Frequent Flyer Program:

Ready for take-off

Frequent Flyer Program at a glance

Almost all airlines have developed a Frequent Flyer Program (or

FFP) in order to help them improve customer loyalty, operating
performance or load factors. Passenger's loyalty can be critical
for legacy carrier airlines which are facing fierce competition
from low-cost airlines on short and medium-haul, and Gulf airlines
on international routes. An FFP should be viewed as a powerful
marketing tool that allows airlines collect value added information
(precise members profiles, consumer habits, etc.) on a population
with high spending capabilities. Hence, the FFP is more and more
becoming a business of its own rather than just nice to have.
These programs provide airlines with a source of recurring and
low volatility income, which could expand rapidly provided that
the airline gives sufficient focus to its program.

| Frequent Flyer Program: ready for take-off

To extract the hidden value of these programs, several options

have been observed; from creating a separate financial reporting
entity (as established by Qantas) to conducting a full spin-off (in
the case Aimia, a listed company which was formerly Air Canadas
FFP).
Why is the FFP business model so financially attractive? What
are the "pros and cons" of the various operating models offered
to airlines? Does creating a seperate entity create higher value
of the FFP and therefore positively impact the overall value of
the parent airline? What are the best ways to optimize the FFP's
value?
These are the main questions that this paper seeks to provide
answers to.

Airline loyalty programs

Two main forms of loyalty programs exist,

the stand-alone program which enables
the accumulation and the redemption
of points from a single provider and the
coalition program (see the diagram
opposite) allowing members to accrue
and redeem points with many commercial
partners affiliated to the network.

accumulate and redeem points leaving

to a better perception of the value of
the program;

Commercial partners can collect data

on customers at reduced marketing
costs, allowing them to optimize the
impact of their marketing campaigns;

The coalition program offers

commercial partners the ability to
acquire and retain at lower members
cost;

Companies can also increase the

exposure of their individual brand
through this network association.

s
et
ck

poi
nts
fo
r
Redemp
tion
for
fre
et
i

Members have more opportunities to

en
tak
ht
ig

Accrual
of

The coalition program is typically seen as

the most meaningful loyalty program, as
it has many benefits over the stand-alone
program:

Pu
rc

AIRLINES FFP

Network
of FFP

points
alty
loy
of
se
ha

A Frequent Flyer Program is a loyalty

program offered by many airlines to
customers allowing them to accumulate
(or earn) points for flights taken
or services bought from the airlines
commercial partners. Members may
redeem (or burn) their accrued points
for free air travel tickets or for other
products and services available through a
network of commercial partners.

Redemp
tion for free products

MEMBERS

Accrual
of points for purchases

COMMERCIAL
PARTNERS

As part of the coalition program, the

quality and extent of the commercial
partnerships are strategic for the success
of the loyalty program.
The main commercial partners of
FFP's are generally banks, credit cards
providers, car rental companies, hotels
and retailers.

Many FFP players but few listed

FFP

Airlines

Members (million)

Asia Miles

Cathay Pacific/Dragonair

4.0

Aeroplan - Aimia

Air Canada

4.7

Avios

British Airways/Iberia

5.9

Smiles

GOL

9.3

Qantas FFP

Qantas Airways

9.4

Multiplus

TAM

11.6

Air China

Air China

19.9

Flying Blue

Air France - KLM

21.0

Miles & More

Lufthansa

23.0

JAL Mileage

Japan Airlines

25.0

AA Advantage

American Airlines

72.0

SkyMiles

Delta Air Lines

74.0

Although almost all airlines are using

loyalty programs however, few are
highly developed. Only three FFPs are
listed (highlighted in the opposite table):
Aeroplan Aimia, which emerged from Air
Canadas restructuring, Multiplus (owned
by TAM airlines) and Smiles which is the
GOL airlines program. The table shows
some of the most well-known FFPs, along
with the number of members.

