How Airlines Quietly Became Banks

Summary

The video script reveals the astonishing financial value of airline frequent flyer programs, which during the COVID-19 pandemic, became a crucial asset for airlines struggling financially. United Airlines, for example, used its MileagePlus program as collateral for a $5 billion loan, with the program valued at $21.9 billion. This valuation was surprising as it exceeded the market cap of the airlines themselves, suggesting that the airlines' primary value lies in their loyalty programs. The script explains how these programs evolved from simple reward systems to complex financial instruments, with airlines acting as banks that control a virtual currency. The programs generate significant profits through partnerships and co-branded credit cards, and have shifted to revenue-based systems to prevent exploitation. The power dynamics between airlines and credit card companies also play a role in the valuation of these programs, with airlines holding the upper hand due to their control over the supply and redemption of points.

Takeaways

• 📈 **Financial Insights**: The public got a first glimpse into the financials of airline frequent flyer programs, revealing their astonishing value during the COVID-19 pandemic.
• 💸 **Collateral Dilemma**: United Airlines sought a $5 billion loan and used their loyalty program, MileagePlus Holdings LLC, as collateral due to their diminished worth at the time.
• 📉 **Market Cap Surpass**: The valuation of loyalty programs like United's MileagePlus ($21.9 billion), Delta's ($26.5 billion), and American Airlines' ($31.5 billion) exceeded their respective market caps, indicating the programs' significant financial contribution.
• 🛫 **Operational Losses**: Airlines like American were losing money on a per-mile basis on passenger seats but offset these losses with substantial pre-tax profits from their frequent flyer programs.
• 💳 **Credit Card Partnerships**: Airlines have lucrative partnerships with credit card companies, which significantly contribute to their profitability, transforming the industry from mere transportation to financial entities.
• 🔄 **Evolution of Programs**: Frequent flyer programs evolved from simple reward schemes to complex financial instruments, with American Airlines pioneering partnerships with other travel-related companies to earn and redeem miles.
• 💵 **Monetary Valuation**: Airlines began to assign a monetary value to their loyalty points, selling them to partners like Hertz, which in turn used them to incentivize customer spending.
• 📊 **Revenue Shift**: The shift to revenue-based earning systems instead of distance-based ones has made it harder for customers to exploit the system, ensuring a more consistent revenue stream for airlines.
• ✈️ **Dynamic Award Pricing**: Airlines have implemented dynamic award charts, linking point redemption rates to cash fares, which has closed the loophole for arbitrage and maximized airline profits.
• 💼 **Central Banking**: Airlines function like central banks for their own virtual currencies, with control over both the supply of points and the availability of flights to spend them on, giving them significant financial power.
• 🧮 **Point Valuation**: The value of points varies by airline, with estimates suggesting an average value of 1.218 cents for Delta SkyMiles, 1.226 for United MileagePlus, and 1.416 for American Advantage.

Q & A

Why did airlines look for loans during the early days of the COVID-19 pandemic?

Airlines were losing a significant amount of money due to the drop in travel demand, and they needed loans to financially sustain themselves until travel resumed.

What did United Airlines offer as collateral for their loan?

United Airlines offered MileagePlus Holdings LLC, which is their loyalty program, as collateral for the loan.

What was the approximate valuation of United's loyalty program, according to the Form 8-K filing?

The valuation of United's loyalty program, MileagePlus, was approximately $21.9 billion dollars.

How did the value of the loyalty programs compare to the market caps of the airlines themselves?

The values of the loyalty programs were equal to or greater than the market caps of the airlines, indicating that, from a financial perspective, the airlines themselves were considered to have negative value.

Why did airlines start to lose money on each seat per mile flown?

Airlines began to lose money on each seat per mile flown because the cost to operate a seat one mile (including factors like fuel, insurance, etc.) exceeded the revenue generated from passenger fares.

How did airlines generate pre-tax profits despite losing money per mile flown?

Airlines were able to generate pre-tax profits thanks to the significant revenue generated from their frequent flyer programs, which included earnings from co-branded credit card partnerships and other benefits.

What was the significance of the American Airlines partnership with Hertz and Holland America in 1982?

The partnership allowed American Airlines members to earn points when renting cars or booking cruises, marking the first time that an airline put a real monetary price on its frequent flyer points, which was a revolutionary step in the monetization of loyalty programs.

How did the introduction of co-branded credit cards change the frequent flyer programs?

Co-branded credit cards dramatically increased the volume at which airlines sold points to external partners, shifting these programs from incentives for more airfare spending to profit centers in their own right.

Why did frequent flyer programs evolve from a distance-based to a revenue-based system?

The evolution to a revenue-based system prevented exploitations where passengers earned more miles on less expensive, longer itineraries. It also aligned the point earning more closely with the actual revenue generated by the passenger.

How do dynamic award charts affect the value of frequent flyer miles?

Dynamic award charts make the point redemption rates rise during high demand periods, correlating them with cash fares, which prevents arbitrage and ensures that the value of miles is more closely aligned with the cost of the flight.

Why are frequent flyer programs considered financial instruments that airlines can hardly lose money on?

Frequent flyer programs are structured in a way that airlines control the supply of points, the availability of seats to be redeemed, and the pricing for point redemptions. This control, combined with the revenue generated from selling points to partners, makes these programs highly profitable for airlines.