AIM.TO - Aimia

[wabuffo]

SJ - great discussion - I'm happy about your skepticism.  Its a good conversation.

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?

 

I don't think so.  Let's use the actual numbers.

 

Gross billings before adjustments = $367

loss of AC, -10% CC + Porter      =($ 58)

Net Gross billings                    = $309

 

Direct costs (same as Q2)            =($222)  very high burn-to-earn ratio which I don't think will actually happen

Cash Gross Margin                      = $ 87

SG&A                                        = $ 80  Note - less SBC & after $70m in annual committed cost cuts.

Cash Operating Income            = $ 7

 

That's $28m of positive annual cash flow - even in your "burn-down" scenario.  But I don't think it will be that bad.

 

1) I'm assuming that debt has been retired - no interest expense post-2020.  I think that's doable. 

2) I would also note that I think AIMIA would take action to bring their direct costs for redemptions down by gating and devaluing - so my guess would be cost of redemptions would be controlled below this number.

3)New Gross billings from Porter would be very positive cash flow from a working capital POV due to expansion of deferred revenues from this source with little corresponding redemption from this new source.  See explosion of operating cash flow when TD came aboard in 2013. 

4) I'm not including the dividend stream from PLM worth $20m per year.

 

Its not an optimal situation but its a worst case scenario that still generates positive free cash flow. 

 

Of course, no one knows for sure - but I think Aimia can do $100m annual EBITDA post AC departure in line with Air Miles adjusted for pro-rata membership.  Again, I could be very wrong.

 

wabuffo

[bizaro86]

I doubt many miles are redeemed the same quarter they are earned. Most people save them for a larger item (flight).

 

Thus, if they have a $58 MM decrease in revenue, they probably have pretty close to a $58MM decrease in free cash flow, since most of the cash redemption expense is from the $2B in existing miles.

[Cigarbutt]

 

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.

 

BTW, these comments are coming from the sidelines for now but the evolving story is simply fascinating and hopefully this discussion is helpful to somebody.

 

First on the redemption liability (deferred revenue), from careful review of Aimia's disclosures and accounting references (but not from direct questioning the CFO department), I'm not sure that the deferred revenue is recorded gross of breakage. Some disclosure suggests that the liability is valued at "unrecognized" breakage ie gross of breakage? (but may mean until breakage rate is changed?) but when looking at most disclosures related to breakage (and numbers affected on balance sheet when breakage has been or would be changed), it looks like the deferred revenue is reported net of breakage. 2013 annual report may be relevant. Edit: in 2013, TD committed to a 100M contribution for "program enhancements".

 

Second, on the breakage topic, there is a lot of confusion because, among others, one needs to define what happens 1- when breakage is changing and 2- when that change is recognized, as these two related scenarios have vastly different consequences on the balance sheet and cashflows. The recognition is simply a way to actualize the results that have happened. Breakage rate is the complement of the redemption rate and may go up and down because of intrinsic and extrinsic reasons. High breakage rates in the loyalty business usually correspond to a poor program and unsatisfactory level of engagement. Management obviously monitors this very closely and can "tweak" the redemption policies to counter redemption pressures but this is tricky for the long term business and, if "detected", can give rise to significant backlash with consumers potentially losing their stickiness. In this case, you could count on a relevant observer (AC) to underline unfavorable trends. The breakage is recognized at 13% which IMO is in a sweet spot and Aimia disclosed in the 2017 AR that a 1% change in breakage would correspond to a 150M change in revenues/earnings before tax, as a reminder of what SJ and bizaro are alluding to.

My base case is that they would produce enough cashflows to meet the debt deadlines but there are many scenarios with very reasonable assumptions where you would have the possibility of zero net free cash flow generation (or worse) for some time.  You can adjust the odds upwards with the new management team but, in a more "hostile" environment, I wonder if AC could not increase capacity in some areas, thereby compounding the redemption problem as Aimia has only relative ability to control timing of redemption using unfunded redemption costs. Potential lawsuits and all but this may end up being a scenario about who has most to lose...

