AIM.TO - Aimia

[fisch777]

As is often the case, when they built the elaborate new downtown HQ with renowned art in the lobby, time to sell.

 

Management is sub-par at best here.  No rhyme or reason when we talked to them.

[petec]

Management is sub-par at best here.  No rhyme or reason when we talked to them.

 

Agreed.

[Uccmal]

As is often the case, when they built the elaborate new downtown HQ with renowned art in the lobby, time to sell.

 

Management is sub-par at best here.  No rhyme or reason when we talked to them.

 

I am not sure I agree.  They are operating in a very competitive industry with low barriers to entry.  And yet they have managed to pay 8% of sales out to shareholders as buybacks and a dividend that is increased annually, over the last 5 years.  They have shifted a platform from one wholly dependent on one airline to multiple platforms.  That said, more could be done to diversify away from Air Canada.  Its not a good place to be, if something bad happens with the relationship. 

[petec]

As is often the case, when they built the elaborate new downtown HQ with renowned art in the lobby, time to sell.

 

Management is sub-par at best here.  No rhyme or reason when we talked to them.

 

I am not sure I agree.  They are operating in a very competitive industry with low barriers to entry.  And yet they have managed to pay 8% of sales out to shareholders as buybacks and a dividend that is increased annually, over the last 5 years.  They have shifted a platform from one wholly dependent on one airline to multiple platforms.  That said, more could be done to diversify away from Air Canada.  Its not a good place to be, if something bad happens with the relationship.

 

Can you elaborate on the competition?  I've never been quite able to make my mind up about this.  Part of me thinks that while there is a lot of competition in airlines and credit cards, once you have your relationships with those two, running a rewards business should be as easy as falling over a log.  Who do you view Aeroplan (mainly) as being in competition with? 

[Uccmal]

As is often the case, when they built the elaborate new downtown HQ with renowned art in the lobby, time to sell.

 

Management is sub-par at best here.  No rhyme or reason when we talked to them.

 

I am not sure I agree.  They are operating in a very competitive industry with low barriers to entry.  And yet they have managed to pay 8% of sales out to shareholders as buybacks and a dividend that is increased annually, over the last 5 years.  They have shifted a platform from one wholly dependent on one airline to multiple platforms.  That said, more could be done to diversify away from Air Canada.  Its not a good place to be, if something bad happens with the relationship.

 

Can you elaborate on the competition?  I've never been quite able to make my mind up about this.  Part of me thinks that while there is a lot of competition in airlines and credit cards, once you have your relationships with those two, running a rewards business should be as easy as falling over a log.  Who do you view Aeroplan (mainly) as being in competition with?

 

I think you sort of covered it: Airmiles, Credit card rewards programs.  The reason they are able to generate free cash flow is from the built in spread in the existing relationships.  It is similar to a utility such as enbridge.

 

The problem with utilities, and the aimia businesses, is that in order to expand they have to do so by acquisition.  Every other similar reward slot in the world is already taken by incumbents.  I wasn't very clear in terms of the low barriers to entry remark.  The barriers to entry WERE low when all these programs were started.  They are now very high and cannot be easily transferred across platforms.

 

Its a strange spot to be in.  On one hand it is quite profitable.  On the other hand you are beholden to a potentially fickle partner.  To grow at all you have to issue equity or debt in a significant enough amount to buy a large established platform elsewhere. 

 

I am not sure I would buy the common stock in this company - the upside is limited.  The prefs are nice though.  I own a 5-6% position in the a's .  They may always trade down, but in this yield starved world their reliability may get recognized.  All that being said, if the relationship with AC soured even the prefs would be worthless. 

 

However, I think that the worry about the contract renewal is all for naught.  In order to start its own rewards program or go with some other established program Air Can. would need  to compensate existing Aeroplan points members.  If AC didn't buyout aeroplan then they would alienate a big portion of their customers who would see it as a ripoff.  I dont know about you but I hate being ripped off, and really only tolerate it from my phone company (which I hold stock in).  So, the contract gets signed before 2020, the status quo persists and Rupert keeps his job managing a stranded asset, and attempting periodic acqusitions when opportunities arise. 

