Description

Executive Summary

• Business Description: Aimia is a leading provider of loyalty marketing programs.  Its biggest program is Aeroplan in Canada (80% of EBITDA), which was started by Air Canada as a frequent flyer program and spun out in 2005.
• FCF Growth is About to Accelerate to Double Digits: Growth has stagnated over the past couple years, but will accelerate to double digits next year when Aimia's new financial partner contracts become effective.
• Multiple Expansion: The acceleration in FCF growth and reduction in overhangs on the stock that have made Aimia uninvestable recently (discussed below) should lead to significant multiple expansion.
• Catalyst Rich: As discussed below, there are several catalysts on the horizon that should clean up the story over the next 12-18 months.  As the story gets cleaner and growth materializes, Aimia's multiple should expand from 9-10x forward FCF to mid teens.
• Capital Allocation is Becoming More Shareholder Friendly: Aimia currently pays a 3.6% dividend and will likely start buying back stock late next year once its business normalizes after transitioning to the new financial partner contracts.
• What's the Upside?  At 15x forward FCF, which is reasonable for a company that is growing FCF double digits and in-line with peers like ADS and AXP, there is 40-50% upside in the shares at my Base Case estimates (see below table).  At my Bull Case estimates, the upside is closer to 70-80%.

Business Description

• Canada Segment (80% of EBITDA): Aeroplan is Air Canada’s frequent flyer program.  It was originally started by Air Canada in the late 1980s and was spun out as a separate entity in 2005.  Aeroplan has 4.6 million members and is a coalition plan meaning that members can accumulate and spend miles at Air Canada and its various partners such as CIBC, Amex, Hertz, and Marriott.  The vast majority of miles are accumulated through Aeroplan’s credit card partners (CIBC and Amex) and Air Canada.  About 75% of these miles are redeemed for flights and 25% are redeemed for other items.
• EMEA Segment (21% of EBITDA): Nectar in the UK and Italy and Air Miles Middle East are coalition plans like Aeroplan.  In the UK, Nectar’s major partners include Sainsbury, BP, and British Gas.  Nectar Italy was launched in 2010 with several grocery and gas partners, but is still somewhat small.  Air Miles Middle East's major partners are HSBC, binSina, du, Sharaf DG, among others.
• US & APAC Segment (-1% of EBITDA): This segment mainly consists of Carlson Marketing, which Aimia acquired in 2009 for $266MM.  Carlson designs and runs proprietary loyalty programs for companies such as JetBlue, Amtrak, Avis, AMC Theaters, GM, and Ford.  Aimia also hopes to launch a coalition program in the U.S. sometime over the next 1-2 years.
• Other: In addition to its main geographic segments, Aimia owns a 49% stake in Aeromexico’s loyalty program called Club Premier and a small stake in Cardlytics, which is a company focused on targeted marketing to consumers.

Situation Overview

Over the past few years, Aimia has grown solidly outside of Canada, but billings growth within Canada have started to stall out as the credit card market has become more competitive.  The "value" credit card companies have paid customers for loyalty has steadily increased over time and Aimia’s current contract with CIBC, which expires at the end of 2013, is under market, and as a result, Aimia has been unable to respond to the competition and has lost market share.

Earlier this year, Aimia began negotiations with CIBC to renew its agreement.  Its hope was to renew at a higher rate and pass along the extra money to consumers by changing the redemption rates for flights.  However, by the middle of the year, negotiations with CIBC broke down and Aimia was forced to start discussions with other banks, including TD, to replace CIBC as its financial partner.  In late June, Aimia announced a 10-year agreement with TD to replace CIBC at a more than 15% higher rate.  As part of the deal, TD agreed to pay Aimia $100MM to help with the transition and guaranteed a minimum level of billings for the next three years.  Simultaneously, Aimia announced a major re-investment in its Aeroplan program and improved redemption rates for consumers by 20-50%, which effectively passes on all the extra money from TD to its members.  Management hopes that volume growth will be re-invigorated next year as it steals back market share from its peers.  As shown in the chart below, Aeroplan members can now accumulate miles and redeem for flights much faster than members at competing programs like RBC Avion and CIBC Aventura.

Average Time it Takes to Get to Departure (Aimia vs. peers)

Despite a new contract with TD at a much higher rate, many investors were worried about what would happen when Aimia transitioned to TD.  Because both TD and CIBC would have to issue new cards, customers would be forced to make a choice.  In my view, customers would be much more loyal to the Aeroplan currency than to the issuing bank.  Northwest Airlines went through a similar bank transition and 90% of its customers migrated in the first 90 days to the new bank.  Aeroplan members are also highly engaged, which was a clear sign to me that they are very loyal to the currency.  For example, 85% of members collect more Aeroplan miles than any other currency and 81% of members engage with Aeroplan communications >1 per month.  Furthermore, according to management, 60-70% of Aeroplan card holders did not have any other products with CIBC.