Sources: Brokers' reports, companies' reports, EY analysis

Frequent Flyer Program: ready for take-off |

Operational benefits of FFP business

Three sources of cash inflows
The sources of cash flows for FFP mainly consist of (i) gross
margin on points redeemed, (ii) working capital benefits,
and (iii) the revenue from the breakage:

The gross margin on points redeemed is the spread between

the cost of points and the price for which they are sold to
commercial partners;

The breakage is the expiration of unused points (which usually

takes place 6 to 36 months1 after issue) which results in no
reward on these points and no associated costs.
The main cash outflow results from the purchase of rewards (free
airline tickets or products/services from commercial partners).

The working capital benefits come from interest on positive

float stemming from the received cash from the sale of points
(an average of 10 months to 2.2 years1 before redemption of
points);

1 Redemption and breakage expiration time observed on the sample of FFP

presented above

| Frequent Flyer Program: ready for take-off

Cash generative business model

As described above, the main operational benefits of FFPs result in the cash generated by the spread on points, interest on negative
working capital and the breakage revenue. In addition, this activity does not require substantial investments so there are low cash
outflows related to capex. The FFP business model is different from that of the airlines as a whole and its benefits could result in a
lower volatility of earnings for the parent airline:
Spread on points
(cost of points)

The frequent flyer program sells points to its commercial partners and can price them
differently with each partner.

Breakage revenue

Some of the points sold remain unused by the members until expiration.
Thus, there is no cash outflows associated with the purchase of rewards.

Negative Working Capital

Requirements

Members generally wait for accumulating enough points to make redemption.

During this period, the FFP receive cash billings (from commercial partners) with no cash
outflows (before redemption) and earn interest income on the cash generated.

Asset-light based

The cash (re)investment requirements for FFP businesses are low compared to the capitalintensive needs of airlines.

Other benefits
for the parent airline

FFP is crucial in order to drive customer behaviors on an airlines market globally impacted
by the price competition from the Gulf and low-cost airlines.
Airlines could derive additional revenue from the monetization of the data mining needed for
running the FFP business.
Thanks to the cash generative nature of the business, the FFP helps reduce the airline's
earnings volatility (driven by oil and currency fluctuations, strong exposure to economic
downturns, etc.).

As outlined above, a FFP could be a very

attractive and cash generative business.
Airlines therefore have interest in
considering their FFP as a business unit,
and are more and more thinking how to
create value with this activity by giving it
more focus and autonomy.
Another key consideration when dealing
with FFP is deferred revenue or debt of
miles. Indeed, under IFRIC 13 (issued
in 2008), airlines reporting under IFRS
need to record on their balance sheets the
miles earned by each customer when he
(she) purchases his (her) flight ticket as a
liability.
Strictly speaking this debt of miles is
deferred revenue; in other words,
the airline which sells a ticket for 100
will defer the portion of revenue
corresponding to the advantage granted
(i.e. the miles, say 1) until the miles are
actually redeemed or expired.

Also, if an airline sells some miles to a

third party (say a credit card company), it
will need to account for the future cost of
providing the service when the customer
will actually burn his mile.
While the situations can sometimes be
a little more complex than that as the
passenger/consumer could also decide to
burn his miles on another airline (which
is part of the same airlines alliance) or by
purchasing a service from another service
provider. The debt of miles however
shouldnt be seen as an issue for the
parent airline.
In the first example (sale of an
airline ticket), this debt will only be
representative of the "cautiousness"
which exists in recording the revenue from
a given sale, while in the second example
we know that the sale of a mile to a third
party will generate a positive spread (as
the mile is sold for more than cost) which

Cash
generative
business

Less earnings
volatility and cash
shortage

is a working capital benefit as the mile

will be redeemed several months after
its issuance or a pure profit in the case of
breakage.
While many just see the debt of miles
as a threat or risk that weighs on the
airline, a more educated vision of it
would be to say that this debt of miles is
representative of the normal functioning
of a highly cash generative business and is
therefore the normal counterpart of a very
valuable intangible asset. But to change
this perception, it often takes more than
an explanation.
As a matter of fact, the process of
subsidiarizing the FFP is often a good way
to help change the perception around the
FFP.

Frequent Flyer Program: ready for take-off |

Unlocking the FFP valuation potential?

