By Asian Venture Capital Journal
The value of airline frequent flyer programs has come into focus over the past 12 months as a cluster of US carriers used these assets as collateral for debt raised to help them navigate the strictures of COVID-19. An appraisal of the American Airlines program last July – in the US alone – came up with a range of $19.5-31.5 billion, versus a market capitalization of $5.9 billion for the entire company at that time. This implies that the business of flying people and goods is essentially worthless.
Credit card providers are willing to pay a premium for access to the kind of well-heeled clients that often get on planes. Frequent flyer programs make money from their parent airlines by selling miles that are distributed to passengers based on ticket tier and distance traveled. But they make even more from the likes of banks who hand out miles to customers as an incentive for using credit cards.
Affinity Equity Partners is to date the only private equity firm globally to make a direct investment in one of these programs. In 2014, when the market was abuzz about a potential private equity deal involving Qantas, it paid A$335 million ($314 million) for 35% of Virgin Australia’s Velocity Frequent Flyer. Affinity exited in November 2019 when Virgin Australia bought back the stake for A$700 million, delivering a 3.6x multiple and a 31% IRR.
“We go through regular brainstorming exercises. This idea came from one of the younger associates in the group,” says K.Y. Tang, founding chairman and managing partner of Affinity. “Airlines were going through a tough time and the frequent flier program is often the most profitable part of the airline. How do we persuade people to unlock it? What is the selling point? We approached the airline directly. It was more than just taking it out; there had to be a bigger value proposition.”
Ticket to ride
The GP’s proposition to Virgin Australia was that together they would boost Velocity’s profits by turning it from an in-house frequent flyer program designed to help the airline sell more tickets into a broader customer loyalty business. To this end, while Affinity had a minority stake, the deal was structured as joint control, with the private equity firm awarded veto power over almost every major decision.
Velocity was restructured into an independent business, which included relocating its headquarters from Brisbane to Sydney so that all divisions were in a single location. Affinity led the recruitment of an entire c-suite – it identified and created 20 key roles and filled 17 of them – and the acquisition of Torque Data, a domestic data analytics business.
Establishing data analytics as a core competence accelerated the use of business intelligence to accumulate customer insights, leading to improved marketing and engagement through tailored miles-earning and redemption opportunities.
“Six years ago, few people really knew what data analytics was. Lots of consultants were willing to teach you about it but we concluded that most of them were also struggling to find their way in this new area,” says Tang. “We went out and bought a data analytics company that had been in the business for more than 10 years. They have a lot of experience working with commercial customers like Samsung, Nissan, and Telstra. We made it the in-house data analytics arm.”
Velocity was encouraged to cultivate banks and credit card companies but also to look beyond them, building a more diversified range of partners that would attract members. The company secured tie-ups with BP (points can be earned and redeemed at gas stations), Flybuys (the loyalty program of Coles, Australia’s second-largest supermarket chain), HNA Group (miles are redeemed for flights with the Chinese conglomerate’s subsidiary airlines), and TEG (miles are redeemed for event tickets).
“Over five years, we took the business from being nearly 60% dependent on the airline to 30%. The next biggest part – and the fastest-growing part – was with banks and financial institutions. And then retail, which is big in Australia,” says Tang. “We went into sectors like utilities as well – anything where they want customer loyalty.”
In addition to reducing the proportion of miles sold to Virgin Australia, Velocity grew its membership base from four million to 10 million. The program won numerous awards across customer service, promotion, redemption ability, and general categories. Meanwhile, revenue and EBTIDA both more than doubled during the holding period, reaching A$448.6 million and A$167.5 million, respectively, in 2019. The improvement in cash flow generating abilities, enabled Velocity to make a dividend payment.
Good timing
The lack of mainstream familiarity with the economics of frequent flyer programs prompted some bemused LPs to pepper Affinity with questions about the rationale of the deal. “They asked, ‘Why did you buy a cost center? A loyalty program is just the marketing arm of an airline, it doesn’t make sense.’ Velocity wasn’t seen as a standalone business in itself; it was something we had to educate ourselves on and educate investors on,” according to another source close to the deal.
LPs had few complaints about the timing of the exit, which was inadvertently opportune. Within months, international air travel had ground to a halt as countries sought to contain COVID-19 by closing their borders to non-residents. Before the year was out, Virgin Australia collapsed under the weight of its A$7 billion debt burden and creditors had approved a restructuring by Bain Capital.
“We don’t have a crystal ball and we aren’t smart enough to predict the future, but at Affinity we do have a disciplined approach to handling exits,” Tang says. “Exits in Asia don’t come about naturally, they take a long time, so you really need to have a plan and prepare. It’s all about being disciplined about the process.”