A Peek Behind the Curtain

Can an airline loyalty program really be worth $23 billion?

July 16, 2020

Text & Infographic by Joseph Slattery

On June 12, 2020, United Airlines Holdings (UAL), the parent of United Airlines, filed a form 8-K with the U.S. Securities and Exchange Commission revealing the terms of a $5 billion loan underwritten by a gold-plated triumvirate: Goldman Sachs, Barclays and Morgan Stanley. The loan itself was little surprise, just one in a series of liquidity-boosting maneuvers by U.S. carriers in the COVID-19 crisis. The second quarter of 2020 was the worst, financially, in United’s 94-year history. The company was burning through forty million dollars in cash per day.

What did raise eyebrows in United’s filing was the loan’s collateral. Rather than aircraft, real estate, or valuable Heathrow landing slots, United put up an asset far less tangible: the airline’s MileagePlus loyalty program.

Perhaps in anticipation of that day, MileagePlus Holdings (MPH) operates as a separate entity under the UAL corporate umbrella. This year’s crisis has sparked renewed interest by major carriers and Wall Street in harvesting value from loyalty programs, an idea popularized three years ago when Joe DiNardi, a partner at the investment firm Stifel Nicolaus, wrote a paper arguing that share prices of five U.S. carriers — United, American, Delta, Southwest, and Alaska — were intrinsically undervalued because investors were missing a goldmine buried under the notoriously thin and erratic margins of the airline business. According to DiNardi, the loyalty programs operated by these five carriers were worth in aggregate more than $136 billion. The most valuable, American Airline’s AAdvantage program was appraised by DiNardi at $37 billion, far more than the airline itself.

In the June SEC filing UAL valued MileagePlus at $21.9 billion, twelve times MPH’s 2019 earnings before interest, taxes, depreciation and amortization (EBITDA). This is well below the “rather conservative” 22x multiple recommended by DiNardi in 2017.

To reassure investors, UAL released a 48-page PowerPoint presentation peppered with previously confidential data. In 2019, MPH earned a profit of $1.8 billion on $5.3 billion in sales. 2019 was by historic standards a good year for the airline industry. Conscious of the 2020 catastrophe, UAL pointed out that “MPH has demonstrated resilient EBITDA independent of United performance and macroeconomic headwinds.” In other words, a safe haven in a category 5 storm.

How MPH Makes Money

(See infographic below)

MPH operates like a bank. It maintains a list of members and their account activity. MPH — not the airline — issues miles. United Airline and MPH’s 110+ third-party partners — banks, hotels, car rental companies, etc. — buy the miles from MPH to reward their MPH-affiliated customers. The price of a mile is fixed by agreement. United Airlines pays an estimated 1.2 cents each (one cent base plus an adjustment amount) out of ticket revenues when members fly United. Third parties pay up to two cents per mile. The largest and most lucrative third-party is Chase Bank, issuer of the MileagePlus co-branded credit cards. The MPH/Chase agreement is confidential, but it is estimated that Chase pays MPH between 1.25 cents and 1.50 cents for miles earned by cardmembers on purchases and as sign-up bonuses.

When MPH members earn miles from either United Airlines or third parties, MPH records the revenue but must carry a balance sheet liability anticipating the future cost of redemption. Although MPH members can redeem miles for a menagerie of goodies, around 80% go towards travel on United. When that happens, MPH must buy the award ticket from the airline at a fixed price of one cent per mile. The “per mile” has nothing to do with the flight miles; it is the price in miles currency set by the airline’s revenue management.

For example, take John, a MileagePlus member from Denver. Let’s say that John flies United occasionally for business and in a year earns 50,000 miles. Behind the scenes the airline has used a portion of his airfare to buy those 50,000 miles from its sister company MPH at a price of around 1.2 cents each, or $600 total. In time, John decides to take a vacation to Hawaii. He finds a round-trip ticket on United priced at 50,000 miles. When he clicks “purchase,” MPH pays the airline one cent per mile — $500 — and removes 50,000 miles from John’s account. MPH earns $100 on the transaction.

Let’s say John also gets the MileagePlus Explorer Visa card. He collects a 40,000 mile sign-on bonus and earns another 20,000 miles through card charges in the first few months. Chase buys these 60,000 miles from MPH at a price governed by their confidential agreement. Let’s assume this is 1.4 cents per mile. Chase pays MPH $840.

When John’s wife learns of his Hawaii plans, a closed-door meeting leads to a late night for John on United’s website. He secures a second ticket, but the price has gone up to 60,000 miles. He sighs, clicks, and watches his account balance drop to zero. MPH pays United $600 and pockets $240 in profit.

