Airlines have burned through substantial amounts of cash in 2020, as the COVID-19 pandemic has crushed air travel demand. With demand unlikely to improve very much in the near term, most airlines are shoring up their liquidity, believing that there's no such thing as having too much cash on hand.
Delta Air Lines (NYSE:DAL) appears to be taking this approach. The company plans to market new loans and bonds secured by its SkyMiles loyalty program next month, according to Bloomberg, bolstering what is already a substantial cash hoard. Here's what makes this decision significant.
Another airline looks to its loyalty program for cash
In early July, United Airlines (NASDAQ:UAL) raised $6.8 billion backed by its MileagePlus loyalty program. United had previously tried to raise capital with more conventional aircraft-backed debt, but the only unencumbered planes it had left were quite old and unattractive to potential lenders. Offering the loyalty program instead allowed it to bring in a ton of cash at reasonable interest rates (6.5% for the secured debt portion of the financing).
During Delta's earnings call later that 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 was keeping its options open for the time being.
Now, it looks like Delta Air Lines wants to move ahead with raising capital backed by its loyalty program. Few of the details have been nailed down 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 of cash and investments on its balance sheet. However, as of last month, the company expected to burn about $27 million of cash a day in July. It is likely to continue burning cash at a meaningful rate for the next few months, consuming billions of dollars before year-end.
Additionally, as of June 30, Delta had $5.2 billion of debt and finance leases maturing within 12 months. That's 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 plenty of interest from lenders. Delta reported loyalty-related revenue of $4.9 billion for 2019, a substantial proportion of which comes from its lucrative credit card partnership with American Express. In fact, last April, Delta said that revenue from the AmEx relationship doubled from $1.7 billion in 2012 to $3.4 billion in 2018 and was on track to double again to around $7 billion by 2023.
This revenue stream carries a very high profit margin, making the SkyMiles program extremely valuable. If it wants to, Delta Air Lines should be able to raise just as much cash from its loyalty program as United did, if not more. Moreover, Delta should be able to secure a much lower interest rate, as it has a stronger balance sheet than United Airlines. Indeed, most of Delta's unsecured debt yields around 6%. The yield on secured debt backed by high-quality collateral would naturally be significantly lower.
Avoiding a CARES Act secured loan?
If Delta successfully raises a significant amount of debt backed by the SkyMiles program, it will probably decline the $4.6 billion federal secured loan it is eligible for under the CARES Act. It has until Sept. 30 to decide whether it wants to borrow under the CARES Act loan program.
Last week, Southwest Airlines confirmed that it won't participate in the secured loan program. There are good reasons for Delta Air Lines to do the same.
First, Delta can probably raise more than $4.6 billion of debt backed by SkyMiles, and the interest rate might not be much higher than what the government would offer. Second, taking a loan from the government when it is about to furlough thousands of employees would make for bad PR. Third, airlines that accept CARES Act secured loans are barred from paying dividends or buying back any stock until 12 months after the loans are fully repaid.
None of these issues would be deal breakers if Delta had no better options. However, by pledging SkyMiles as collateral for secured borrowings, the airline giant should be able to raise plenty of capital at reasonable interest rates without further help from the government. That's good news for shareholders.