Description

Points International (PCOM) is a Toronto, Canada based company with shares listed on the Toronto exchange and NASDAQ.  The company has a market cap of about $160 million, no debt, and cash of $68 million (which is generally offset by redemption liabilities). Share repurchases have slightly reduced share count over the past few years, with share count falling from 15.6 million at year end 2015 to 13.7 million today. Approx 98% of PCOM volume is on the NASDAQ.  

We believe even a modest underperformance of management’s stated 2022 goals would lead to a share price that is 50%+ versus today.

PCOM shares represent a relatively stable, recurring and capital-light business at a reasonable valuation with the potential for a rapid growth phase, as management has recently publicized goals to reach by 2022 $90 million in gross profit and $40 million EBITDA. The company is financially sound - free cash flow generative, no debt, buying back stock - and has grown slowly over the past half decade, with a gross profit CAGR over 10% per annum.   Over the last 5 years, the company has converted more than 100% of its EBITDA to free cash flow.

PCOM owns and operates a loyalty commerce platform. For many of the largest loyalty programs, the company provides alternative redemption capabilities (such as using United miles for a hotel), purchase capabilities, and reinstatement services.  Reward transactions are realized by program members in realtime and paralelled/settled via actual monetary transaction (where PCOM pays the loyalty program for the points). The company has over 50 partners in its network, representing over 1 billion loyalty accounts across more than 30 languages and 50 currencies.  Notable partners are United Airlines MileagePlus, Delta Skymiles, American AAdvantage, Marriott Bonvoy, Alaska Mileage, Southwest Rapid Rewards.While not suggesting it has the network strength of an EBay or Facebook or Visa, there seem to be some modest network effects developing that will lead to growth on a business that trades reasonable valuation multiples.

In December 2018, the company kicked off its strategic partnership with Amadeus (the largest airline reservation system with more than 400 carriers).  Management believes the pre-engineered integration with Amadeus will yield benefits to expanding its loyalty platform. Amadeus, in return, gets to pitch new airline and hotel customers and retain existing ones by offering revenue generation (and revenue guarantees via LCR) instead of just IT costs.  Financial terms have not been disclosed but management has indicated economics remain intact for PCOM.

The company operates through 3 segments:

1. Loyalty Currency Retailing - sells points/miles directly to the member of a given loyalty program.  If you’re 50 miles shy of an upgrade or free flight and visit the airline’s website to purchase needed reward miles, this transaction would be fulfilled through PCOM’s LCR segment.  The business has minimum revenue guarantees in place and in turn has access to members’ to market promotions and generates sales. GAAP gross margins are in the low-teens as a result of the company booking the full transaction as revenue and the wholesale cost of the reward miles as cost of sales.  LCP also allows members gift or transfer rewards miles if the underlying loyalty program permits.

2. Platform Partners - this segment provides effectively a cross-currency network from earning and redeeming points across loyalty programs, 3rd party channels, and merchants/retailers.

3. Points Travel - white label e-commerce platform that facilitates wider adoption of a loyalty program’s reward currency but enabling rewards to be earned from hotel stays or car rentals or redeem through hotel stays or car rentals.  It allows reward program members to have wider range of options to earning and redeeming points while allowing the loyalty program to interact with the member for longer (rather than forwarding them to Expedia’s site). Unlike LCR, revenue recognition is from PCOM’s cut of the total transaction value.  As a result, gross profit exceeds 90%. The company acquired Accruity, which owns PointsHound, in 2014 for $16 million according to the cash flow statement. PointsHound serves as the backbone of Points Travel. The company has wholesale arrangements with Expedia and priceline, tourico, hotelbeds, and Get A Room to find rooms at the best available wholesale price to PCOM.

Given the accounting variations for a principal versus agency type transaction mgmt focuses on gross profit as more of a topline measurement.

Airlines learned long ago that loyalty programs 1) increase customer retention rates and thus LTV, and 2) rewarding & selling points is a highly lucrative business.  There are several white papers that discuss loyalty programs. Hotels and airlines want their customers to use their points (https://www.bloomberg.com/news/articles/2019-03-05/airlines-want-you-to-burn-your-miles) .  To encourage this behavior, loyalty programs began offering alternative redemption capabilities such as using your United points to book Hyatt room or Hertz car rental.  Loyalty programs also realized selling points directly to members/consumers was a highly profitable business that further encouraged engagement and customer retention. For example, Delta, which generates $40 billion in revenues annually, sold $3.5 billion in miles through 3rd party marketing arrangements.  And these miles are highly profitable, at 50% margin or more (https://www.bloomberg.com/news/articles/2017-03-31/airlines-make-more-money-selling-miles-than-seats) .  PCOM is (and has been) establishing relationships across loyalty programs, the travel & leisure industry in general, and merchants.   