 

Third, in a previous post you alluded to BlueChip Stamps. Details are not known AFIK but I suspect that 1- when Mr. Buffett and Mr. Munger bought it, it was fully funded, 2-breakage was probably high and getting higher over a long period of redemption and 3-the new management then invested the "float" in things like See's Candies which continued to provide a rising tide of free cash flows instead of (like bizaro described) distributing to outside investors as dividends (FWIW, using a few debatable and "subjective" inputs, I come to 1B+ in excess distribution especially in terms of an entity where going concern is called into question). Of course, the previous Aimia team suggested that they were "ready" even if the non-renewal announcement was unexpected ???

 

Apologies. I'm doing to you what I would hope you'd do to me if our positions were reversed. Good luck.

[wabuffo]

I doubt many miles are redeemed the same quarter they are earned.

 

Never said they were -- the average round trip takes 24-30 months. (earn to burn).

Thus, if they have a $58 MM decrease in revenue, they probably have pretty close to a $58MM decrease in free cash flow, since most of the cash redemption expense is from the $2B in existing miles.

 

Yes except Revenue (gross billings) IS NOT EQUAL TO Cost of goods (redemption expense).  Its called deferred revenue AND NOT deferred redemption expense for a reason.

 

wabuffo

 

 

[wabuffo]

Third, in a previous post you alluded to BlueChip Stamps. Details are not known AFIK but I suspect that:

1- when Mr. Buffett and Mr. Munger bought it, it was fully funded,

2-breakage was probably high and getting higher over a long period of redemption and

3-the new management then invested the "float" in things like See's Candies which continued to provide a rising tide of free cash flows instead of (like bizaro described) distributing to outside investors as dividends

 

CB - I'm glad you brought up Blue Chip Stamps. I was going to go into more detail about this and forgot to add this table. Max Olson has published some annual reports from Blue Chip Stamps, so full credit to him for the data in this table I've constructed (I hope he doesn't mind). 

 

                              http://i64.tinypic.com/15cln9t.jpg

 

This IMO is as good a model for AIMIA's liability as I can think of.  And a grocery program like trading stamps turns over much faster in terms of float/earn-to-burn than an airline mileage program (12 months for grocery vs 24 months+ for mileage).  Even as Munger/Buffett got control of it -- the program was still earning and burning billings & redemption expense.  But as the popularity declined, the liabilities ran off much more slowly than the gross billings decline as you can see from the duration column.

 

This is my central point - I don't think anyone really understands the dynamics of a loyalty program in run-off.  Everyone assumes the liability is money good when its not.  I just hope the current AIMIA CEO does.  Its clear the previous CEOs didn't and Mr. Market sure doesn't.  I think very little of AIMIA's current liability will decline even during the transition -- which means it will not have a liquidity problem - even before gating/devaluation tools that would be left in the toolbox.

 

wabuffo

[StubbleJumper]

SJ - great discussion - I'm happy about your skepticism.  Its a good conversation.

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?

 

I don't think so.  Let's use the actual numbers.

 

Gross billings before adjustments = $367

loss of AC, -10% CC + Porter      =($ 58)

Net Gross billings                    = $309

 

Direct costs (same as Q2)            =($222)  very high burn-to-earn ratio which I don't think will actually happen

Cash Gross Margin                      = $ 87

SG&A                                        = $ 80  Note - less SBC & after $70m in annual committed cost cuts.

Cash Operating Income            = $ 7

 

That's $28m of positive annual cash flow - even in your "burn-down" scenario.  But I don't think it will be that bad.

 

1) I'm assuming that debt has been retired - no interest expense post-2020.  I think that's doable. 

2) I would also note that I think AIMIA would take action to bring their direct costs for redemptions down by gating and devaluing - so my guess would be cost of redemptions would be controlled below this number.

3)New Gross billings from Porter would be very positive cash flow from a working capital POV due to expansion of deferred revenues from this source with little corresponding redemption from this new source.  See explosion of operating cash flow when TD came aboard in 2013. 

4) I'm not including the dividend stream from PLM worth $20m per year.

 

Its not an optimal situation but its a worst case scenario that still generates positive free cash flow. 

 

Of course, no one knows for sure - but I think Aimia can do $100m annual EBITDA post AC departure in line with Air Miles adjusted for pro-rata membership.  Again, I could be very wrong.

 

wabuffo

 

 

Okay, that makes sense.  You are hanging your hat on future cost cuts to get quarterly SG&A down from ~$110m to $70m.  You ought to throw some maintenance capex into the works (it's damned near impossible to avoid some minimal IT investments), but you can certainly make the argument that AIM will be slightly FCF positive instead of slightly FCF negative.