 

The final irony and a credit to Aimia management is that they hold the most consistently profitable piece of the Air Canada franchise. 

 

 

[petec]

Uccmal,

 

I agree with you on barriers to entry.  I don't agree on the contract risk: the risk isn't that AC goes elsewhere, it's that the new contract has lower margins.  It's been interesting watching Multiplus and Smiles renegotiate with their parent airlines.  So far it's always been possible to find a win-win solution and hopefully that's possible here.  But, managing the spread at these businesses is actually pretty complex - they are a bit of a black box in that regard - and the contract details are key.

 

I need to do some digging on the prefs - haven't invested in prefs before so a lot to wrap my head around.

 

P

 

Edit - I realise that AC's inability to go elsewhere strengthens Aimia's hand; but since Aimia is just as dependent on AC, I still see risk that the balance of profitability could be tilted in AC's favour.

[Uccmal]

Uccmal,

 

I agree with you on barriers to entry.  I don't agree on the contract risk: the risk isn't that AC goes elsewhere, it's that the new contract has lower margins.  It's been interesting watching Multiplus and Smiles renegotiate with their parent airlines.  So far it's always been possible to find a win-win solution and hopefully that's possible here.  But, managing the spread at these businesses is actually pretty complex - they are a bit of a black box in that regard - and the contract details are key.

 

I need to do some digging on the prefs - haven't invested in prefs before so a lot to wrap my head around.

 

P

 

Edit - I realise that AC's inability to go elsewhere strengthens Aimia's hand; but since Aimia is just as dependent on AC, I still see risk that the balance of profitability could be tilted in AC's favour.

 

From ACs perspective it looks like a honey pot, no doubt.  I guess thats why Aimia is trading down, and may always trade at a discount.

[petec]

Just digging into the prefs.  It strikes me that an advantage of convertibility to Series 2 (where the rate is set off the 3-month T-bill) is that you are fully inflation protected *and* protected against NIRP because the 3-month is highly unlikely to trade materially below zero.  Does that make sense?

 

 

[intothebreach]

petec,

 

If you are digging into any Canadian pref shares, it is really worth checking the following thread where fellow board members sculpin, SafetyInNumbers and Carboard (among others) have made extremely useful contributions (thanks to all by the way!):

 

http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/dumbdee-the-goodmans-the-bad-the-ugly-30-of-nav-bargain/msg269602/#msg269602

[petec]

Thanks!

 

[bbarberayr]

Uccmal,

 

I agree with you on barriers to entry.  I don't agree on the contract risk: the risk isn't that AC goes elsewhere, it's that the new contract has lower margins.  It's been interesting watching Multiplus and Smiles renegotiate with their parent airlines.  So far it's always been possible to find a win-win solution and hopefully that's possible here.  But, managing the spread at these businesses is actually pretty complex - they are a bit of a black box in that regard - and the contract details are key.

 

I need to do some digging on the prefs - haven't invested in prefs before so a lot to wrap my head around.

 

P

 

Edit - I realise that AC's inability to go elsewhere strengthens Aimia's hand; but since Aimia is just as dependent on AC, I still see risk that the balance of profitability could be tilted in AC's favour.

 

From ACs perspective it looks like a honey pot, no doubt.  I guess thats why Aimia is trading down, and may always trade at a discount.

 

They sure weren't at a discount when then were at $19!

[bbarberayr]

I think Air Canada has realized that the Aimia business practices have hurt the Air Canada brand and are not willing to give a lot to support Aimia.  Just google "aeroplan crappy" and read some of the web sites.  Reality is Aimia management made a bunch of money by goosing profits a number of years ago by "burning" customer air miles by doing things like adding fees and fuel surcharges (and not removing when fuel came down), making it hard to book flights, sending out 1 email in the midst of many promotional ones warning about expiring miles, and then taking them away with no recourse, etc.  Worked for a few years when there were a lot of customers with many air miles, not so much any more.

 

Now when you buy an Air Canada ticket, the cheapest fares only get 25% of Aeroplan Miles, so you can see how Air Canada has de-emphasized miles already.

 

So Air Canada probably seeing a lot less value in Aeroplan (as do Aeroplan's customers), so Air Canada not willing to pay up.

