Come Fly with Me but not for Free: Increasing Aeroplan’s DistributionsJune 24, 2005 12:44 am Uncategorized
Thanks to the online edition of Moneysense magazine for naming The Market Guy to their list of “Best Canadian Investment Blogs.” Also thanks to Investor’s Digest Canada for a favourable mention. Needless to say I’m keeping the “Market Guy sucks” reviews to myself.
In this humidex-free edition:
- Feature: Come Fly With Me But Not For Free: Increasing Aeroplan’s Distributions
- Trading notes: Calpine Power Income Fund (CF.UN); Saxon Financial
- Market Guy Mailbag: DRIPs and Pizza Pizza
- Market Guy’s Closing Bell: Geldof, Live8…and dinosaurs?
Come Fly With Me But Not For Free: Increasing Aeroplan’s Distributions
This fall I will be teaching first-year psychology, among other classes. One of the lectures pertains to states of consciousness and deals with topics such as sleeping, dreaming, the effects of psychoactive drugs and lastly, hypnosis. Although the students seem to enjoy the discussion of how ecstasy and alcohol alter our neurochemistry and experience of reality, for the purposes of this column I’m more interested in hypnosis (more on this later). As I was preparing the lecture, my thoughts started to drift to a consideration of the recent Aeroplan initial public offering…and why not? The fund will have a number of compelling attributes. Let’s have a look:
- Brand recognition. How many on Bay Street have an Aeroplan card in their wallet right now? 75% 90%? You don’t think this matters?
- An offering of decent size. Contrary to so many of the $50 million to $100 million trust offerings, a $250 million deal is more likely to attract institutional interest. Size matters.
- Canadians love customer loyalty programs. How many loyalty cards do you have in your house right now? I have close to ten. Don’t just include the credit cards. That old, beaten-up “get a sub free ” card counts. Aeroplan is expanding the number of reward options beyond free flights, and this should add to the appeal of membership.
Recipe for an income trust: A tiny piece of plastic, a formerly bankrupt airline, and a dream
- A business plan that makes sense. Here are a few tidbits: 1) Much of their revenue comes from financial partners who pay for the right to issue points (e.g., CIBC and their Aerogold and Aero Classic Visa cards). Aeroplan is trying to diversify their revenue stream by adding to the list of partners; 2) There is a 21-cent spread between what is paid for the points and what it costs to furnish the reward; 3) There is, on average, a 30-month lag between when points are sold and miles are redeemed. During the time period, Aeroplan is free to do whatever it wants with the money. Sweet deal.
- Perhaps the most interesting factoid coming out of the prospectus relates to the number of miles expiring before they can be redeemed. This is known as breakage, and Aeroplan estimates the figure to be as high as 17% of all miles issued. This is astounding. Derek DeCloet of the Globe and Mail recently outlined the effects that a decline in breakage can have on distributable income. He’s right to advise caution.
But here’s something that I’d like to know: Who are these people failing to redeem free stuff? More importantly, is there a way to make money off them? Linking back to my psychology lecture, there must be a way for me to use my knowledge of hypnosis to convince others not to redeem their points, thereby enhancing or even increasing the number of miles that are never redeemed. This would lead to increased margins, distributable cash, and hopefully distributions. As always, it’s all about the cash.
This places me in the unusual position of arguing against free stuff. Given that Canadian Tire Options Mastercard should be offering me a commercial, this is not a position that falls within my comfort zone. However, my greed takes precedence here, so I feel an obligation to give it a shot. All I am saying is give greed a chance.
In order to run the plan, it’s necessary to consider a few points about hypnosis:
- People can’t be hypnotized against their will and it sure helps if the individual scores high in suggestibility. Well, approximately 10-20% of the population is extremely suggestible, 10% can’t be hypnotized, with the majority of people falling in between the two extremes. Those scoring high in suggestibility also tend to be able to immerse themselves completely in whatever they are doing. This makes sense, as the ability to concentrate and block out the outside world comes in handy during hypnosis. So where can highly-suggestible Aeroplan members be found? Hey, I can’t figure out all of this myself. You’re not really doing anything productive right now.so get on it. Although I will say this: One way of increasing suggestibility is to increase people’s expectation that they have the ability to be hypnotized.
- Contrary to popular belief, hypnosis can induce people to perform self-injurious behaviours, although this has less to do with hypnosis and more to do with a tendency to follow the orders of an authority figure in certain contexts. Given the failure to redeem a reward is clearly harmful and likely against the best interests of clients, my success in increasing breakage will be in part dependent on the extent to which I am perceived as an authority figure.