 

1) I would agree that interest expense will become irrelevant after the banks announce the non-renewal of the revolver -- it's already pretty trivial today.

 

2) Agreed that reducing redemption costs is AIM's best lever at this stage.  Either increase the miles required for a reward or crank up the "scam charges" associated with flights (eg, carrier surcharge, admin charge, booking charge, whatever they elect to call it).

 

3) I don't understand how new gross billings from Porter will be any more cash flow positive than existing billings from AC.  Do you contend that a bulk of Porter clients will be new to Aeroplan?  I fly AC and I fly Porter on occasion, so for me any new miles from Porter flights will just get added to my existing miles from past AC flights.  I'm guessing that 90%+ of Porter clients are also current or past AC clients.  The other consideration is that the actual dollars of Porter billings will probably be very small (AC looks to be about 10 times as large as Porter if you just look at fleet size).

 

4) Yep there'll be a few bucks every year from PLM which will be helpful.

 

 

So the conclusion is that AIM is slightly cashflow positive if the world works out well, or slightly cashflow negative if things don't go well, unless measures are taken to control redemption costs?  Makes sense to me.  I don't see this working out well for pref holders or common shareholders.

 

 

SJ

[Homestead31]

I’d just like to say I enjoy watching Canadians disagree and debate. Just soooooo polite it’s hilarious.

[Cigarbutt]

 

CB - I'm glad you brought up Blue Chip Stamps. I was going to go into more detail about this and forgot to add this table. Max Olson has published some annual reports from Blue Chip Stamps, so full credit to him for the data in this table I've constructed (I hope he doesn't mind). 

 

                              http://i64.tinypic.com/15cln9t.jpg

 

This IMO is as good a model for AIMIA's liability as I can think of.  And a grocery program like trading stamps turns over much faster in terms of float/earn-to-burn than an airline mileage program (12 months for grocery vs 24 months+ for mileage).  Even as Munger/Buffett got control of it -- the program was still earning and burning billings & redemption expense.  But as the popularity declined, the liabilities ran off much more slowly than the gross billings decline as you can see from the duration column.

 

This is my central point - I don't think anyone really understands the dynamics of a loyalty program in run-off.  Everyone assumes the liability is money good when its not.  I just hope the current AIMIA CEO does.  Its clear the previous CEOs didn't and Mr. Market sure doesn't.  I think very little of AIMIA's current liability will decline even during the transition -- which means it will not have a liquidity problem - even before gating/devaluation tools that would be left in the toolbox.

 

wabuffo

 

I looked into this also. There is some documentation that is easy to find up to 1982. What happened after is, to me, mostly inference.

 

The BlueChip program was funded and my understanding is that float continued to match redemption liabilities even when stamp accumulation revenues markedly decreased. Different scenario. One could say that things have changed (really?), but can you imagine Mr. Buffett paying 325M for Aimia with a clearly documented 2,4B unfunded redemption liability?

 

Interesting to note that they used conservative accounting reporting profit as a difference between invested float revenue (interest and dividends) and accumulation revenue minus all expenses. In the table that you provided, what is interesting especially is the redemption liability column. When you read the actual annual reports (what I looked at did not provide financial notes) what you find is that the decreases in redemption liability in 1980 and 1982 was essentially the result of a re-evaluation of the liability (increased estimated breakage rate) and not increased redemption activity with negative cashflow pressure. The stamp collection industry was dying, not exactly the same scenario that we are actually going through with AC and AIM since both want to expand the loyalty program, in a very public way!

 

What is super interesting is the description that Mr. Munger provides in the 1982 report about a potential "run" on the liability. It's not clear what happened after 1982, but from some indirect evidence and deductions, I come to the conclusion that the liability slowly decreased over time in a relative inflationary environment and I suspect that the liability became re-adjusted down as the eventually recognized estimated breakage rate went up. But, they were not sure of that in 1982:

 

"Our continued substantial profits in the trading stamp business, in the face of huge decreases in sales, are made possible only by the slow departure of "float" from trading stamps sold in earlier and better years. This "float" — resulting from past issuance of trading stamps when volume was many times greater than the current level — is very large in relation to current issuances. (Trading stamp revenues peaked at $124,180,000 in fiscal 1970, and our 1982 revenues of $9,203,000 therefore represented a decline of 93% from peak volume.) Eventually, unless stamp issuances improve, earnings from investing "float" will decline enormously. And, since the trading stamp business already operates at a loss before taking investment revenues into account, such future declines in "float" will aggravate what is already a poor situation. This happens because any significant decline in non-investment revenues is inevitably more rapid than the related decline in costs. Such is the normal result for any operator of a chain of retail stores (like our trading stamp redemption stores) whose "same store" sales decline in dollars from year to year."