In his 2017 report, DiNardi minced no words in linking the phenomenal value of airline loyalty programs to their co-branded credit cards. “A very good business to be in,” he said. Overall, less than 30% of MPH revenue involves United Airlines. COVID-19 or not, recession or not, credit cards are buying enough billions of miles to have impressed Carl Sagan. It’s a cash cow. MPH gets paid upfront and keeps the money until miles are redeemed. About 14% of miles are never redeemed, according to UAL’s 2019 annual report.

The 23 Billion Dollar Question

So how reasonable is this $22.9 billion valuation for MPH? I am not a believer. Valuing any airline loyalty program as an independent business implies a potential spin-off, like American and United did with their reservation systems back in the ‘90s. Even DiNardi thought this unwise, although he floated the idea of selling partial equity. At UAL, the corporate siblings are like Siamese twins with a relationship manipulated by the parent in the corporation’s best interests. That’s why United’s internal transactions favor MPH. When United fliers earn miles and later redeem them for free travel, MPH earns a guaranteed 20% margin. It’s neutral to the parent company, but if MPH and the airline were to split, which side has the chips? Why would the airline pay third party margins on transactions involving their own customers on their own flights?

As with all airline programs, the co-branded credit cards are MPH’s crown jewel. The Chase contract runs through 2029, so for at least that long, assuming that MPH can buy United seats at the current 1 cent per mile, MPH can count on 0.4 cents per mile margin on the lion’s share of today’s activity. But this math is deceiving. The MPH presentation brags about a “dynamic pricing engine that adjusts Air Award pricing in response to a variety of demand signals and discretionary levers.” This is a fancy way of saying revenue management. Who controls this? The airline. United can charge whatever it wants for an air ticket, in miles or money. Unencumbered by the Chase golden egg, United’s revenue management could in the airline’s best interest devalue miles, raising costs for MPH, diluting the value of member miles as well as the credit card’s reward proposition. In other words, the success of the co-branded cards ultimately depends on how United’s RM manages the availability and affordability of award seats.

The MPH member list and appended data is itself a valuable asset — “premium” and “highly attractive” according to the presentation. Among the good things this membership “drives” at United is “enhanced revenue generation.” Over half of United’s flight revenues come from MPH members. That contribution grew at double the non-member rate over the last three years.

I’m always amused by such inside-out logic. Is MileagePlus causing these results or is MileagePlus just a reflection of the airline’s business? MileagePlus is free. It takes maybe 5 minutes to join, with the kids screaming and the dog barking. The value is geared to those predisposed to fly United. Yes, with the credit card you can spend your way to Australia, free and in first class, without flying a single United mile beforehand, but United’s competitors have the same proposition. I wonder how many of the MPH mega-members live in Atlanta, or Dallas?

Leveraging the Insights

In addition to the recognition and perks that are de rigueur in any loyalty schemes, almost all airline and hotels programs reward customer behavior with equity — points or miles that are potential liabilities against salable inventory.

With a few minor exceptions the cruise industry has steered clear of this practice. Among travel segments, cruise line loyalty programs are a joke. You can spend $100,000 and wind up with a steak dinner and a fruit basket. Measuring the ROI of any loyalty program is difficult. Measuring the cost is easy, but measuring marginal revenue involves low resolution and often arbitrary assumptions, even in a “data-driven” marketing environment.

Most cruise lines meet the loyalty obligation with a simple equation: Find the lowest cost scheme that that meets guests’ expectations, is reasonably fair, and is competitive. To some cynics loyalty is no more than a defensive necessity.

There are many dissimilarities between the cruise and airline businesses, but nonetheless I find these polarized strategies hard to reconcile.

Carnival Corporation, the world’s largest cruise operator, hosted nearly 13 million vacationers in 2019, collecting around $20 billion in ticket and onboard revenues. Carnival controls about 50% of the global cruise market, a far larger share than any hotel company, airline or even airline alliance. Yet far from leveraging this scale, each of the corporation’s nine brands maintains its own loyalty program. Some have their own co-branded credit cards but these are disconnected from loyalty. Royal Caribbean and Norwegian Holdings operate in a similar way.

For the airlines, windfall revenue from co-branded credit cards may prove neither scalable or sustainable. But with some creative thinking, the underlying business model — selling inventory upfront and opaquely through complimentary third-party businesses -- may be both. Cruise lines have not even scratched the surface and seem to be doing less than ever to find new markets, shake off the fire-sale merchandising, and diversify distribution. At a time when they need to challenge everything they do and reconsider every maxim held dear, this seems like ripe territory to explore.