[misterkrusty]

I think what you're saying was true in the years leading up to 2013, but starting in January 2014 aimia revamped aeroplan to make it easier for members to get the flights they want.  You can see it in their margins, which compressed significantly that year (and last year as well).  Also, they did away with the 7-year expiration policy back in 2013

 

Aeroplan margins will likely compress again in 2020 when the current CPSA expires, simply because the current contract was crafted under extraordinary circumstances (air canada was in distress and wanted to IPO aeroplan to raise cash).  Obviously those circumstances no longer exist. 

[txfan2424]

- Competitive position is erroding. Part of the value of a shared currency loyalty program is having a number of large retailers / partners signed up. AIM has lost a few partners (grocery) which is a worrying sign. Why would partners leave if things were going well?

- Canada has more credit cards per capita than any other country in the world (I think) so this is an incredibly competitive business. Large scale retailers should be trying to monetize their brand / size as much as possible. I think pricing pressure continues. AIM margins are already less than half vs five years ago. If it halves again, they might have trouble covering their fixed obligations (interest + pref div). I think they'll have to sell assets to repay debt

- Only competitive advantage is Air Canada contract and with large program participants leaving, it isn't clear that Air Canada can't leave also. So, we have a binary event coming in the next few years

 

This is a pass for me. A few ways the prefs work (asset sales, buyout, etc.) but all are dice rolls.

 

 

 

 

[petec]

I've still got a lot of work to do on this one but my initial take isn't so negative.

 

- Coalitions don't work for every partner.  Seeing some leave is an issue, but not necessarily a fatal one.  The benefits are very different to each partner, for a start.

- If Canada has more cards per capita, credit cards are very competitive.  But Aimia doesn't issue cards.  It provides the issuer with a competitive edge: free flights on Air Canada.

- Air Canada needs a loyalty programme.  Setting up an entirely new one is a major project.  They have an incentive to stay.  The question is, on what terms?

 

I reserve the right to change my mind as I read more ;)

 

Pete

[misterkrusty]

Any U.S. citizens here?  I just got my preferred dividends and it looks like I got hit with a 25% withholding tax ... don't the U.S. & Canada have a tax treaty that reduces the rate to 15%?

 

thanks

[scorpioncapital]

Might be useful - http://topforeignstocks.com/2015/10/17/an-update-on-canadian-reduced-tax-withholding-rate-for-us-investors/

 

 

[Uccmal]

Is anyone still following this? 

 

They just released earnings this week, and announced an early buy in of their Series 3 prefs. 

 

I hold a middling position in the .series 1 prefs (Aim.pr.a) which is up about 20% from my buy in. 

 

I am looking at a small position in the common but need some outside input while I try to figure out the financial position. 

[Cardboard]

I still hold the "B"s and much less "C"s.

 

You should actually switch the "A"s for "B"s: slightly higher yield right now + since they are exchangeable for each other in 2020 on a 1 for 1 basis, you get some additional capital appreciation built in. You also participate immediately on any interest rate increase with the floaters.

 

By the way, it is not preferreds that they are redeeming but, a note (debt) that is due in 2017. It is still a Serie 3 note which may be confusing.

 

Regarding the stock, I would not touch it. Not when you can get into the "B"s still at these prices. You only get 1% more yield with the stock and similar capital appreciation upside. If things go sour, they will stop buybacks, then cut the dividend on the stock. The expenditure for stock dividends is much larger than for all preferreds combined. So there is quite a bit of protection with the preferreds IMO against business deterioration or like a worst than expected contract renewal with Air Canada due in 2020.

 

If confidence returns to this name, I would expect a big move up in the prefs. The stock will likely move as well but, fixed income instruments tend to react very quickly to any stabilization in a business. At that point, it will be time to look at the stock and see if the upside justifies an investment.

 

Cardboard

[Uccmal]

Thanks Cardboard,  I just did a quick cursory review of the balance sheet, and income.  Wish I had a memory like Buffett, then I wouldn't need to look at these two three times or more. 