 

So, if you want to make a parallel, the genius behind what the two legends did appears to be 1- making money that reproduces itself through float and 2- invest in a loyalty business where people will eventually forget about the currency.

 

 

Homestead31,

 

Why don't you jump in? Insult me and I'll insult you back and we'll have fun. :)

If you want real entertainment about Aimia and "investing", I can refer you to other on-line forums. Brutal.

 

 

 

 

[wabuffo]

The Blue Chip program was funded and my understanding is that float continued to match redemption liabilities even when stamp accumulation revenues markedly decreased. Different scenario. One could say that things have changed

 

CB - I actually think they are very similar in nature.  Part of the problem in defending my argument is that I keep switching back and forth between a going concern scenario (ie, that Aeroplan/AIMIA squeaks through to the other side of a non-AC CPSA world in 2020 and becomes a viable loyalty program) and a liquidation scenario (there is no future post AC CPSA 2020, and even TD/CIBC leave in 2024 when their agreement ends).  I am no way arguing that this is an acquisition target as I understand that the assets from this accumulated deferred revenue liability were long ago pissed away (unlike in Buffett's case, where the assets were still there sitting in municipal bonds waiting to be redeployed into See's, Wesco and the Buffalo News).

 

I'm using the Blue Chips stamps data to argue that in a worst-case -- i.e., liquidation/run-off scenario, the ultimate liability of the deferred revenue liability is very low on a cash NPV basis and it can be put into run-off on a cash flow positive basis.  But first let's highlight the different operating parameters of the two loyalty programs (Blue Chip Stamps - BCS) vs (AIMIA/Aeroplan - AIM):

 

Steady State                                                BCS                            AIM

 

Loyalty Unit                                                stamps                          miles

Earn-to-Burn Duration (months)                      12                              24

Breakage %                                                  3-7                            11-18

Non-loyalty unit direct cost (ie SG&A)%          50%                            30%

 

I post these statistics (from the Blue Chip Stamps and old BRK annual reports) because they show that the BCS loyalty program would be harder and more costly to unwind than the AIM program.  BCS had lower breakage and faster turns which meant that members could accumulate and redeem more easily.  It was costlier to administer during its wind-down because of its higher fixed costs. I.e., it operated 23 retail locations in California where members would go with their book of stamps to redeem prizes for much of its decline (until 1985 when Buffett/Munger finally closed them down for good and went mail-order). BCS also lost big customers (Stater Brothers that represented 51% of revenues) like AIM potentially will.  AIM's program isn't burdened with such high operating costs -- or doesn't have to be. (it's basically on-line and all of its expensive marketing and overhead costs could be dramatically scaled down in a liquidation scenario).

 

I think these loyalty programs can be unwound with very high breakage, so long as:

(1) you never threaten to extinguish points -- e.g, Buffett said that Blue Chip Stamps generated $26 thousand of revenue in 2006(!) so he has never extinguished stamps or put a time limit on them.

(2) you slowly depreciate the currency so that nobody notices it or feels it.

 

I think Aeroplan is much more likely to effectively strand a lot of miles because it takes longer to accumulate enough miles for a free flight.  A declining program actually makes redemption harder as accumulation options decline (AC leaving in 2020, CIBC/TD leaving in 2024) a lot of miles will get effectively stranded - much more than in Blue Chip Stamps experience.  Put it this way - Aeroplan has probably 200 billion miles divided amongst 5.5 million members.  That's about 36k miles per member on average.  That's not enough for a free flight.  Yes - Pareto says that the frequent fliers and biggest spenders will redeem easily, BUT there is a long-tail of 2-5k mile holders that ultimately will get stranded.  Its not a literal run on the bank, because you can demand your deposit from a bank even if you have just $1 in your account.  To extend the bank metaphor further, you kinda get the points for "free" so stranding a few isn't a big deal, whereas your bank deposit is cash you saved after taxes on your pay so you feel much more strongly about it.