Business cases: Partial sell-down or separate financial reporting can benefit the
whole airline group perception

EBITDA margins comparison

Business metrics

History

Only few airlines companies have tried to capture the market

value of their FFP business: Air Canada with Aeroplan - Aimia,
TAM with Multiplus, GOL with Smiles and Qantas Airways with its
program.These limited business cases suggest that partial float
or carved out financial reporting can benefit the core airline while

the complete spin-off, as Air Canada did with Aeroplan, could lead
to extract even more value but with a risk of a reducing value in
the residual airline business. The table below summarizes the
main specifications of the four analyzed business cases:

Spin-Off

Partial Float

Separate Accounts

ACE (Air Canadas holding)

sold Aeroplan

Brazilian airlines TAM and GOL sold portion of their FFP

(respectively 27% of Multiplus and 28% of Smiles)

Qantas decided to carve out

its FFP as a separate division
in 2008

Aeroplan - Aimia (Canada)

Multiplus (Brazil)

Smiles (Brazil)

Qantas FFP (Australia)

Created in 1984, Aeroplan was

a FFP integrated to passenger
business operations of Air
Canada until 2002. In 2005, ACE
Aviation Holdings (Air Canadas
parent company) sold 12.5% of
Aeroplan through an IPO unit trust
structure. From 2005 to 2008, ACE
progressively sold its remaining
stake.
The Aeroplan Group made several
acquisitions of loyalty management
and marketing companies and is
now a pure loyalty management
company. The companys names
changed to Aimia Inc. in May 2012.

Multiplus was created in 2009

to manage TAMs Frequent Flyer
Program (TAM Fidelidade). TAM
Fidelidade, launched in 1993 and
was the first Brazilian FFP.
In April 2010, TAM decided to float
27% of Multiplus, keeping a 73.2%
interest. Mutliplus is listed on the
Brazilian index.
TAM airlines has merged in April
2012 with LAN airline (Chile) to
form the LATAM group.

Smiles was created in 1994 by Varig

airline as its Frequent Flyer Program
until 2007 when Varig and Smiles
were acquired by the airline GOL.
As a successful loyalty program,
Smiles became an independent
business unit of GOL in January
2013.
In April 2013, 28% of Smiles went
public, while GOL retained a 57%
stake. Smiles is listed on the Brazilian
index.

The Qantas FFP was launched

by Qantas Airways in 1987, and
merged with Australian Airlines
domestic loyalty program in
1992.
In 2008, Qantas carved out its
FFP as a separate division but still
internal to the airline.
Now, the financial accounts of
Qantas display the FFP financial
performance, as a separate
business and reporting unit.

Airline tie up: Air Canada

Revenue (FY12): 2,249m CAD
EBITDA margin (FY12): 15.5%
Members (active, FY12): 4.7m
Partners (FY12): 75
Points expiration: n/a
Breakage: n/a

Airline tie up: TAM (LATAM group)

Revenue (FY12): 1,476m BRL
EBITDA margin (FY12): 16.4%
Members (Q213): 11.6m
Partners (Q213): 445
Points expiration (FY12): 2 years
Breakage (FY12): 21.3%

Airline tie up: Qantas Airways

Revenues (FY13): 525m AUD
EBITDA margin (FY13): 20.2%
Members (FY13): 9.4m
Partners: n/a
Points expiration (FY12): 10 m.
Breakage: n/a

Multiplus vs. LATAM

Aimia vs. Air Canada

Airline tie up: GOL

Revenue (FY12): 317m BRL
EBITDA margin (FY12): 37.1%
Members (Q213): 9.1m
Partners (Q213): 203
Points expiration (Q213): 3-5 years
Breakage (Q213): 16.3%

Smiles vs. GOL

37%

Qantas vs. its loyalty program

22%

15%

14%

13%
11%

14%

20%
13%
16%

11%

20%

28%
24%

16%

15%

10%

9%

8%

22%

18%

24%

12%

7%

9%

10%

9%

11%

7%
8%

7%

7%

10%

9%

-5% -5%

Aimia

2013a

Air Canada

2014e

2015e

Airlines industry

2013a

2012a

Multiplus

LATAM

2014e

2015e

Airlines industry

2013a

2012a

Smiles

8%

9%

10% 10%

-5%

-5%
2012a -5%

11%

10%

13%

GOL

2014e

2015e

Airlines industry

2013a

2012a

Qantas FFP

2014e

Qantas

2015e

Airlines industry

Based on the business cases analyzed, we observe different options to extract the hidden value of FFP from airlines.
The choice of each option is a complex question and depends on many factors (operational, strategic, etc.).
For each option, we seek to identify the main pros and cons that airlines have to consider before engaging in a separation process.