 

I agree with you on the common stock.  I dont like the way they present the earnings.  There is too much non-GAAP metrics in there for my tastes.  Thanks for the clarfication on the bonds versus the preferreds.  And thanks for the tips on the preferred variances. 

 

I will have a serious look at switching if I can get any. 

 

Confidence would return alot faster if they stop raising the dividend and showed they can collect the cash, rather than issuing more debt.  Just my opinion. 

 

 

[petec]

I also own prefs.  My view after doing quite a bit of work is that there is an extremely high likelihood that the prefs are money good unless (and possibly even if) the Air Canada renegotiation is a complete catastrophe which I do not expect.  However, I haven't been able to get enough info to get comfortable with the common, so I totally agree with you both.

 

The prefs strike me as an incredible security:

- 9% yield, roughly.

- double upside to rising rates, given that the dividend is computed as a % of par and you're paying half that.

- very limited downside even in a seriously bad scenario for the company.

- moving up the capital structure as they pay down debt.

 

The major risk is that inflation rises and rates don't, but even then, you're still getting your 9%, which is ahead of what stock markets produce in the very long run.

 

My other risk as a UK investor is currency, but I tend to think that comes out in the wash over time, and I intend to hold these for a very long time.

 

P

[misterkrusty]

by the way, there's a writeup pitching a long position in these preferreds on valueinvestorsclub.com  it was posted on oct 6th, so even if you're not a member you'll still be able to read it soon (if you sign up with your email you can read ideas on a 45 day delay).

 

plus, the author sounds like an absolute genius  ;)

[Uccmal]

I also own prefs.  My view after doing quite a bit of work is that there is an extremely high likelihood that the prefs are money good unless (and possibly even if) the Air Canada renegotiation is a complete catastrophe which I do not expect.  However, I haven't been able to get enough info to get comfortable with the common, so I totally agree with you both.

 

The prefs strike me as an incredible security:

- 9% yield, roughly.

- double upside to rising rates, given that the dividend is computed as a % of par and you're paying half that.

- very limited downside even in a seriously bad scenario for the company.

- moving up the capital structure as they pay down debt.

 

The major risk is that inflation rises and rates don't, but even then, you're still getting your 9%, which is ahead of what stock markets produce in the very long run.

 

My other risk as a UK investor is currency, but I tend to think that comes out in the wash over time, and I intend to hold these for a very long time.

 

P

 

Your in the UK.  I have wrestled for years over currency implications between Canada and the US.  I came to the conclusion that over time it is a wash.  I do however move currency between my US and Canadian accounts, more in response to where the values are rather than trying to trade the actual currency.  Three years ago I held almost no Canadian stocks, now I hold almost no US stocks.  Coincidentally, when Cdn. stocks go on sale the dollar is also way down.  Anyway this is off piste - sorry. 

[sculpin]

Good write-up on AIM prefs by MPK391 at VIC. Aval now to those who have partial mbrship (anyone can access this) as the below copy & paste does not include the charts....

 

 

AIMIA INC AIM.PR.B

 

October 06, 2016 by mpk391

2016 2017

Price: 11.14 EPS 0 0

Shares Out. (in M): 3 P/E 0 0

Market Cap (in M): 165 P/FCF 0 0

Net Debt (in M): 0 EBIT 0 0

TEV: 0 TEV/EBIT 0 0

Submit an idea for full membership consideration and get access to the latest member ideas.

 

Description / Catalyst

Messages (2)

Description

 

Worst case scenario, this is a ~10% yield that should be covered nearly 4X over.  There’s a double discount here: Canadian preferred shares have been dumped en masse, and investors are overly concerned about the renewal of Aimia’s contract with Air Canada in mid-2020.  So you get paid handsomely to wait for these shares to once again trade near par - roughly a double from here.  There’s a good chance the contract gets renewed early -  perhaps in the next year or so – which would be a great catalyst.

 

 

(all amounts in C$ unless noted)

 

 

 

 

 

A word on liquidity: the series 1-3 preferred shares together have $165M in market value and trade about $150K per day.  I own the Series 2 exclusively, since it has the widest discount to par and it pays a floating interest rate (and since I had to enter a share price, shares out, and symbol, I entered the Series 2 data.  But they’re all cheap.  If I were more constrained by liquidity, I’d be happy owning all three.