 

So let's run some numbers indexing the BCS experience to Aeroplan's experience post 2020.

 

                http://i65.tinypic.com/2dtaate.jpg

 

This example is purely illustrative - the actual Aeroplan experience will be different.  For example, the 2021 drop in billings is likely to be less severe because AC goes but the credit card billings will still be there.  The big drop may be in 2024 after the banks and their Aeroplan credit cards leave.  But let's go with it.

 

Now let's run a pro-forma deferred revenue account with opening and closing balances and gross billings coming in, thus, solving for revenues (ie, deferred revenue coming out.). I know that there are re-statements happening every year that adjust the deferred revenue balance up and down -- but let's ignore these.  To convert the revenue into cash redemption expense, I am starting at a 59% assumption (ie. $1 deferred revenue = 59-cents of cash redemption expense).  But just like the Fed, I will set a 2% inflation target (ie, reducing the value of the cash redemption by 1% per year).

 

            http://i68.tinypic.com/1z2ke9g.jpg

 

IMO, the deferrred revenue liability never comes due, even in a liquidation scenario because by 2030, that deferred revenue liability is probably 60-80% breakage and after you factor in conversion to redemption cash expense and bring it back to present value - its negligible.  And that is even with large burn-to-earn-ratios in the early years of 125%+!  Of course gross profit is before SG&A, but I'm assuming in a liquidation scenario, the expensive marketing people and expensive offices are gone and in their place is an accounting guy working out of a dingy lawyer's office with no windows and the only art on the walls is "Dogs Playing Poker".

 

It's a controversial viewpoint, but:

(1) once the revolver/long-term debt is paid off,

(2) the preferreds can be perpetually stranded, and

(3) the deferred revenue liability can be put off for a long time without being cash-flow negative.

In the hands of the right kind of activist CEO, you could create value over a long period of time even if Aeroplan dies.  I don't think it ever becomes insolvent because loyalty programs can't.  Back to the Fed example, its the same reason why the US Treasury will always pay back its debt.

 

But that's the worst-case scenario.  I think they can replace Air Canada, and after a bumpy transition, emerge as a viable loyalty program post-AC.  I just wanted to tie my argument together more coherently.

 

Of course, I agree that this is a risky and speculative common stock right now.  So stay away!

 

wabuffo

[bizaro86]

It's hard for them to excel as both a liquidation and a going concern, in many ways management needs to pick.

 

As one example, they have said you'll be able to transfer miles to hotel and/or airline programs. That makes the program more attractive for continued use, but hurts it for liquidation. A lot of these 5-7k balances that would otherwise break will get transferred elsewhere.

[Cigarbutt]

"But that's the worst-case scenario.  I think they can replace Air Canada, and after a bumpy transition, emerge as a viable loyalty program post-AC.  I just wanted to tie my argument together more coherently."

 

Thanks for your time.

 

-On the redemption runoff, here's a link that you may find interesting:

http://articles.latimes.com/1993-08-19/news/vw-25199_1_blue-chip-stamps

I see your point but the comparison has some significant differences.

 

I understand that the BlueChips program faded away quite significantly after 1982 with both revenues and redemption activity going down. In 1993, the sub president seems to refer to a 10M+ redemption liability which is way below your "projection" for Aimia in a liquidation scenario and I think that the most likely cause for this was (for BlueChips) not an increase in redemption activity but quite the opposite, a reduction of redemption activity AND a proportional increase in the recognized breakage rate.

 

So for Aimia, the challenge seems to be to promote their currency while at the same time hoping for less engagement ???.

 

But, this investment makes sense if you "believe" in the transformation. I have to say that I find the Canadian loyalty market to be quite crowded with more and more programs chasing the same customers. If AC does not eventually buyback Aeroplan, the outcome may be related to who can transform better: the loyalty program that wants to become an airline or the airline that wants to build a loyalty program from quasi-scratch. Sometimes, one has to wonder about the rationality of those involved but maybe I lack vision as I have never been comfortable with the concept of printing money and relying on goodwill. :)

[bizaro86]

There is definitely more competition entering the marketplace.

 

PC Optimum is a relatively new program born of the merger between the largest grocer program and the largest pharmacy program. They also recently added Esso/Mobil gas stations, so have the potential be a formidable competitor. Somewhat relevant, Esso used to be an Aeroplan partner.