- What happens if investors remember what occurred during their hypnotic experience? Surely they’d be upset remembering some putz with a website trying to make them give up free stuff. Plus, I’m not especially warm to the idea of a band of angry Aeroplan members burning down the Market Shack. Therefore, I need to initiate post-hypnotic amnesia, thereby protecting myself and ensuring a dandy dose of extra distributions for unit holders. That is, I need to plant a suggestion that investors will not remember what occurred during the hypnosis session.
With these factors in mind, I feel prepared enough to give it a whirl. Here’s a proposed script:
|(In a relaxed, montone voice)
Our highly-scientific tests indicate that you have the ability to be hypnotized.
Before we begin, you need to know that I am a very important person.
I want you to make sure the room is completely quiet.
Have a seat and make yourself comfortable.
Now, I want you to focus on a spot on the wall.
Keep focussed on that spot.
You’re going to feel very relaxed, almost as if you’re floating.
Your eyes are getting very heavy.
You are feeling very sleepy.
You are feeling completely relaxed.
(Now let’s get down to business )
You don’t want to redeem your Aeroplan miles. None of their rewards appeal to you.
You are going to let the miles expire.
You won’t remember that it was me who told you to do so.
These aren’t the droids you’re looking for. Oops, sorry, scratch that.
And would it kill you to move your chequing account and mortgage over to TD? I own their stock. And stay away from the Doritos….you’ve gained a few pounds (heck, as long as I am here).
I’m going to snap my fingers and you will be totally awake.
Well, at least I’ve done my part. The question is, will Air Canada find a way to screw it all up? Does anybody know if CEO Robert Milton is highly suggestible?
|Hey Bob: You are not going to crash Aeroplan into the ground. You are going to concentrate on generating a steady stream of safe and predictable distributions.|
So what is an investor to do? Here are a few negatives to consider:
- An opening yield of only 7%, which is the lowest I’ve seen on a new issue. After one day of trading, the units had appreciated 18%, reducing the yield to under 6%. This is lower than Yellow Pages (YLO.UN), one of my holdings. Well, Yellow Pages is a monopoly and a monopoly deserves to trade at a premium price. Aeroplan does not qualify as a monopoly. Heck, Riocan (arguably the gold standard of trusts) trades at a 6.3% yield. You’re telling me that Aeroplan deserves to trade at a lower yield than Riocan? As we say in the psychology business, that’s bonkers.
- The fund has no track record as a publicly-traded entity. We have no idea if their projections are accurate and if their plans will pan out.
- This is an entity having intimate ties with Air Canada, a company that recenty left their shareholders holding the bag. ‘Nuff said.
- The company is expected to issue more units in the near future.
Fair enough, However in the final analysis, the business case for Aeroplan made sense to me and I placed an expression of interest at the issue price of $10 and 7% yield. However, apparently the issue was 4x oversubscribed and the dealers were unsuccessful in getting Air Canada to float more units. I was completely shutout and when I heard the news, my day was ruined. Hearing of the 18% pop on day one made the situation worse. My broker tells me that 90% of their clients received no allocation whatsoever. Apparently one of their larger investors received only 4% of his request. Hey, at least misery loves company. If I had received an allocation, I would have owned the units for about 30 seconds and promtly flipped them at the open. For those buying on the first day, you’d better hope distribution increases are in the offing to justify the current trading price. Maybe Robert Milton should learn hypnosis.
Calpine Power Income Fund (CF.UN on the TSX)
I have eliminated my entire position at just under $10. The position was initiated in 2003 at roughly the same price and had been a steady performer. However, with some recent volatilty in the unit price, my returns are now based exclusively on the monthly distributions. Here’s the problem: the fund has been hit by their association with their corporate sponsor, Calpine Corporation in the US. The sponsor’s financial problems (insane debt, rumours of bankruptcy, etc.) had cast a pall over the Canadian fund and more questions than answers remain. Sure, the analysts have been “pounding the table” and providing solutions for all of the ten things that could go wrong with the fund if the sponsor renegs on their obligations. The sponsor itself issued a denial that chapter 11 was imminent, followed shortly by the power fund issuing a “business as usual” statement to the press. But who needs this kind of uncertainty and intrigue from a power income trust? The only time I want to hear about my power or pipeline holdings occurs when they have made an accretive acquisition or are confirming / raising distributions; that’s it. Inter Pipeline Fund (IPL.UN) never bothers me and that’s what makes our relationship work (OK, they’re having some issues with the crazy weather in Alberta…but that’s one time). I suppose it comes down to the old, “how can I love you if you won’t go away?”