 

 

 

Rate reset preferreds such as Aimia’s Series 1 & 3 began appearing in 2008, when interest rates were falling and everyone thought they’d rebound sooner rather than later.  Sold largely to yield-seeking retail investors, they now account for ~60% of the almost $67B Canadian preferred share market.  Floating rate preferreds – such as Aimia’s Series 2 – aren’t as common, but obviously offered another way to play this seemingly-inevitable rebound.  And of course, rates went on to sink even lower, especially around early 2015 when the retail investors started throwing in the towel.  This probably explains the initial swan-dive in the Series 1-3.

 

But it’s company-specific fear that probably explains why there’s been hardly any rebound.  The market is worried about what happens to Aimia when its contract with Air Canada (AC) expires in mid-2020.  Aimia grew out of Aeroplan – originally AC’s frequent flyer program – which was spun off from AC in 2005.  Today, Aeroplan is a full-blown loyalty “coalition” – in which lots of consumer-focused companies buy points (fka “miles”) to reward their customers.  Last year, just over 20% of points were purchased by AC to reward their frequent fliers.  70% were purchased by credit card issuers (CIBC, TD Bank, and Amex), and other ~10% by a hodgepodge of supermarkets, gas stations, etc.  But AC still remains hugely important to Aeroplan, since when these customers redeem their points, they spend 80% of them on airfare.  AC, along with its low-cost carrier Rouge, provides perhaps 86% of that 80%, while the other Star Alliance airlines provide the rest.

 

It might seem strange that anyone is freaking out about a contract that doesn’t run out for another 3.7 years, particularly when there’s never been any friction (in public, anyway) between the two sides.  And it is strange.  But it’s not totally crazy.  The CEO of AC has been flagging the upcoming renegotiation as a source of future cost savings[1].  The original contract was signed under some fairly unusual circumstances.  BMO’s analyst – perhaps the most bearish guy on Aimia – has gone so far as to say that “there is longer-term existential uncertainty around the Air Canada contract expiry in 2020.”

 

If you really think the contract won’t be renewed, this idea just isn’t for you.  Aimia might survive such an event,[2] but it’s hard to say how the cash flows would change.  At best you’d be in for a white-knuckle ride.

 

But it’s extremely unlikely that AC and Aeroplan part ways.  Yes, the new terms won’t be as good (but they’ll be good enough).  To understand why, one needs to know some history.  The current contract was probably not the product of an arms-length negotiation.  I doubt there was a negotiation at all.  Instead, this was the result of why I’d call “valuation-multiple arbitrage.”  Cerberus – which came to control ACE Aviation Holdings[3] through its 2003 bankruptcy - was looking for ways to pay down some debt at ACE and maximize the value of ACE equity.  To do so, they carved out some of AC’s higher quality income streams, including its frequent flyer program[4].  Thus, AC agreed to set aside 8% of its capacity for sale to Aeroplan at cost[5].  These flights were dubbed “ClassicFares” and in the early years they represented nearly all the flight rewards that Aeroplan offered.

 

 

It’s all about ClassicFares…

 

In addition to Aeroplan, Aimia today has lots of other loyalty-marketing operations around the globe.  But these cats & dogs basically just about offset corporate overhead, and thus Aeroplan remains the key to the fate of these preferreds.

 

So we need to estimate much a renewal could ding Aeroplan’s roughly $200M of annual free cash flow.  Let’s try to get a sense for how much room there is to renegotiate..  Looking at AC’s financials, it seems likely that variable costs are at least 75% of revenues.  See for yourself:

 

https://1drv.ms/x/s!Aqrw-OOY6WUhgP5PphXArKZqyAApwA

 

The exact amount looks a bit more like 80% to me, but to avoid quibbling and to be conservative let’s use 75% instead.

 

So if Aeroplan buys ClassicFares at cost, and cost is at least 75% of market prices, then we know that Aeroplan’s cost for ClassicFares is probably not more than 25% under-market[6][7].  Since the worst that AC would demand under a new contract is full market prices, the maximum increase over current prices would be 33% (=100%/75%-1).

