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Airline Mismanagement

United Airlines declared Chapter 11 bankruptcy in December 2002.  It is still struggling to emerge, more than two and a half years later.

During its struggles, it has laid off staff, cut back on salaries and benefits, reneged on contracts, and received massive taxpayer aid.

So how then to explain the $15 billion asset it owns - and could cash in - but which doesn't appear on its balance sheet?

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United Airlines' undisclosed $15 billion asset

If this is being bankrupt, bring it on!

For most people, being bankrupt means having no money.

For most people, getting government assistance means having no money.

But do different rules apply to airlines?



Bankruptcy is expected to be a last resort desperate measure of a company that finds its very survival threatened.

And taxpayer aid to a bankrupt company should only be given (if ever!) after the company has exhausted every other possible source of funding and way of raising cash.

United Airlines is both bankrupt and also receiving $6.6 billion in government funding to bail out the pension schemes it says it can't afford to make good.

So you'd assume, wouldn't you, that United didn't have a single unspent penny, and nothing left it could sell off without endangering its future survival?

Well, you know what they say about assuming......


A history lesson - the airlines' former 'hidden asset'

Many years ago, the then American Airlines CEO, Bob Crandall, was quoted as saying that if he had to choose between owning the airline part of AMR's business or the Sabre computer reservation system part of AMR, he'd choose Sabre as being the more profitable

Back in those good old days, before the internet, airlines were rumored to make more money from their CRS systems than from their actual flight operations.

AA subsequently sold Sabre and most other airlines have divested themselves of their own CRS ownership - and a very sensible move this was, too.  New competition from internet based information distribution and travel booking systems has massively marginalized the one-time near monopoly (and profits) of the major CRS systems.

The airlines new 'hidden asset'

The latter day cash cow equivalent of the CRS systems has to be airlines' frequent flier programs. Why and how are they so profitable?

Simply consider this : The airlines sell frequent flier miles for 2c or more a mile. It takes 25,000 miles or more to earn a restricted domestic roundtrip airfare, which means the airline has received $500 for the capacity controlled 'bottom dollar' ticket you get in return.

The airline's cost of flying you on that roundtrip is probably in the order of $25 (especially now it doesn't have to feed you, or perhaps give you pretzels, or a pillow or blanket, and limits the weight of your luggage).  There's even a good chance they'll charge you a 'redemption fee' when you go to claim your supposedly free ticket - the redemption fee may be as much as the $25 cost of flying you!

What's more, many miles never get redeemed, and sit in people's accounts for years before eventually expiring or being forgotten about.

So - simple equation. Receive $500 up front. Sit on the $500 for an unknown number of years, and then, at some future point, offer a flight costing you $25 (or less if you charge a redemption fee).

See how even an airline can make a profit with these fundamentals?

Then add to that the opportunity for other list marketing activities, and you have an enterprise that, while ostensibly being designed to reward its members, actually rewards, most of all, the company operating it.

An unexpected light shines on these hidden assets

People have often wondered just how much profit these programs earn their airline owners, and have also idly speculated what their break-up value would be if sold off to an unrelated company.

No clear answers have been available.  But on Wednesday 22 June 2005, an interesting event occurred.  Air Canada sold 12.5% of its frequent flier program (Aeroplan).

As this press release describes, the 12.5% slice of Aeroplan sold for CAD $250 million.  This implies a total market value for Aeroplan of CAD $2 billion.  At current exchange rates, this equates to US$1.6 billion.

Aeroplan has approximately 5 million members, which suggests each member is valued at about US$325.

So how much is United's Mileage Plus program worth?

United is believed to have more than 45 million members in its Mileage Plus program.

If it is fair to simply extrapolate from Aeroplan's US$325/member valuation, this would suggest Mileage Plus is worth right around US$15 billion.

Are United's members worth more or less than Air Canada's members?  That is hard to accurately answer, because there are both major differences and some surprising similarities between the two programs, and some of the differences cancel out some other of the differences.

Aeroplan's 5 million members represent 16% of Canada's population.  United's 45 million members represent 15% of the US's population.  Although both calculations need to be adjusted for international membership, it is interesting to see the close match in percentages.

A more significant difference is that in Canada, Air Canada has the very largest share of the market, whereas in the US, United's share of air travel is much lower.  This might mean United's members are individually less valuable than in Canada.