OK, so this is more of a pre-trading note…but I’ve placed an expression of interest in the IPO of Saxon Financial, a value-focused investment management firm known for lower than average MERs and a stable of no-load mutual funds. However, institutional asset management is their bread and butter, providing the bulk of the firm’s revenue. Add a stable of private clients into the mix and you get a relatively diversified revenue stream. In less than five years, assets under management have grown from $2.5 billion to over $9 billion. The prospectus notes 50 consecutive months of net sales, positioning Saxon as one of only two Canadian firms to accomplish this feat. In terms of dividends, they are aiming at a payout ratio of 80% of trailing consolidated net income. The top dogs, Richard Howson and Robert Tattersall have each been in the business for over 30 years and are clearly the faces of the firm. Although going public will do wonders for their retirement funds, those worried about a quick cash-out should look to the employment agreements locking these guys up until at least 2010. Even so, the firm has been expanding their management team in order to facilitate succession planning. Sure, there is a case to be made against owning mutual fund companies, as investors are increasingly-enamoured with exchange-traded funds. However, Saxon’s low-fee structure and solid track record may leave it less vulnerable than its peers to the shift. Besides, I’ve been a holder of their small-cap fund for many years and it would be nice to recoup some of the fees by owning shares in the actual company.
Market Guy Mailbag
In the last column, I offered some thoughts on why I don’t use dividend reinvestment plans (DRIPs). In response, a reader offers the following:
Letter #1: Dave C writes
I agree with your comments about DRIPS. Investors with substantial portfolios are better off retaining control of their cash flow. However, I would point out that DRIPS are useful for younger investors. If they choose some good quality names, they can accumulate a decent position without incurring brokerage commissions. Also, having a DRIP discourages the trigger-happy from trading their positions. They can also work for very young investors who don’t even know they have the plans. I set up DRIP plans in trust for both of my sons when they were babies and put all their income into them. Because it was their income, the investment income was not attributable to me, so it grew tax free. By the time they were adults, they both had a substantial down-payment for a house. The experience also taught them a lot about the merits of investing.
Good points. If the Market Gal and I ever decide to have kids and pollute the gene pool, we’ll keep these ideas in mind. In the meantime, let’s hope for a greater empahsis on investing and personal finance in school curricula.
Letter #2: Mark in Huntsville, Ontario writes
I’m going to invest in the Pizza Pizza Royalty Income Fund…the prospects of receiving cash from all those pizzas is too hard to pass up.
Agreed. I’ve been complaining about a lack of places to put money to work and then, bang, all of a sudden I’m all over the market like Tom Cruise on Katie Holmes. I placed an expression of interest in Pizza Pizza and was, again, shutout. Perhaps I’ll have more to say about this another time. By now, many of you are getting close to reader fatigue and there’s no way I can be brief about pizza. It’s just not possible. Let’s just say this was the most entertaining prospectus that I’ve read in a while.
|When it comes to discussing pizza, brevity is not the soul of wit.|
The Market Guy’s Closing Bell
Remember the movie Jurassic Park and the character played by Jeff Goldblum? After discovering that a series of dinosaurs engineered to be female had somehow managed to breed, Goldblum’s character noted that “life finds a way.” In watching the current situation involving Bob Geldof’s Live8 concert and the inevitable scalping of tickets on eBay, I think we can conclude that money also finds a way. You can regulate it, roadblock it, tax it, repress it, and try to keep it out of the picture…but it always finds a way. Although this may frustrate the heck out of Geldof, it was also the most predictable outcome imaginable. Demand for the British concert: 2 million tickets; supply: 150 000 tickets. Enter capitalism. Geldof tried to keep money on the other side, but as though part of some osmotic reaction, the money found its way across the membrane. What a wonderful world in which we live. This is what I think about while waiting for baggage at the airport.
|If you try and keep money out of the picture, The Market Guy will be making the same face as Jurassic Jeff (shown here).|
The Market Guy is an Instructor with the Department of Psychology at Carleton University. He’s not a professional advisor. He’s just a guy who loves investing and talking about the markets…so do your homework before making any investment decisions. He doesn’t understand Much Music anymore and recently listened to, and enjoyed, Paul Anka’s “Rock Swings.” The times they are a changing over at email@example.com