Benje Patterson explores Air New Zealand's currency printing scheme and tries to figure out what its worth and how it makes so much for its owner

By Benje Patterson*

Imagine being able to print your own currency.

Click a button, add a few zeros and voila you’ve increased the money supply.

The Reserve Bank can do it, and, believe it or not in a similar vein so too can Air New Zealand.

Our national carrier doesn’t have control over the New Zealand dollar, but it does control the supply of New Zealand’s second biggest currency – the Airpoints Dollar. 

Airpoints Dollars conform to the standard definition of a currency – they are a medium of exchange for goods and services, they can be used to store value through time, and they are a quotable unit of account.

Air New Zealand operates a fixed exchange rate policy for its currency, where one Airpoints Dollar can be redeemed for one New Zealand dollar worth of flights.

Furthermore, in addition to being a currency, the Airpoints Dollar loyalty scheme also adds to Air New Zealand’s bottom line.

Air New Zealand is the sole institution with the ultimate authority to issue the Airpoints Dollar currency and back-of-the-envelope calculations show that the value of the airline’s loyalty scheme could be around $400 million.

At first brush, this valuation of Air New Zealand’s money printing prowess may seem a little far-fetched, but bear with me. The remainder of this article outlines how I arrived at this rough valuation and describes how an airline can generate revenue from a loyalty scheme.

Valuing Air New Zealand’s Airpoints programme

Although Air New Zealand releases detailed information regarding the profitability of the various parts of its air operations, unfortunately our national carrier is somewhat cagier when it comes to its Airpoints loyalty scheme.

Air New Zealand chooses not to report on the profitability of its loyalty scheme, but the airline does regularly divulge the number of Airpoints members and how much these members’ outstanding balances are worth.

As at 30 June 2013, the Air New Zealand Airpoints programme had more than 1.4 million members, up 17% from a year earlier.  These members had outstanding Airpoints Dollar balances valued at $236 million (recorded as revenue in advance), compared to $234 million in June 2012.

This growth in outstanding balances appears modest, but bear in mind that the purchasing power of Airpoints Dollars was boosted over the past year by falling domestic airfare prices.  Using airfare price information from Statistics New Zealand and passenger numbers data from Air New Zealand, I estimate that the real purchasing power of the Airpoints Dollar money supply increased by just under 10% over the past year.

However, although it is interesting to understand how the supply of Airpoints Dollars to members has evolved recently, this information is still not enough to even crudely value how much the Airpoints scheme is worth to Air New Zealand.

In order to derive such a valuation, I need to have an idea of how much profit the loyalty programme generates.  With Air New Zealand not releasing such detailed profit information, I was forced to get an idea of potential profitability by looking across the Ditch at Qantas.

In the year to June 2013, Qantas’s loyalty scheme generated A$260 million of Qantas group’s A$372 million EBIT.

With the rumour mill abound that Qantas is set to sell off its successful frequent flyer scheme in an effort to raise cash and stabilise the airline’s balance sheet, some analysts have used these profit flows to value the Australian national carrier’s loyalty scheme at up to A$2.5billion.

Given that Qantas’s loyalty scheme has 9.4 million members, this valuation equates to a value of around A$265 per member.  If one assumes that Air New Zealand’s Airpoints programme is equally as profitable as Qantas’s loyalty scheme and has a similar profit outlook, then the same valuation multiple could also be applied to Air New Zealand’s 1.4 million Airpoints members.

This methodology would suggest that Air New Zealand’s Airpoints programme could be valued at just over $400 million. Not bad considering that the total market value of equity in Air New Zealand in its entirety currently sits at $1.8 billion.

How can a loyalty scheme be worth so much?

Many of you may wonder how a scheme that involves creating a currency out of thin air, that is redeemable for flights, can be worth so much.

To get to the heart of this issue, one must understand that, like Qantas’s loyalty scheme, Air New Zealand’s Airpoints programme generates profits in several key ways.

Firstly, the carrot of loyalty points earned by flying with Air New Zealand is a mechanism for attracting customers in the first place and retaining their loyalty.  Thus an Airpoints member will be more likely to purchase flights through Air New Zealand rather than competitors.

Secondly, Air New Zealand can also utilise its currency issuing authority to create additional Airpoints Dollars and sell them to third parties such as credit card companies, hotels, car rental firms, etc. These third parties can then use the offer of Airpoints Dollars as a way of attracting and retaining their own customers.

Other more minor sources of value for Air New Zealand are related to the length of time between when the Airpoints dollars are sold and when they are redeemed for flights. During this period, the airline has free use of the capital and can consequently reduce its funding costs.

Furthermore, there is also a subset of Airpoints members who fail to redeem their Airpoints Dollars before they expire. Air New Zealand can keep the cash received from issuing these particular Airpoints Dollars without ever having to provide a service in return.

Although the basic framework of Air New Zealand’s Airpoints programme is broadly similar to Qantas’s loyalty scheme, it would be difficult at present to come to more rigorous conclusions regarding value than I have outlined in this article.

However, if Qantas does indeed sell off its frequent flyer scheme then intense interest from the investing community may force Air New Zealand’s hand to divulge more detailed information regarding its Airpoints scheme in future sharemarket briefings.

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Benje Patterson is an economist at Infometrics. He is a shareholder in Air New Zealand. You can contact him here »