Source: Annual reports

| Frequent Flyer Program: ready for take-off

Separation process: from internalized FFP to complete spin-off

Based on the business cases observed, the
evolution of airlines FFP seems to follow
a step-by-step separation process in order
to develop and enhance further value of
this business. As presented in the graphic
opposite, a FFP could develop from an
(1) internalized loyalty program to a (2)
separate business unit (eg. Qantas, Smiles
before IPO), then to a (3) partially floated
subsidiary (eg. Smiles and Multiplus)
and finally to (4) an independent loyalty
management company (eg. Aeroplan Aimia).

Observed development of FFP

Internalized
FFP

Separate
Business Unit

Pure FFP controlled by the parent

airline company

Partial Float
Subsidiary

Spin-off

Independent loyalty
management company

1 Internalized FFP requires relatively low operating costs

3 Partial float/subsidiary allows a highly transparent view

2 Acting as a separate Business Unit gives more autonomy

4 After a complete spin-off, a FFP company could offer

and investments. It is fully focused on passenger loyalty as

it is completely controlled and managed by the passenger
business management team. It is more difficult to attract
third party revenue stream (from commercial partners) and to
clearly communicate the impact of the FFP on overall financial
performance to the market.

on decision making (separate budget under the supervision of

the parent airline) and helps develop partnerships and revenue
from third parties. Also, for listed airlines such, such as Qantas
which discloses financial accounts for its FFP, it could positively
contribute to the overall financial performance and could improve
the value of the entire airline group. Nevertheless, the full
valuation potential of the loyalty program may not be achieved
as the volatility of the airline business earnings may mitigate its
development.

on the profitability of the FFP. The transfer pricing relationships

between the FFP and the airline, which could be a critical
issue, remains under the control of the airline. When listed, as
with Smiles and Multiplus, investors can access a pure FFP
investment without being exposed to the airline business
volatility.

better valuation upside for investors and more flexibility for

the management to develop as Aimia did, making strategic
acquisitions after separation from Air Canada. But, the standalone airline business would have no access to operational
benefits of the FFP and remain fully exposed to the airline
earnings volatility. Also, the loyalty company may no longer focus
on passengers loyalty and the transfer pricing policy would not be
under control.

Sources: Booz & Company research, Aeroplan, EY analyses

Frequent Flyer Program: ready for take-off |

FFP valuation insight

Higher trading multiples for loyalty management companies than airlines
When looking at the trading multiples of
our loyalty management peers sample
(FFP and pure loyalty management
companies1), we observed a higher
valuation perception of FFPs compared to
listed legacy carriers.
Indeed, the analysis of the average EV/
EBITDA multiples of loyalty management
companies results in a 79% premium
over the average EV/EBITDAR (Earning
Before Interests Taxes Depreciation &
Amortization & Rents) for our airlines peer
sample as presented in the chart2 below.

Based on operational benefits and on the

higher value of FFP businesses compared
to airlines, it could be surprising that
only four airlines have engaged in to a
separation process. This can be partly
explained by the fact that such a process
implies certain organizational and
strategic questions to be answered and
could require costs and time for setting-up
a separate subsidiary with no guarantee
of success. As an illustration of the higher
focus given to FFP, we can however note
that at least three private transactions
recently took place relating to FFPs (see
next sector).

