de Soto Applied to Frequent-Flyer Miles

It seems that airlines may be catching on to the thinkings on hidden-asset value popularized by economist Hernando de Soto. The 2007 Nobel Prize winner in economics, de Soto has made an iron-clad case that the unrealized value of capital in the developing world -- in countries like Egypt or his homeland of Peru -- often meets or exceeds the value of so-called real capital in these countries. de Soto points to the fact that most of the poor in developing countries have fungible assets in the form of property -- homes, land, farms, etc. -- that are simply unrealized because they are not properly titled due to regulation and government neglect. Not having a title means that a putative landowner cannot sell their property or legally hand it down to their children; nor can they take out a loan on that property in order to improve it, invest, or start a business. In short, the property is a dead asset, and because of this the people (and their countries) remain poor or in debt.

And debt is what brings us to the airlines, which are suffering under crushing debt brought on by poor management, pension and health-care costs, idiotic regulations, security costs, sky-high sales taxes, and post-9/11 flyer concerns. What could help them? According to Inside Flyer magazine, the answer lies in spinning off their frequent-flyer programs. It's shocking to ponder the dollar figures behind this unrealized asset:

How might it work? A stand-alone public company would retain the gross proceeds and liability from selling miles. As members of a particular frequent flyer program use the miles earned through means other than air travel, then redeem a travel award on the airline or its partners, the stand-alone company would be obligated to compensate the airline for the value of this award travel. Likewise, the airline would be obligated to pay the stand-alone company for miles earned through air travel if they are redeemed for any non-air travel award. The price of a mile sold between the two entities as a result of these arrangements would always be expected to be contractually mandated and fixed. Terms would be updated on market factors and conditions such as alliances. The spin-off benefits from the so-called margin or spread between how much it charges to sell miles to the program partners and how much it costs to purchase a product or service from those partners, whether it be airline travel or merchandise.

The strength of such a public spin-off would be that it would make miles safer for program members, since with the huge cash reserves for liability, it could easily arrange to purchase free air travel from other surviving airlines or new entrants should the airline become a victim of a bad economy. This sense of security would go a long way toward soothing some of the highs and lows of members' emotions regarding the safety of their miles, if an airline is in bankruptcy.

But even that might be secondary to the amount of cash that could be raised to help airlines today. For instance, Air Canada is selling off just 18 percent of Aeroplan, but that is likely to put more than $200 million in the coffers of Air Canada, which just recently came out of bankruptcy. Since these programs could become stand-alones, it's conceivable they would turn their attention to acquisitions and actually running loyalty programs for many other industries and businesses -- something most would assume that frequent flyer programs are good at anyway. [...]

...[A] program such as American's (which we pick along with Mileage Plus as the logical first candidates for the stock market among U.S.-based programs) could fetch a valuation greater than $2.5 billion.

On top of the obvious value for the airlines -- imagine a multi-billion-dollar cash infusion for struggling airlines like American, plus a ready cash source in the form of guaranteed payments from the spun-off frequent-flyer company -- is the value for customers. Safer frequent-flyer miles. More successful airlines -- and the spun-off companies -- to invest in. More competition for customers between airlines and between the new companies. It's easy to imagine this leading to better service and lower prices both in the air and at the virtual ticket counter. And that's not even taking into account that this could help stave off any future 10-figure government airline bailouts. For airlines to capitalize on these hidden assets is a winning proposal for everyone, and one that Inside Flyer (taking a cue from de Soto) must be lauded for promoting.