Airlines spent large sums of money in 2020 as the COVID-19 pandemic crushed demand for air travel. With demand unlikely to improve much in the short term, most airlines are stepping up their cash flow, believing that there is no such thing as having too much cash on hand.
Delta Airlines (NYSE: DAL) seems to take this approach. The company plans to market new loans and bonds backed by its SkyMiles loyalty program next month, according to Bloomberg, bolstering what is already a substantial cash treasury. Here’s what makes this decision important.
Another airline turns to its loyalty program for cash
Beginning of July, United Airlines (NASDAQ: UAL) raised $ 6.8 billion through its MileagePlus loyalty program. United had previously attempted to raise capital with loans backed by more conventional aircraft, but the only unused planes it had left were quite old and unattractive to potential lenders. Rather, offering the loyalty program enabled it to bring in a ton of cash at reasonable interest rates (6.5% for the secured debt portion of the financing).
When Delta’s earnings call later in the month, a Wall Street analyst asked if Delta could raise capital through a similar structure. CFO Paul Jacobson responded that it would be possible for Delta to do something similar and that the carrier is keeping its options open for now.
Now it looks like Delta Air Lines wants to move forward by raising capital backed by its loyalty program. Few details have been resolved 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 its balance sheet. However, last month the company expected to spend around $ 27 million in cash per day in July. It is likely to continue to burn cash at a significant rate over the next several months, consuming billions of dollars before the end of the year.
In addition, as of June 30, Delta had $ 5.2 billion in debt and finance leases maturing 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.
Debt backed by the SkyMiles program is likely to generate a lot of interest from lenders. Delta reported loyalty-related revenue of $ 4.9 billion for 2019, a significant portion of which comes from its lucrative credit card partnership with American Express. In fact, last April, Delta said revenue from the AmEx relationship doubled from $ 1.7 billion in 2012 to $ 3.4 billion in 2018 and was set to double again to around $ 7 billion by 2023.
This revenue stream generates a very high profit margin, which makes the SkyMiles program extremely valuable. If they wish, Delta Air Lines should be able to raise as much money from their loyalty program as United, if not more. Additionally, Delta should be able to get a much lower interest rate because it has a stronger balance sheet than United Airlines. In fact, most of Delta’s unsecured debt earns around 6%. The return on secured debt backed by high quality collateral would naturally be significantly lower.
Avoiding a CARES Act Secured Loan?
If Delta is successful in raising a significant amount of SkyMiles-backed debt, it will likely turn down the $ 4.6 billion federal secured loan to which it is eligible under the CARES Act. He has until September 30 to decide whether he wants to borrow under the CARES Act loan program.
Last week, Southwest Airlines confirmed that he will not participate in the guaranteed loan program. There are good reasons for Delta Air Lines to do the same.
First, Delta can possibly raise over $ 4.6 billion in SkyMiles-backed debt, and the interest rate might not be much higher than what the government would offer. Second, taking out a government loan when it is about to lay off thousands of employees would be poor communication. Third, airlines that accept loans guaranteed by the CARES Act are not allowed to pay dividends or repurchase shares for up to 12 months after the loans have been paid in full.
None of these issues would break the deal if Delta didn’t have better options. However, by pledging SkyMiles as collateral for secured loans, the airline giant should be able to raise a lot of capital at reasonable interest rates without further help from the government. This is good news for shareholders.
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