WHEN FRAMES at American Airlines unveiled the world’s first frequent flyer program 40 years ago, they probably never imagined it would ever be worth more than the airline itself. Last year, analysts valued the program at around $ 18 billion to $ 30 billion, eclipsing the company’s current market capitalization of $ 12.9 billion. Such programs have proven to be a boon for US carriers in the pandemic. Companies, including American Airlines, have raised $ 30 billion in debt backed by these programs.
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Airlines once hoped to simply foster loyalty by giving freebies to customers. Passengers accumulated miles as they traveled and got a free flight once they accumulated enough. But today’s patterns are much more sophisticated. Airlines profit by selling miles to credit card companies at a price that exceeds the cost of award flights and by offering other perks, such as hotel stays. They also earn when miles expire unused or are redeemed for something of low value. According to McKinsey, a consulting firm, 15 to 30% of miles expired unused before the pandemic.
Credit card issuers in turn use the miles to attract customers with bonuses. Cards affiliated with airlines tend to generate significantly more transactions per year than other cards. Many miles are therefore earned not in the air, but by spending cards on the ground.
This explains why customers earned $ 6.8 billion in miles from major loyalty programs in 2020, even though many stayed home. If they rushed to convert those miles into free flights as travel resumes, the profitability of such devices would be jeopardized. But airlines have another way to make sure their programs stay profitable: they can deflate the value of their miles. In the early 2010s, US airlines began calculating the value of a mile based on a complex formula of fares and routes. In 2015, Delta Air Lines stopped disclosing how the value of its miles was calculated and embarked on a series of devaluations, prompting its competitors to follow suit. Over the past year, Delta, Southwest and United have devalued miles on major roads by 6-20%.
Airlines have previously used loyalty programs for cash by selling miles to credit card companies at discounted rates. United traded miles with bank JPMorgan Chase for $ 600 million during the financial crisis. But the pandemic saw the first use of loyalty programs as collateral in America, says Benjamin Metzger of Barclays, another bank. United were the first to do so with a secured loan in June 2020. Delta followed with a bond offer shortly thereafter.
Transactions have attracted more investors than bonds covered by old planes (which, unlike loyalty programs, depreciate). Debt backed by a program tends to have a better credit rating than the airline that issued it. And investors are reassured by the structure of the agreements, which use program cash flows to repay debt and limit risk in the event of an airline bankruptcy. Affinity Capital Exchange, a financial technology company, is working with JPMorgan to securitize airline miles, so they can be more easily redeemed.
The trick for airlines in all of this is to balance the costs against the benefits so that customers stay engaged, while preserving carrier margins. Endless devaluations could upset this balance and upset securitization agreements. Exorbitant valuations are not guaranteed. ■
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This article appeared in the Finance and Economics section of the print edition under the title “Lifting off”