In addition to low transition risk, there was still a chance that CIBC would exercise its right of first refusal and renew with Aimia.  CIBC had 5-15% of its earnings at-risk and was under pressure from shareholders to reach a deal.  Not surprisingly, in early August, CIBC used its right of first refusal to re-open discussions with Aimia and TD.  By mid-September, Aimia agreed to a three-way deal with TD and CIBC.  CIBC will keep half of its credit card portfolio and sell the other half to TD.  TD will become the primary issuer of Aeroplan cards, but CIBC will retain customers with several other CIBC products.  Importantly for Aimia, both banks agreed to pay a higher rate.  Overall, this new deal is a win-win for Aimia because it eliminates transition risk next year and provides Aimia with two strong financial partners.  Aimia will still receive $100 million from TD next year to help fund the Aeroplan program changes, but agreed to pay $150 million to CIBC this year to get the deal done.  Its rationale was that a deal that included CIBC eliminates transition and litigation risk and also reduces the marketing spend that a potential transition would have required.

Investment Thesis

• Aimia's proprietary relationship with Canada's #1 airline, Air Canada (55% domestic market share, 35% transborder market share, and 37% international market share), provides a sustainable competitive advantage versus peers.  Its contract with Air Canada extends through 2020.  Under the contract, Aimia is able to purchase 8% of Air Canada's capacity at a heavily discounted rate.  As shown in the chart above, these "classic" seats are much easier to earn than other seats in the plane.  Aimia and Air Canada also recently launched a tiered recognition program called Distinction.  Under this program, members can earn 20-35% discounts on market fare flights in addition to bonus miles and preferential treatment.

• FCF growth is at an inflection point and will begin to reaccelerate next year when Aimia’s contract with CIBC (50% of Aeroplan billings) resets at a higher rate and TD becomes the primary issuer of Aeroplan cards.
  • Aimia is using the extra money from the CIBC and TD contracts to fund a major improvement in the redemption rates that will begin next year.  On average, Aimia is lowering redemption thresholds by 20-50%.  For example, a one-way ticket will now cost 12,500 miles instead of 17,000 miles.
  • Aimia hopes this reinvestment will reinvigorate volume growth to the mid-to-high single digits, which should lead to double digit bottom line growth.  For context, the overall high-end loyalty market is growing in the high single digits.
  • In addition to these program changes, Air Canada is increasing its capacity by 9-11% next year, which will make it more attractive and easier for members to redeem miles for flights, which will further benefit growth.

• Attractive valuation with renewed growth prospects.  Aimia currently trades at 9-10x forward FCF.  FCF will dip next year as the company deals with heightened redemption, but then growth will reaccelerate in 2015 as redemption normalizes and the Aeroplan changes take hold.  Given its double digit growth prospects post 2014, Aimia should trade closer to its peers, which all trade at a mid teens multiple or higher.  Alliance Data Systems trades at 20x earnings, American Express trades at 16x, and Smiles (a Brazilian loyalty company) trades at 24x.  In addition to a cheap multiple, Aimia pays a healthy dividend (3.6% yield), which helps support the stock and limit downside.

• Multiple expansion driven by accelerated earnings growth and improved sentiment.  Aimia has been uninvestable for many investors because of several overhangs on the stock.  All of these have been resolved or will be resolved in the next 12 months.
  • CIBC contract renewal – In September, management signed three-way contract with TD and CIBC.  The contract is for a much higher rate and Aimia will use these additional proceeds to re-invest in its Aeroplan program.  Once these changes go into effect next year, investors will be able to see the growth benefits, which should lead to multiple expansion.
  • American Express contract renewal – In November, Aimia announced it signed a new contract with Amex, its other large financial partner, on similar terms to its CIBC/TD contract.  These additional proceeds from Amex will also be used to fund the Aeroplan program changes next year. 
  • Competition Tribunal decision – This overhang lifted in July when the Competition Tribunal dismissed its case against Visa and MasterCard.  The Tribunal was considering whether or not to allow merchants to deny or surcharge customers for using certain credit cards to help recover interchange fees.  Ultimately, the Tribunal ruled in favor of consumers and the credit card companies, and against the merchants.
  • 7-year Mile Expiry – This overhang lifted in June when Aimia revamped the Aeroplan program and removed the mile expiry that was set to take effect at year-end.

• Poised for more shareholder friendly capital allocation.
  • Aimia recently authorized a buyback for 10% of its float.  Once miles redemption normalizes next year and cash flow improves, I believe Aimia could start buying back stock.  Management also has explicitly said they would be opportunistic if their stock is weak.
  • In addition to the potential buyback, Aimia pays a 3.6% dividend and has committed to grow this over time.

Risks

• Consumer discretionary – Billings are tied to consumer spending and would suffer if the economy weakens.  The value of the miles to consumers would also deteriorate in a weaker economy because less people would be interested in travel.
• Increased competition from other credit card loyalty programs.  Because of the three-way agreement, there will be less uncertainty in the market.  This should lead to less aggressive competition/marketing from peers.  Also, CIBC and TD will primarily be competing together against RBC instead of competing against each other.
• Redemption spikes due to favorable changes to the Aeroplan program, which will pressure FCF.  Management has been very clear that redemption will increase next year when the Aeroplan changes go into effect.  I have modeled a spike above 100% for the burn/earn ratio next year.
• Air Canada contract renewal.  This contract does not expire until 2020.  Furthermore, Air Canada was publicly very supportive of the changes Aimia made to the Aeroplan program.

Summary Financials

Below is a summary of my model.  Let me know if you have questions about specific assumptions like burn/earn, cost per mile, price per mile, billings growth by geography/partner, etc. and I will post them in the comments section.

Catalyst