Airlines burned significant amounts of cash in 2020 as the COVID-19 pandemic reduced demand for air travel. Since demand is unlikely to improve in the near future, most airlines are support their liquidityBelieving that there isn’t too much cash.
Delta Airlines (NYSE: DAL) seems to take this approach. The company plans to launch new loans and bonds backed by its SkyMiles loyalty program over the next month, according to Bloomberg, to boost its already sizeable cash supply. Here’s what makes that decision meaningful.
Another airline is looking for cash on their loyalty program
Beginning of July, United Airlines (NASDAQ: UAL) Raised $ 6.8 billion supported by its MileagePlus loyalty program. United had previously tried to raise capital using more conventional airborne debt, but the only unencumbered planes it had left were quite old and unattractive to potential lenders. Instead, offering the loyalty program made it possible to raise a lot of cash at reasonable interest rates (6.5% for the secured debt portion of the financing).
During Delta’s earnings meeting later that month, a Wall Street analyst asked if Delta could raise capital through a similar structure. CFO Paul Jacobson responded that Delta was able to do something similar and that the airline keep your options open for the time being.
Now it looks like Delta Air Lines is looking to drive fundraising through its loyalty program. Few details have been set so far, according to Bloomberg, but the goal is to finalize the terms after Labor Day.
An attractive source of capital
Delta Air Lines ended the second quarter with $ 15.7 billion in cash and investments on balance sheet. However, last month the company expected to burn about $ 27 million in cash every day in July. It is likely that it will continue to burn cash on a significant scale over the next several months, consuming billions of dollars by the end of the year.
Additionally, as of June 30, Delta had $ 5.2 billion in credit and finance leases due within 12 months. This is another reason why it makes sense to raise more capital now, even though Delta has a lot of cash on its balance sheet.
Debts covered by the SkyMiles program are likely to attract great interest from lenders. Delta reported loyalty-related revenues of $ 4.9 billion for 2019, a significant portion of which from its lucrative credit card partnership. originates American Express. In fact, Delta said last April that the AmEx relationship revenue doubled from $ 1.7 billion in 2012 to $ 3.4 billion in 2018 and is on the right track double again to around $ 7 billion until 2023.
This source of income carries a very high profit margin, which makes the SkyMiles program extremely valuable. If so, Delta Air Lines should be able to raise as much money from their loyalty program as United, if not more. In addition, Delta should be able to secure a significantly lower interest rate because it has a stronger balance sheet than United Airlines. In fact, the majority of Delta’s unsecured debt is yielding around 6%. The return on secured debt securities backed by high quality collateral would naturally be significantly lower.
Avoid A CARES Act Secured Loan?
If Delta successfully borrows a substantial amount of debt that is covered by the SkyMiles program, it will likely get the state secured loan of $ 4.6 billion. It has until September 30th to decide whether to borrow under the CARES Act credit program.
Last week, Southwest Airlines confirms that it will not participate in the secured loan program. There are good reasons for Delta Air Lines to do the same.
First, Delta is likely to have more than $ 4.6 billion in debt backed by SkyMiles, and the interest rate couldn’t be much higher than what the government would offer. Second, taking out a government loan when thousands of employees are on leave would result in poor PR. Third, airlines that accept loans secured by the CARES Act are excluded from paying dividends or buying back shares for up to 12 months after the loans are fully repaid.
Neither of these issues would be a deal breaker if Delta didn’t have better options. By pledging SkyMiles as collateral for secured loans, the Airline giant can raise a lot of capital at reasonable interest rates without further government assistance. This is good news for shareholders.
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