We’ve long known that airlines make big money from their loyalty programs, but the exact structure has been shrouded in secrecy. That is now changing as airlines look to leverage these money-makers as collateral for financing. United has just unlocked more than $5 billion by putting up its MileagePlus loyalty program, but to do that, it had to give a lot more public information about the nuts and bolts of how it all works. Lucky us.
The 47-page MileagePlus document has a lot of charts and dizzying details, but underneath, there is a very clear understanding of just how these programs make their money — as expected, it’s by selling miles to third parties. In 2019 alone, MileagePlus pulled in $5.3 billion in total revenue and $1.8 billion in profit (EBITDA), but those numbers need to be broken down.
Loyalty programs have to be more independent for them to be usable for collateral, so United has taken a page out of Norwegian’s book and created one of the most complex structures around. I mean, just look at this ridiculousness:
Ok, now stop looking at it, because it doesn’t really matter. What does matter is that with this independence, United has to record money moving around within United Airlines, Inc. For the most part, this isn’t new money for the company. The one exception is when someone buys miles from the airline instead of earning by flying, but let’s pretend that doesn’t exist and be even more conservative. Of the $5.3 billion in cash that came into MileagePlus, 29 percent came from United itself, so we will conservatively assume that’s not net new cash at all.
Confused? I can’t say I blame you. So, let’s use a real-life example.
Cranky Flies to Newark
Back in January, before the world ended, I flew United from LAX to Newark. I bought my ticket for a mere $133.30. In the old system, I would have earned 2,454 miles for the flight, but now that United awards miles based on the money spent instead of the miles flown, I earned a lot less. Since I’m not an elite member, I get 5 times the BASE fare, not the total amount paid. The base fare before taxes and fees was $110.70. Since United so kindly rounded up, I received a whopping 555 miles.
When I earned those miles, United “paid” MileagePlus Holdings (MPH) at least a penny per mile. The formula — as United so eloquently puts it — is:
The price at which United buys miles from MPH is subject to adjustment such that MPH’s United related EBITDA margin (defined as the quotient of (i) United related revenue, minus MPH operating expenses excluding depreciation and amortization, minus estimated future redemption cost of miles sold, divided by (ii) United related revenue) is at least 20%
Technically this means that United paid MPH at least $5.55 so it could award me my miles, but it could have paid more if required to get MPH up to that 20 percent margin. Just keep in mind that this is funny money. This is just United moving money from its left pocket to its right pocket.
Where the Big Money Comes From
The real money here — the remaining 71 percent — comes from selling miles to third parties. Do you have a United credit card issued by Chase? For every mile you earn, Chase pays United. In fact, if you have any Ultimate Rewards-earning Chase credit card, every time you transfer points to United, Chase pays United for the privilege. (Technically it settles up quarterly, but you get the idea.) If you buy flowers from Telefora or earn miles by shopping or dining, those vendors all pay United every time a mile gets awarded to someone who bought through them.
This is real money that comes from outside companies. How much? Well, United gives an example of a partner buying 15,000 miles from United at 2 cents each. I would assume that’s probably an average. A massive buyer like Chase probably gets a better per-mile deal than a small player. But if United is pulling in 2 cents a mile overall, then that’s a nice chunk of change.
Giving That Money Back
MPH is sitting here collecting all this money, but it doesn’t just get to keep it. Of course, when a MileagePlus member goes to redeem those miles, then MPH has to pay money out to the vendor. Here’s how those redemptions break down:
More than 77 percent of redemptions are for travel on United so that is money moving from the right pocket back to the left. United values redeemed miles at a penny per mile, so for miles that were originally sold to third-parties for two cents, MPH is making half as pure profit. For miles sold internally, it’s making a paper profit of 20 percent. These are pretty hefty margins. Now let’s do some more math.
The Power of the Program
United generated $3.7 billion in revenue from selling miles to third parties last year. If we assume that those were at 2 cents each, then United issued 185 billion miles from those transactions. Add in the ones issued to people flying United — and assume those were at the minimum cost of a penny per mile — then you have another 154 billion miles for a total of 339 billion miles issued.
Let’s make the silly assumption that all of these miles get redeemed. Since 77.6 percent are on United flights, there is again no money changing hands. Sure, there are some costs involved for carrying that passenger and potentially bumping a paying traveler, but we can’t accurately evaluate what that is. Let’s just assume that United’s valuation of one cent per mile redeemed is right. That means this costs $2.6 billion. I tend to think that’s overstating things, but again, we’ll go conservative.
That leaves us with 76 billion miles that will be redeemed with partners. Now on this point, we don’t know how much that costs, but let’s just say that it’s at 1.5 cents per miles redeemed which equals just over $1.1 billion. That means combined, United would be paying out about $3.7 billion ($2.6 billion of which just goes back into United’s pocket). This equals the amount it generates in pure revenue from third parties.
Now remember, I’ve made a lot of stupidly conservative assumptions here assuming people will redeem all their miles and that United derives no revenue from the miles it awards internally, among others. In essence what this suggests is that if United saw zero internal value to the program, which we know isn’t remotely true, it would still break even just from third-party sales.
This is all wrong, of course. There is enormous value in the program for United, but the selling of miles to third parties means everything else that generates value is done with no real cost to the airline. Since we can’t get more clarity without more details, this can at least point us in the right direction regarding the value of the program.
Of course, if United goes out of business, then there’s a problem. But the chance of that happening is so slim that it’s hardly worth considering. Sure, bankruptcy is possible, but the program is so beneficial to the airline that there is no chance the miles and related value would be wiped out. This is an important piece of the airline, and so nobody should be surprised to see banks being willing to lend big money with that as collateral.