According to Moody’s, the LifeMiles upgrade to B1 mainly reflects an improvement in its main shareholder, Avianca Holdings S.A.’s (NYSE: AVH, BVC:PFAVH) credit profile, reducing the risk of LifeMiles upstreaming extraordinary cash flows: either in the form of dividends, most likely financed with incremental debt or anticipated purchases of airline tickets. The recovery in Avianca’s liquidity follows a debt exchange concluded on December 31, 2019 and the availability of new credit facilities. Avianca’s credit profile remains weak, creating risks for LifeMiles’ credit quality and overall operation, says the ratings firm.
LifeMiles’ B1 rating also incorporates what Moody’s sees as its adequate liquidity and solid business model being the sole operator of Avianca’s frequent flyer program, its diversified and sticky base of commercial partners and co-brand credit card growth. Also reflected in the rating are the potential benefits to the company’s growth plan from improved economic dynamics in its largest markets. The corporate family rating is at the same level of the senior secured rating given that it is the only debt in the company’s capital structure.
The rating of the term loan takes into consideration its secured position within the capital structure of the company and the existence of a mandatory prepayment clause that obliges the use of a percentage of excess cash to pay down the term loan. This clause partly offsets the risk of cash leakage at LifeMiles before fulfilling its debt payment obligations. In addition, LifeMiles liquidity policy of maintaining a minimum cash balance equivalent to six months of rewards plus two quarters of debt service also mitigates this risk.
Avianca successfully completed the exchange of substantially all its senior notes due 2020 for new senior notes due 2023 easing its short-term liquidity pressure. In addition, Avianca was able to obtain new financing of $250 million USD from its shareholders (United Airlines Inc. (NASDAQ: UAL) and Kingsland Holdings Limited) and $125 million from Citadel Advisors LLC and a group of Latin American investors. At the same time, Avianca successfully renegotiated its operating and financial leases and extended their contract period, resulting in a more manageable capital structure.
The stable outlook reflects Moody’s view that the company will maintain adequate liquidity and credit metrics.
LifeMiles has a strong business model that leverages unrelated commercial partnerships (including co-branded credit card agreements with the largest banks in its core markets), but its single largest contributor to gross billings are miles sold to Avianca and its air partners, accounting for 32% of gross billings. As such, if Avianca were to face operating problems this would hamper LifeMile’s operation as customers’ interest in purchasing, adding or converting LifeMiles miles into Avianca’s air tickets would decline. Furthermore, if Avianca liquidity were to deteriorate, it may require LifeMiles to upstream dividends—most likely financed with debt as done in the past—resulting in higher leverage. Moody’s estimates that, absent additional indebtedness, LifeMiles’ adjusted debt/EBITDA would gradually decline from 2.8 times as of September 30, 2019 to below 2.5 times by year-end 2021.
Moody’s believes that LifeMiles has adequate liquidity. The company cash and cash equivalents of $65 million USD as of September 31, 2019 can cover 1.3x its short-term debt. In addition, LifeMiles benefits from a five-year $20 million committed revolving credit facility, which is currently undrawn. LifeMiles has posted negative free cash flow (defined as cash from operations minus dividends and capex) in 2017, 2018 and over the twelve months ended September 31, 2019 resulting from the high dividend payout.
LifeMiles’ largest contributors to gross billings are its financial partners, which include credit card co-brands (47%) and airlines (32%), Avianca being its largest customer, responsible for approximately 27% of gross billings. Around 80% of accrued miles are redeemed, with 90% being redeemed into air tickets. The 10% balance is redeemed into hotel nights, merchandise and other rewards. LifeMiles benefits from Avianca’s leading market position in Colombia and Central America.
LifeMiles has around 9.5 million members, more than 100 mileage agreements with financial institutions, and more than 723,000 co-branded credit cards. The number of members has grown steadily at a 9.9% CAGR in the last five years. LifeMiles’ largest market is Colombia where it generates 52% of its gross billings. It also operates in Peru, Costa Rica, El Salvador, Honduras, Guatemala, and the US; each of which contributes less than 10% to gross billings. Moody’s forecasts the Colombian economy will grow by 3.3% in 2020. Similarly, Moody’s estimates that, in Colombia, private consumption will grow by 3.5% in 2020 and 3.6% in 2021.
An upgrade is unlikely in the short term due to LifeMiles indirect exposure to Avianca’s operation and weak credit profile. Longer term, the ratings could be upgraded if the company were to maintain strong liquidity and credit metrics combined with an improvement in Avianca’s credit profile. An upgrade would also require strong ring-fencing provisions that limit cash upstream to shareholders, as well as the maintenance of adequate liquidity and profitability. Quantitatively, an upgrade would require LifeMiles to maintain its adjusted debt/EBITDA lower than 2.5 times on a sustained basis.
The ratings could be downgraded if the company’s profitability or credit metrics worsen, with an adjusted debt/EBITDA ratio remaining above 3.5:1. A deterioration in the company’s liquidity or profitability, or a change in the company’s financial policy leading to excessive cash distribution to shareholders can lead to a downgrade. Also, a weakening on Avianca’s credit profile or repetitive amendments to the loan agreement such that the mandatory prepayment provisions are waived or canceled, and excess cash flow is not used to pay down debt could result in a downgrade.
LifeMiles Ltd. is a coalition loyalty program and the sole operator of Avianca’s frequent flyer program. LifeMiles has 586 active commercial partnerships that allow its members to accrue and redeem miles for different products and services such as airline tickets, hotels, and rental cars among others. LifeMiles is 70% owned by Avianca Holdings S.A. and 30% owned by Advent International. LifeMiles reported gross billings of $331 million over the twelve months ended September 30, 2019.