have a run on the bank/cash flow problem.  People tend to forget about their miles and rarely remember the redemption grids.  But tell them that they will lose their points at a certain date and you will invite a run.  The whole loyalty industry learned from the Air Miles fiasco.  Aeroplan which had a time limit also removed it as well.

 

Devaluing rewards is the one real meaningful lever that AIM still has.  Aeroplan miles from Porter flights cannot replace those lost from AC flights because the size of AC's business absolutely swamps Porter.  There's not much to do about that unless AIM can convince Porter to award 2 or 3 reward miles for every mile that people actually fly.  If a certain portion of the flying public choose to migrate to AC's new program and sign up for a new credit card for that program, there's not much that AIM can do about that, short of offering some really sexy (and expensive) promotions to keep their existing base of credit card users.  They don't have many good levers left, but devaluation is still there.

 

I think they can and will pay down debt and continue to strand the preferreds.  At that point, they will be free to execute their non-AC Aeroplan strategy.  But they will have to communicate what they are doing with all stakeholders (members, banks, creditors, etc) and execute well.  The new CEO gives me more confidence than previous mgmt but his window is closing since Aimia should've been doing this years ago.

 

We'll see I guess.  I could be very wrong about this situation.

 

wabuffo

 

 

Oh, they will definitely pay down their debt.  If you were a note holder for the notes that come due next spring, would you renew?  What kind of interest rate would it take for you to renew?  Would 10% be high enough, or would you just insist on getting your capital back and find a safer fixed income investment?  What kind of covenants would you require from an outfit like AIM? My sense is that they have almost zero hope of extending the existing notes through an exchange offer and almost zero hope of floating new notes.  In my opinion, AIM will be paying back its existing notes out of cash.  Same thing for the line of credit.  Can you think of any Canadian bank that would want to renew AIM's revolver at this point?  The revolver will be paid back too when it comes due in two years.  All of that can be done with existing cash and investments.

 

Sadly, I am unconvinced that a happy ending is coming for pref-holders and common shareholders.

 

 

SJ