 

We can also estimate how much Aeroplan is currently paying.  Consolidated “cost of rewards and direct costs” were 1,601.9 in 2015.  Star Alliance airlines were 43% of this number, and Aeroplan is the only Aimia coalition affiliated with Star Alliance. 

 

So, 1,601.9 * 43.0% = 688.8 total spent by Aeroplan on flight rewards (all from Star Alliance)

 

688.8 * ~86% = 592.7 spent on Air Canada/Rouge vs other Star Alliance airlines

592.7 - $180 cost of MarketFare revenue (more on this in a moment) = 412.7 spent on ClassicFares

 

33% max increase * 412.7 = $137.6M worst-case hit to Aimia’s FCF (approximately)

 

Which means…

 

200 of current annual FCF[8] – 137.6 = 62.4 FCF still available to pay preferred dividends

 

62.4 / 16.9 of preferred dividends = 3.7x worst-case coverage

 

But this is very much a hypothetical exercise.  There’s no way Aimia is going to pay even close to full retail prices for these seats.  Aeroplan’s MarketFare program proves that it can negotiate a discount to market rates for bringing AC a large volume of business.  Adding the ClassicFare flights to the mix, that volume of negotiated-rate business will more than triple.

 

Since the supply of ClassicFares is limited, Aeroplan has long offered flight rewards to members who can’t get a ClassicFare on the flight they want.  The first iteration of this was the Avenue program, followed by ClassicPlus in 2006, and finally by MarketFare in 2014.  These were a small part of the mix at first, but they’re ~30% of Aeroplan flight rewards today and total ~$180M in annual revenue to AC.  While the prices on these are closer to market rates, they’re still at a significant discount, particularly for members who earn lots of points on a regular basis.

 

Finally, keep in mind that AC doesn’t hold all the cards.  One big reason is that the revenue that AC gets from MarketFare flights comes with attractive margins.  MarketFare rates were negotiated just a few years ago, when neither party was in any sort of weak bargaining position, thus AC is likely still happy with these prices.  It would be hard for AC to replace all of this lost revenue – creating a new coalition requires signing a major credit card issuer, and it’s not clear who that would be.  Canada’s top 4 issuers (RBC, CIBC, TD, BMO) have something like 72% of Canada’s general purpose credit card purchase volume (5th place has ~6%), and they’re all pretty tied up as far in terms of loyalty coalitions.

 

Another big reason is that Aeroplan has developed close relationships with essentially all of AC’s best customers in the process of managing AC’s frequent flyer program.  If AC were to take its program back in-house, one can imagine all sort of ways these customers could get upset and take their business to WestJet, Porter, American, et al.

 

By the way, Aeroplan’s earnings come from more than just the gross profit on ClassicFares:  In 2015, It might[9] make some money on MarketFares too, albeit a smaller margin.  It definitely makes money on non-airfare rewards, which now attract ~20% of all points spent, and carry gross margins much higher than the margins on airfare overall.  It probably makes some money on various travel-related fees (e.g. flight change fees), as well as a tiny profit for managing AC’s frequent flyer program.  Last and certainly not least, Aeroplan makes money on the points that members never use, which in theory would be 100% gross margin revenue.

 

 

Catalyst – early renewal

 

Aeroplan has a 6/28/2019 deadline by which it must notify AC if it intends to not renew the CPSA on 6/28/2020.  But Aimia has a debt maturity on 5/17/2019, and AC has a veritable “wall” of debt maturing in 2019, so one would expect the renewal discussion to get underway in 2018.  From there, it’s not a stretch to think that Aimia might be able to push for a deal in advance of its 1/22/2018 debt maturity[10], which would allow it to refi at a decent rate and free up cash for its hefty dividends and buybacks.  (Aimia’s capital allocation certainly doesn’t suggest any nervousness about Air Canada.)

 

 

 

 

 

Starting negotiations early won’t put Aimia in a bad negotiating position, for the simple reason that generates nearly enough free cash flow to pay down all three pieces of debt as they come due.  In fact, Aimia is prepared to do just that for the upcoming January 2017 maturity.  The CFO will give an update on this issue during the 3Q16 call in November.  In addition, there’s also:

 

excess cash of $130M[11]

a $300m revolver which is nearly untapped

Cardlytics biz is on the block - worth maybe $70m.  A sale should be neutral or better to FCF.

