2020 was a crippling year for the aviation industry. With daily cash burn running into the tens of millions of dollars for many airlines, access to liquidity has been critical as treasury teams and fleet managers juggle expenses with decimated revenue. Many governments pledged state aid but what has been delivered to date has simply not been enough.
The 'Golden Goose'
Frequent flier programmes ("FFPs") have long played a central role in airlines' marketing strategies with many people assuming them to be balance sheet liabilities but, conversely, they are profit centres in their own right. FFPs generate significant revenue from the sale of frequent flyer miles to programme partners and passengers and revenue from the sale of the miles, minus the cost of actually flying passengers paying with redeemed miles, still creates a significant positive margin for the airline. Revenue from the sale of miles has remained stable even at times when demand for flights has dipped.
FFPs have been heralded by the industry press as a 'golden goose' for airlines, being more valuable than slots, routes and gates or even the aircraft themselves. Although airlines have in the past used their FFPs to raise capital in times of distress, it has been limited to selling stakes in their FFPs or pre-selling miles to programme partners. The unique challenges posed by Covid-19 has meant airlines required an alternate path to monetise their FFPs.
The valuation of FFPs has long been a secret guarded by airlines with very few public details emerging. The United deal changed that1. The value in an FFP is underpinned by the essential nature of the FFP to the airline and the diversified consumer cashflows. Research analysts and independent appraisers have valued FFPs by multiplying the cashflow2 and currently, the top three FFPs in the world are valued in excess of US$20 billion3.
The United MileagePlus financing was the first of its kind and, together with the loyalty backed financings which followed for Delta and Spirit, was structured as a hybrid securitisation and corporate debt issuance. Integral to the highly structured nature of these transactions are the bankruptcy remoteness protections afforded to the financiers and investors. Those protections are satisfied by using Cayman Islands exempted companies incorporated with limited liability (special purpose vehicles or "SPVs"). SPVs also satisfy the general criteria rating agencies look for to ensure sufficient protection against both voluntary and involuntary insolvency risks when rating these deals.
Key bankruptcy remote features of SPVs include restricted corporate objects, appointment of independent directors to mitigate the risk of (among other things) substantive consolidation with affiliate(s), detailed restrictive covenants within the financing documentation and traditional limited recourse and non-petition provisions, the latter of which is statutorily recognised in Cayman company law.
A unique feature of these transactions is that the Cayman SPVs remain "on-balance sheet" as direct or indirect subsidiaries of the airline. As such, special structuring is required to achieve the intended bankruptcy remoteness. The most common structuring tool adopted is the inclusion of a special share also known as a "Golden Share" to achieve "synthetic" bankruptcy remoteness. The Golden Share is held by an independent trust company on charitable trust pursuant to a declaration of trust which restricts the trust company's ability to, among other things, vote in favour of a resolution to wind up the SPV. Where it is not always possible to issue a Golden Share in the capital of the SPV, "super-synthetic" bankruptcy remoteness can be achieved through the use of an irrevocable proxy granted by the ordinary shareholder in favour of the security agent allowing the security agent to exercise the voting rights granted to the holder of the ordinary share following an event of default.
Further details on establishing Cayman SPVs and bankruptcy remoteness can be found here in our client memo.
In each FFP transaction above, a Cayman SPV has acted as the borrowing and/or issuing entity and owner of the FFP intellectual property ("Loyalty IP") which forms part of the collateral package. Security was granted over a combination of the Loyalty IP and shares in such SPV and the cashflows generated by the FFPs. These carefully crafted structures were all overcollateralised. For example, the United deal raised US$6.5 billion against the MileagePlus programme which is valued in excess of US$20 billion.
The cornerstone to these deals is the bankruptcy remoteness of the structure. It is critical for the lenders and investors that the collateral securing the transactions is ring-fenced from any potential future bankruptcy of the airline. In any event, a hypothetical Chapter 11 filing by an airline would not trigger an automatic event of default as cashflows from the FFP are sufficient to cover debt service and would still be generated notwithstanding the filing.
Aviation is by no means the only industry suffering from the reduction in global travel nor is it the only place where FFPs can be found. Loyalty programmes have long been popular amongst service providers in the tourism industry from hotel brands to limousine operators as well as airports, coffee shops and concourse retailers.
United's ground-breaking MileagePlus financing was the largest capital markets transaction by an airline and since then the other deals to date have exceeded initial expectations of investor appetite. While the valuation of each loyalty programme differs, inevitably the emergence of the use of FFPs as collateral to generate liquidity will be of interest to others watching the success achieved by the airlines to date.
2 Cashflow being EBITDA (earnings before interest, taxes, depreciation, and amortization)
3 On Point Loyalty
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