On the other hand, another significant difference is the size of the two airlines.  United is many times larger than Air Canada.  This means it has a more valuable route system and can offer a richer 'bundle of benefits' to its frequent flier members.  This might mean United's members are more valuable than Air Canada's.

If the airlines were to fully disclose everything that makes up their frequent flier programs, it would be easy to more accurately value each program.  But, absent such data, it is perhaps close enough to say that United's Mileage Plus program might be worth about $15 billion.  It is probably not worth more than $20 billion, but probably is worth more than $5 billion.

An apparent discrepancy

On Thursday 23 June, United's total market capitalization was only $176 million.

Does this mean that an investor could simply buy up all United's outstanding shares, sell the frequent flier program for some billions of dollars, and then close down the airline and walk away with a huge profit?

Probably not.  United's Mileage Plus program only has value as long as there is a United to drive the program's ongoing cycle of mileage earning and redemption.

And it is also not uncommon for a company's market capitalization to be lower than its break-up value if it was simply closed down and sold off.

But - the discrepancy modified

These days, miles are increasingly earned for non-flying transactions.  Maybe you get one mile for every dollar you spend on your credit card.  Maybe you get five miles for every dollar you spend on long distance.  Maybe you get bonus miles from your supermarket every time you've added up to $250 worth of grocery purchases.  Maybe you also get miles for hotel stays, for car rentals, or for flying on different airlines.  And so on, and so on.

A frequent flier program could continue to generate miles even without the actual flight miles.

And the flip side is increasingly miles are redeemed for non air travel purposes.  Whether it be electronics from a catalog, cruises, travel on a different airline, or something/anything else, frequent flier programs these days have become very similar to the trading stamp type programs of yester-year.

This is not to say that UA's Mileage Plus program would be a $15 billion value if UA were to fold.  But the valuation of Mileage Plus or any other frequent flier program is only partially rather than completely influenced by the underlying strength (or, ahem, weakness) of the airline sponsoring it.

Where does the $15 billion appear on United's balance sheet

Here is a pdf copy of United's 2004 Annual Report.  Can you find any value attributed to their Mileage Plus program?

Let's look first at an analysis of their $20.7 in total assets.  This will show on either page 31 or 32 of the pdf.

You can see figures for all sorts of items, but unless the Mileage Plus program is included in the mere $399 million given for intangibles, or the $831 million of 'other', it doesn't seem to exist under United's assets at all.

If you keep reading, you'll come across an even more surprising outcome.  On page 25/26, you'll see a discussion about their frequent flier program which says they've entered an $840 million liability to allow for the value of future award redemption.

So it seems United values its Mileage Plus program as being worth a negative $840 million on its balance sheet, even though it could potentially sell the program for as much as $15 billion.

Is it any wonder United is claiming bankruptcy when it values its assets this way?

Is it fair to expect United to sell Mileage Plus?

No-one is saying United has to sell all of its Mileage Plus program (indeed, the value of Mileage Plus is probably greater if only some share of the operation is sold rather than if the entire business unit was split off.

But if Mileage Plus as a whole is worth $15 billion, maybe United could sell half for a quick $7.5 billion in cash and exit its seemingly never-ending, always extending bankruptcy (and give back most of the $6.6 billion taxpayer bailout).

Here's United sitting on a $15 billion dollar asset that it could sell some or all of, without affecting its core business of providing air transportation. But it declares bankruptcy, and now gets the government to bail it out of $6.6 billion of pension liabilities, as if the airline truly was penniless.

Conclusion :  Unanswerable - and Unasked - Questions

How can a company, sitting on a $15 billion asset, throw itself into Chapter 11, and accept billions of dollars in government aid due to ostensibly being unable to meet its obligations?

Let's not forget all the other ways that United is breaking contracts under the excuse of bankruptcy.  It isn't just taxpayers who are suffering.  Suppliers large and small are finding they can no longer count on contracts formerly entered into in good faith to be honored.

Is it fair to expect United to sell some of all of Mileage Plus?  Yes.

It is certainly a lot fairer to expect that than to expect taxpayers, present and retired employees, and suppliers in general to carry the costs of this 'bankruptcy' (how can an airline be bankrupt when it still has $2.2 billion in cash as of 31 Dec 2004?).

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Originally published 24 Jun 2005, last update 20 Jul 2020

You may freely reproduce or distribute this article for noncommercial purposes as long as you give credit to me as original writer.


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