48.9% stake in PLM – a Mexican loyalty coalition built around the frequent flyer program of AeroMexico.  This business is a gem – grows quickly while throwing of lots of FCF.  PLM has been rumored to be worth US$1B[12], which would put Aimia’s stake at C$650M (note that a sale would reduce FCF by ~$15M - the dividends Aimia receives from PLM).  It’s highly likely that PLM will be IPO’d eventually.

 

But what if Air Canada goes bankrupt again?

 

AC has been doing well for a while now.  Last I checked, adjusted[13] net debt to EBITDAR was below 2.5X.  Interest expense + aircraft rental was ~1/3 of EBITDAR.  But of course, there could still be trouble if demand drops severely enough.  The question is, what then would happen to the current contract?

 

Thankfully, we can look to history as a guide.  In 2009 AC went through an out-of-court restructuring and the contract remained intact.  If AC were to actually file, the contract would probably still survive.  Management addressed the reasons why at their Analyst Day on 10/1/13 and I’ve pasted their words below.  But if you’re short on time, it boils down to:

 

Canadian bankruptcy law forces debtors to abrogate contracts completely or not at all (unlike Chapter 11 in the U.S., where they can tinker with individual terms).

This contract brings in a critical amount of FCF for AC which it couldn’t fully replace, or at least not quickly.  Therefore, it’s unlikely that any judge would allow them to abrogate the contract.

Since AC is the national flag carrier, the government would probably come to the rescue, as they did in 2009.

 

 

CEO Rupert Duchesne  – “Luckily or unluckily in 2009, we had a chance to put it to the test when Air Canada did get close to filing for bankruptcy. We did an out-of-court refinancing of the airline. We participated. We lent them $150 million at 12.75% coupon, which was I think fair with the risk, if anything. But I think that's very illustrative of the -- at the point that it really gets serious, we are a critical source of cash flow for the airline and being able to make up in a very short period of time for the loss of that would be almost impossible. And therefore, there wasn't the even any discussion at that time of what we going to do and see if we can find somebody else to do this for you. ... Also in a bankruptcy filing there's a whole lot of sort of legal and accounting issues that make it extremely hard for them sort of day off to do without, and we don't book.

 

The advice we received is that we don't think any bankruptcy judge in Canada would allow the airline to abrogate the contracts in such a way that gave cash flow risk to the airline. Frankly, if it did happen, our view is that we've actually got a fairly strong argument for the airline not to do anything. Because if we were to take that customer base and that revenue flow and provide it immediately to their competitors, WestJet, OneWorld Alliance, et cetera, et cetera, it will be a crippling blow to them. So I think what you'll see happen is have a fairly logical argument with them about is the price we're paying for Classic seats compensating you fairly for the opportunity cost of those seats? And we've done that work fairly regularly and the answer to that is yes. Are we paying you a fair price for the MarketFare rewards? And we've just done that deal so you could argue that in a moderate time, like we're in today, the answer to that obviously is yes at this point. And therefore, is there any incentive for anybody really to do anything? I think the answer is no. There are much more important things to worry about in the restructuring than a contract that is net cash flow positive to you in a much higher degree than if you did it yourself, which is what this is.

 

So we were lucky to be able to prove that in 2009, and our position now having done – just done this new deal with the card partners is much stronger than it was even in 2009 because the total revenue pile coming from these because of the breakage reduction we're talking about a moment ago and the increased price being paid by the bank means that the net cash flow in favor of the airline is even higher than it was in 2009 and will continue to grow as we get closer to the renewal of that relationship and the increased price being paid by the bank means that the net cash flow in favor of the airline is even higher than it was in 2009 and will continue to grow as we get closer to the renewal of that relationship.”