Loyalty management peers

Multiplus

Alliance Data

Aimia

Points International

Smiles

Airline peers
Delta

Qantas

United Continental

Air France - KLM

Lufthansa

GOL

LATAM

Air Canada

British Airways & Iberia TAM

Cathay Pacific

13,9x
12,2x
10,8x

Loyalty Management - EV/EBITDA

8,4x

Airlines - EV/EBITDAR

7,3x
5,1x

2013e

2014e

2015e

Recent transactions in FPPs show high valuation potential

The table below presents three transactions that took place in 2012 and 2013:
Date of deal Target (FFP)

Buyer

Seller

Deal value

% acquired

Eq. Value
(100%)

Eq. Value
mEUR

Total
members

20/11/2013

Etihad

Jet Airways

150 USD

50,1%

299 USD

228

2,5

91

Jet Privilege

Eq. Value/
Member ()

18/12/2012

Topbonus

Etihad

Air Berlin

200 EUR

70%

286 EUR

286

3,1

92,2

29/10/2012

Aeromexico
PLM

Aeroplan Aimia

Aeromexico

88 USD

20%

440 USD

341

2,9

117,7

The transaction member multiple related to these operations results in a value per member comprised between 91 and 117.7.
Applying an average of 100 to the number of members of any FFP could therefore indicate its potential market value. For obvious
reasons, a price per member shouldnt be used to derive a precise fair market value of a given FFP but it can be considered as a back
of the envelope computation of how much such a business could be valued, assuming it is run successfully.

Sources: EY analysis, brokers' reports

1 Alliance Data and Points International
2 As the FFP have virtually no rent charges, their EV/EBITDA is equivalent to their
EV/EBITDAR and provide a more apple to apple comparison to the legacy
airlines EV/EBITDAR
8

| Frequent Flyer Program: ready for take-off

Frequent Flyer Program: ready for take-off |

Conclusion: Why only few separated FFP?

Establishing a performing separate FFP
requires a large active member base and
a strong partnership network, but the
process to become a pure loyalty player
is more demanding and complex. As our
analysis demonstrate, FFP and loyalty
management companies seem to generate
more value than the traditional passenger
business (based on trading multiples).
However, when looking at the higher
multiples, one should keep in mind that:

The higher current multiples are not

only arising from the business model of
the FFP, but also translate the high
expected growth of the programs (eg.
exposure to emerging markets for
Multiplus and Smiles).

The companies that we analyzed, have

Some major operational issues (carve

a successful track record at as airline

loyalty programs and have a strong
coalition network.

The impact of spinning-off the FFP on

The listed companies analyzed have

demonstrated their ability to constantly
increase the percieved value of their
program (clients segmentation,
rewards, etc.); so as to obtain an active
and large member base.

10

| Frequent Flyer Program: ready for take-off

Keeping the FFP internalized would

certainly not enable it to unlock its
full value potential. On the contrary, a
complete spin-off raises significant risk
issues,
such as:
out, IT, social law, data privacy, etc.).
the airlines financials (potential
increased volatility of earnings).
Nevertheless, the trend towards greater
autonomy and focus given to the FFP
should expand in the future as airlines will
realize that they hold a valuable asset.

Contacts
Arnaud Cohen

Partner
Transaction Advisory Services
Valuation & Business Modelling
arnaud.cohen@fr.ey.com
+33 155 61 07 10

Louis-Adrien Lussey

Senior Manager
Transaction Advisory Services
Valuation & Business Modelling
louis-adrien.lussey@fr.ey.com
+33 155 61 00 54

Frequent Flyer Program: ready for take-off |

11

EY | Assurance | Tax | Transactions | Advisory

About EY
EY is a global leader in assurance, tax, transaction and advisory
services. The insights and quality services we deliver help build trust and
confidence in the capital markets and in economies the world over. We
develop outstanding leaders who team to deliver on our promises to all
of our stakeholders. In so doing, we play a critical role in building a better
working world for our people, for our clients and for our communities.
EY refers to the global organization, and may refer to one or more, of
the member firms of Ernst & Young Global Limited, each of which is a
separate legal entity. Ernst & Young Global Limited, a UK company limited
by guarantee, does not provide services to clients. For more information
about our organization, please visit ey.com.
2014 Ernst & Young Advisory
All Rights Reserved.
Studio EY France - 1403SG568
In line with EY's commitment to minimize its impact on the environment, this document
has been printed on paper with a high recycled content.
This material has been prepared for general informational purposes only and is not
intended to be relied upon as accounting, tax, or other professional advice.
Please refer to your advisors for specific advice.

ey.com