 

Canadian Tire/sportcheck/marks has also recently launched a combo program called Triangle.

 

Also, I think Blue Chip breakage in the 80's might not be equivalent on a run down. Those stamps would get physically lost, whereas if you remember your email address your aeroplan miles will still be there in 5 years when someone casually mentions you can convert them to hotel points to get something out of them.

[wabuffo]

In 1993, the sub president seems to refer to a 10M+ redemption liability which is way below your "projection" for Aimia in a liquidation scenario and I think that the most likely cause for this was (for BlueChips) not an increase in redemption activity but quite the opposite, a reduction of redemption activity AND a proportional increase in the recognized breakage rate.

 

CB - thanks for the article.  I hadn't seen it before.  Yes - I think accumulation and redemption are the opposite sides of a reflection into a mirror.  I don't think these loyalty programs ever exhibit explosive burn-to-earn ratios.  Rather as accumulation goes down, redemptions go down as well and breakage increases so that the redemption liability stays at a historical level.

 

After 1985, BRK stopped breaking out the trading stamp business financials and md&a in the annual report.  The redemption liability stayed constant at around $60m dropping slowly each year.  Then this appeared in the annual report for 1985:

"...the factor for redemption-probability used in the computation of the 1985 year-end unredeemed liability was revised further downward.  The revision had the effect of reducing the unredeemed liability at December 28, 1985, and Berkshire’s cost of services sold, by approximately $10,800.  The after-tax effect was to increase Berkshire’s 1985 net earnings approximately $5,300

.

I think there's a reason Buffett resisted the urge to write down the redemption liability and keeps the business open, even to this day.  It is to delay paying taxes on the breakage income, and we know Buffett loves deferring taxes.  That's why the guy in your article says "the IRS would agree with that".  The only pressure on writing it down is justifying to the IRS why you shouldn't pay cash taxes on the real economic gain. 

 

That's what makes these loyalty programs so interesting -- you get the cash from billings up front, you defer the cash costs of redemptions out 24-30 months, on average, and delay much of the cash taxes for as long as the IRS or CRA will let you.  Plus you get to set the price on your costs.  That's a dream business - you can never go insolvent, just like the US Treasury!

 

wabuffo

[wabuffo]

I have to say that I find the Canadian loyalty market to be quite crowded with more and more programs chasing the same customers.

 

I think this is an excellent point, CB and bizaro86!  It is a crowded market -- particularly in credit cards. This is actually to Aeroplan's advantage.

 

I think this is what brought AC to the table to make a bid for Aeroplan.  My pet theory is that AC is having trouble lining up credit card partners for their new mileage program.  All the big banks are locked-up.  Its not a coincidence that Westjet signed up with RBC last year when AC dropped Aeroplan.  It locked up all the big banks plus AMEX after they re-upped with Aeroplan.  I guess Laurentian Bank might be available.

 

Getting to the pole position in a consumers' wallet for spending is getting more and more difficult.  The banks make so much money from the credit card receivables and fees.  Switching consumers from one credit card to another is hard, risky and getting more expensive.  Think about it -- you have to offer free miles (20,000 miles costs the bank $200 per consumer) and there's no guarantee that the card becomes no. 1 for that consumer's spending after the switch.  That's why AC's $50 per member offer was ridiculous.

 

Now if you are already on an Aeroplan card, you will demand that your points follow you if TD is trying to switch you to an Air Canada card.  Well that's going to cost TD an average of $400 to buy your miles (avg Aeroplan member = 40k miles @1-cent per mile) and bring them into the new card. TD is going to want Air Canada to pay for that.  If you remember in 2013, when TD bought half of CIBC credit card accounts, they also got paid $150m to make cardmembers whole.

 

I think Aeroplan has a strong hand here - and I hope the new CEO plays it well.  Focus on getting the debt paid down and then take your time rebuilding your loyalty program. 

 

wabuffo

[bizaro86]

I would imagine Scotiabank would be pretty interested in getting the Air Canada credit card business...

 

 

[mcliu]

Are there any examples of less successful loyalty runoffs than Blue Chips as a comp for Aimia? Just in case that Blue Chip was the exception not the norm..

