When Aeroplan spun off from ACE Aviation, Air Canada’s holding company, IRO Trish Moran and CEO Rupert Duchesne had to explain how the company could make money from handling frequent flier miles for an airline that had been on the verge of crash-landing not long before.
Because Aeroplan was going public as an income trust, they also had to explain to foreign investors how this peculiarly Canadian structure worked. Then, shortly after the IPO, Moran and Duchesne also had to contend with a looming government decree to remove many of the fiscal privileges that made investing in income trusts so attractive. Moran confesses it took ‘a lot of handholding’ with investors south of the border, where Canadian news is as scarce as penguins at the North Pole.
Six months after a vastly oversubscribed IPO and with the government’s tax issue resolved satisfactorily, Moran and Duchesne could declare their mission accomplished. Not least among their achievements was winning best IPO at the IR Magazine Canada Awards on January 26.
In fact, the valuation their endeavors have given Aeroplan has made the company the biggest part of ACE, so the frequent flier plan seems to have proven more commercially successful than actually flying the planes. The achievement was all the more laudable in that it was – for Moran in particular – something of a scramble.
‘You need someone like me…’
With ten years of investor relations under her belt, Moran was senior manager of IR at TD Bank Financial Group when she met Duchesne in August 2004. Inspired by the rumors that Aeroplan was about to take off, she told him: ‘You probably need someone like me.’
Duchesne agreed, and what’s more, remembered. In April 2005 he called Moran and asked her to start immediately. She stubbornly insisted on giving a week’s notice and taking a week off. ‘I’m glad I did,’ she reminisces, since her first day set the pace for the next six months by including a dawn flight to Montreal and a 14-hour day with the lawyers and investment bankers drafting the prospectus.
ACE wanted the deal closed by June, leaving just weeks to put the prospectus together, plan the roadshow, meet with investors, and price the deal. ‘I hit the ground running and haven’t stopped,’ Moran recounts.
With the help of Toronto-based IR agency Barnes McInerney, the roadshow took Aeroplan from Vancouver to Calgary, Winnipeg, Montreal, Toronto, Boston and New York.
Preparing the content of the roadshow presentation was important. ‘Firstly,’ Duchesne points out, ‘this is a peculiarly appropriate company to become an income trust. We have an annual cycle of earnings but it is a very steady one, with very predictable capital expenditures before you get to free cash flow. Secondly, it makes for a higher valuation, since we remit our profits gross to our unit holders. With more free cash flow, that’s a higher multiple.’
Clearing up confusion
Since Aeroplan was the first loyalty marketing business to go public, Duchesne also had to clear up some arcane points for investors during the roadshow. He explains that whenever a customer buys a ticket from a partner airline or retailer, the latter pays Aeroplan cash per mile. Then when customers redeem their miles, Aeroplan buys them tickets or other goods. The difference between the two is Aeroplan’s gross profit. Although there can be a long gap between when miles are accumulated and when they are redeemed, Gaap accounting recognizes revenue only when miles are ‘spent’.
As it got ready for the IPO, Aeroplan modeled worst-case scenarios like the loss of a major partner, against which it set up a reserve equal to approximately 50 percent of the miles outstanding at the time of the offering. The reserve is for C$400 mn ($352 mn), although the tested scenarios got nowhere near that amount.
It helps, Duchesne adds, that the business is counter-cyclical. When airline traffic falls, the airlines offer more frequent flier miles to passengers – sometimes as much as double or treble the usual number. When asked if the September 11 attacks affected the business, Duchesne states: ‘Bizarrely, after September 11, we found people were using Aeroplan miles and did not seem to be scared of flying.’
On the roadshow, Duchesne discovered that the two big questions were ‘What is the reserve and how is it calculated?’ and ‘How robust are your breakages?’ Currently and at the time of the IPO, breakage, which refers to unredeemed miles, was estimated at 17 percent.
Although the program is rapidly expanding to become more of a general loyalty scheme, the core of Aeroplan’s success is its relationship with Air Canada, which guarantees 15 percent of its seats for Aeroplan members.
Cozy majority
Of course, Air Canada is paying for those seats, and such a cozy relationship with a majority shareholder could ring alarm bells in these days of corporate governance activism. However, Duchesne reassured investors that all the inter-company agreements were vetted by a third-party accounting firm to make sure they were fair and reasonable, and at arm’s length. ‘We had to do that because some of our directors sit on the ACE board as well, so we had to protect them from a conflict of interest.’
Since the IPO was so overwhelmingly oversubscribed, most investors were clearly comfortable with ACE’s 85 percent holding. Even so, institutional investors are pressing for ACE to disgorge more of its stock, which would increase liquidity. Duchesne and Moran would also like to see this, since once Aeroplan has a float in the $500 mn to $600 mn range, and it has been public for a year, it is eligible to be included in the S&P/TSX Composite Index. Indeed, shortly after we spoke, ACE announced a special distribution of Aeroplan units that, once complete, will increase Aeroplan’s float and see ACE’s stake in Aeroplan drop to 75.5 percent.
While everyone seems to think that inclusion in the index would be a good thing, Duchesne engagingly admits that if you ask the bankers to quantify the gains, ‘they start wriggling’. While he has doubts about the index’s effect on valuation, Duchesne keeps in mind that ‘it allows you to access the capital markets much more quickly and effectively if you want to make an acquisition’.
Retail investors were avid buyers in the IPO, but large turnover subsequently occurred. ‘The big investors got so few units, they were desperate to get up to par with their holdings,’ Duchesne explains. ‘This caused the price to move up quite smartly, so a lot of retail holders who got in at $10 took their profits and got out at $13.’
Investors and management alike are also focusing on the degree to which the Aeroplan concept is transferable to foreign shores. There is certainly no shortage of US airlines flying on empty tanks that could benefit from monetizing their loyalty plans. ‘Because of
our cost of capital, unique ownership structure and links with other airlines through the Star Alliance, we are in a strong position to do that internationally,’ Duchesne says.
Having overseen the take-off, Moran is now charting the IR flight plan by retracing the original roadshow for follow-up meetings with investors. ‘We are also going to redevelop the IR web site, take a fresh look at the presentation materials we are using, and put together a formal IR strategy to take to the board of directors,’ she says. Given her thorough approach, there must be many companies that ‘need someone like’ Moran. Her CEO will be hoping she’s not so bold as to advertise that fact again.