 

Former CFO David Adams – “Yes, just 2 other data points to that: one is Air Canada is a little bit different than many other airlines because it is a national flag carrier. And when it was put to the test in 2009, the Canadian government through EDC came to -- participated in the out-of-court refinancing and bridge loan. So the international gates are viewed as a national asset. And so notwithstanding WestJet's growth in the Canadian marketplace, I still believe that when push comes to shove, the Canadian government will be there with the financial support. So in a disaster scenario, we shouldn't be thinking about would the airline evaporate because there's a very, very low probability to that outcome. And for those of you, because we're here in London, just a finer point of Canadian bankruptcy law, we're not Chapter 11, right? So don't think of us that we are U.S. Chapter 11. And the difference is, is that in the U.S. you can actually cherry-pick contracts, I mean you get a judge to abrogate certain terms or conditions. In Canada, you have to abrogate the agreement in total. So it's either you keep the agreement out or you have to abrogate it completely. So when you talk about the risk of renegotiation, risk of cash flows, it's much higher in that circumstance than it would be under Chapter 11.”

 

 

 

By the way, Aimia’s equity was previously written up on VIC by castor13 in 2011 (under the old name of “Groupe Aeroplan”) as well as by Ragnar0307 in 2013.  I’m not sure if the equity is cheap today, but in any case, I think the preferred shares offer at least as much upside with less risk.

 

Also, note that Aimia is one of those rare small-caps where IR (Karen Keyes) can answer most if not all of your questions.  Not that you shouldn’t talk to the CEO/CFO, but you might want to try her first.

 

 

 

 

 

 

[1] AC CEO Calin Rovinescu at a conference on 12/2/15 - “10 years ago, Air Canada spun out its loyalty program to create shareholder value at that point in time. With that came a fairly expensive commercial contract.  And we will be restructuring that contract in 2020 with Aeroplan, and that will create value at that point in time.”  At AC’s 2Q16 call on 6/29/16 - “there's no question the expectation will be that, anything that is a below market, the term will be brought to market [upon renewal of the CPSA]”

[2] CEO Rupert Duchesne on the 6/27/13 analyst call – “So in the worst-case outcome where we wouldn't reach agreement with Air Canada in 2020, which is I said, I think it's extremely unlikely, we would have a hugely successful and economically viable program even without them. And frankly, it would be a program that would have been -- would be a great interest to other participants in the travel business.”

[3] ACE was the holdco which owned AC at the time.

[4] There is some evidence that AC had thought about eventually spinning-off Aeroplan prior to the 2003 bankruptcy, but in any event, I think it’s obvious that AC never would have agreed to these terms in an arms-length deal.

[5] CEO Rupert Duchesne at Analyst Day on 10/1/13 - “when we did the spinoff, we very carefully analyzed the real cost of the airline of providing those 8% of seats and we pay that pretty precisely. "

[6] Technically, there’s some circularity here, as ClassicFares are a component of AC’s revenue.  But we can overlook this since they’re probably not much over 3% of the total, and since our final estimate of the worst case scenario suggests a big margins of safety.

[7] For what it’s worth, Aeroplan’s own margins on ClassicFare seats seem to be close to 20%.  Since 2004, the program has offered seats at prices closer to market levels for those times when ClassicFare flights aren’t available.  In recent years, these have grown to ~30% of flights, but in the early years of 2002-2007 these were likely just a small portion of total flights, meaning that the Aeroplan’s gross margin on ClassicFare flights was probably close to its overall gross margin on airfare.  The latter margin never went much higher than 20%.  But it’s possible that Aeroplan was passing some of its savings on to coalition partners (e.g. CIBC) during that time, so this number might understate the true gap between ClassicFare and market prices.

[8] After interest expense but before preferred and common dividends

[9] This depends on the price that coalition partners pay for points, which could be less than the market value of the airfare it can buy

[10] CEO Rupert Duchesne at CIBC conference on 9/21/16 – “we would hope that we would get an Air Canada deal done long before we get to the end maturity on any of this debt.”

[11] CEO Rupert Duchesne at CIBC conference on 9/21/16

[12] http://www.bloomberg.com/news/articles/2015-07-30/aeromexico-said-to-value-loyalty-program-at-1-billion-for-ipo

[13] Adjusted for aircraft leases

 

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.

I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

 

Good chance they renew the contract with Air Canada in 2017.

[brendanb22]

Anyone have the series B preferred prospectus?