[Homestead31]

http://www.mittlemanbrothers.com/wp-content/uploads/2018/08/AIM-CN-open-letter-to-BOD-08-06-18-FINAL.pdf

 

 

[bathtime]

http://www.mittlemanbrothers.com/wp-content/uploads/2018/08/AIM-CN-open-letter-to-BOD-08-06-18-FINAL.pdf

 

I think this is such a bad-ass letter to the board — whether or not you agree with his points.

[wabuffo]

The new CEO and Mittleman really need to get on the same page.

 

wabuffo

[Cigarbutt]

http://www.mittlemanbrothers.com/wp-content/uploads/2018/08/AIM-CN-open-letter-to-BOD-08-06-18-FINAL.pdf

 

I think this is such a bad-ass letter to the board — whether or not you agree with his points.

 

I think the tone of the letter was OK.

I was wrong on the negative cashflow event with the "improved offer" but I assume the offer became barely positive and AC had targeted the reserve funds as part of the closing conditions. It just goes to show how far apart the two parties were.

 

In the letter, the comments about the redemption liability being part of business as usual deal (negative working capital) is interesting. When you think about it, if AC starts their own program, they would gradually build this liability and all corresponding incoming cashflows would account for most of the NPV value that they attribute to this hypothetical venture at this point. Also of note (versus the BlueChip example mentioned before whereby the program became gradually forgotten), is the fact that AC, assuming a successful "launch", would likely try to "drive" their program and encourage redemption using unfunded costs recorded in the liability section of their new competitor.

 

Since the issue is price discovery and given what the letter implies about the redemption liabilities, I wonder why other players (private equity) are not getting involved, especially given the present context of optimistic projections and ease with leverage. In other forums, LoyaltyOne is mentioned which is interesting but I suspect that they would also lowball an offer because the move would simply be to consolidate market share.

 

[Cigarbutt]

https://www.aimia.com/newsroom/news-releases/

 

[KJP]

https://www.aimia.com/newsroom/news-releases/

 

 

I haven't followed to closely, so there may have been developments over the last few weeks that I missed, but what does it say about Mittleman that he's supporting this after telling his investors just last month that Aeroplan is worth $1 billion CAD at the absolute minimum, and is really worth closer to $1.5 billion CAD.

 

You all probably have already seen it, but here's what Mittleman was saying to his own investors (and to Aimia's board):

 

In writing to my clients about Aimia, I have used a very conservative value of C$1B for Aeroplan,

which was quoted in the press recently. But that valuation is based on my most conservative

estimate of C$100M in EBITDA post-2020 on a standalone basis, and not reflective of any control

premium. The strategic value of Aeroplan is clearly much greater than its stand-alone value to

Aimia. Thus, a compromise between what it’s worth to Aimia, at certainly no less than C$1B,

and what it’s worth to the consortium, at C$2B+, seems reasonable. That is 4.3x to 8.6x EBITDA

of C$234M currently, versus 10x to 20x EBITDA of C$100M in 2021 to a buyer other than Air

Canada, and really less than 10x to 20x given the much higher EBITDA and FCF in the next 2

years would reduce the effective multiple significantly for the buyer closing in 2018.

 

If Aimia cannot obtain at least the stand-alone value of Aeroplan, C$1B, plus a modest control

premium of 20%, then I’d prefer Aimia not sell it.

[wabuffo]

Mittleman's comparisons with previous airline mergers never made sense to me because the float is assumed to remain constant in those cases.  Each example was strictly a buy analysis.  In Air Canada's case, they are looking at buy-vs-build comparative cash flow economics so their offer would always be lower to reflect the lack of a cash-flow springloading benefit from ramping up a new mileage program.

 

There are important details that have yet to be disclosed so we should wait and see before judging the deal (employee transfer, pension liabilities, working capital adjustments, etc).  For example, the press release says the deal is "cash-free, debt-free" - so in addition to getting $450m at deal close, AIM will get to keep their current $250m in cash plus additional cash accumulation over the next 6 months (Q3/Q4).  In addition, we have to hear Aimia's plan for the rest of their assets.

 

wabuffo

 

[mcliu]

Haven't followed this closely, but was curious if anyone did the math on valuation pro-forma this deal?

[KJP]

Haven't followed this closely, but was curious if anyone did the math on valuation pro-forma this deal?

 

Here's one that Mittleman just released:  https://www.prnewswire.com/news-releases/mittleman-brothers-llc-statement-on-sale-of-aeroplan-300700225.html