Historically, some carriers viewed “breakage” as a positive, as it generates 100% profit when the company releases the liability.  But breakage means the loyalty program is failing - failing to engage and retain customers - and carriers realize this.

Tight airline capacity means that carriers are faced with finding new ways to offer value to a consumer through its loyalty program, without frequently giving up available seats that could otherwise be sold for cash. Enter alternative redemption options such as hotels, merchandise, and car rentals.

Hotels are somewhat similar to airlines in that the marginal cost of providing a room (or passenger seat) is close to zero and marginal profit close to 100%. Hotels are also interested in maintaining price.  Discount the value of a room too much too frequently, and customers begin to wait for future discounted values. Loyalty redemption capabilities offer the ability to increase occupancy and yields for a hotel operator without, on the margin, displaying price in traditional USD to consumers.

Merchants are faced with a different set of challenges.  The idea of shelf-space scarcity - where Coca-Cola fights for a few feet or more of eye level shelf space at a grocery store - has been transformed in the digital world.  Shelf space at a warehouse is, in theory, unlimited. What is finite is screen/eyeball space to trigger a customer to buy a company’s good or service. Overlay this with the rise of subscription services for goods such as meal delivery kits, and it makes sense why Home Chef executed a partnership with PCOM to reach loyalty programs as a method of redemption.  Discounting (again without quantifying the discount in USD currency but rather through points redemptions) can be an effective way for subscription service companies to acquire customers while maintaining pricing power.  

All of these pieces fit better together than apart, and PCOM provides an efficient, one-stop way to connect these pieces across and within loyalty programs.  We believe PCOM is developing a platform that will begin exhibiting network effects on both sides and across segments.

If management comes close to meeting 2022 goals, PCOM shares should trade in the $17-$21/share price.  At ~3 1/2 years out, that’s an IRR of 10-17%.

We believe management will deliver for a few reasons:

1. Management has in fact delivered 10% Gross Profit CAGR over the past 5 years.

   

2. On the company’s Q1 2019 call, management reiterated that the company is on track for its multi-year plan. CEO Rob MacLean: “We remain well on track to achieve our

3. growth targets for both 2019 as well as our multiyear outlook. As for our reiterated guidance, we continue to expect solid annual growth in 2019 and are making progress

4. on key elements of our long-term strategic plan to significantly grow our business.”

    

5. PCOM has shown success in adding partners across all segments.  With partners added, it has shown the ability to generate and increase rewards transactions with underlying members. According to the company’s investor slides, it signed 25 new partners from 2014 to 2018. Deals average from 3-5 years and the company cites a 95% retention ratio. Offsetting the 25 is airline mergers and attrition.  

    

    

6. Multiple levers for growth, not all need to work - Sell to existing customers (ability to expand product penetration within existing customer base), Corporate initiatives (Amadeus), new regions (opening office in Singapore in 2nd half 2019), new verticals (financial services where credit cards compete aggressively with one another on rewards but customers face friction/pain points on redemptions).

7. Management’s Long-term incentive compensation is tied to vesting of performance options upon hitting gross profit and adjusted EBITDA targets. 

   These were issued in 2018 and expire on the 6th anniversary (2024) and have minimum targets of $72 million in gross profit and $25 million in adjusted EBITDA before

   any are awarded.  The highest tranche is set at $200 million of gross profit and $100 million of adjusted EBITDA. It would be better to see this targets based on

   per share amounts but offsetting absolute goals is the fact that management receives LT incentive pay in stock and short-term bonus pay in shares as well. 

   CEO Rob MacLean and President Chris Barnard each have 978,500 shares through this program. PCOM’s CFO Erick Georgiou and COO Peter Lockhard

   have 386,400 each. In 2017, the company began paying executive officers entirely in restricted stock units versus cash as in prior years.

Catalyst

• Operating profit growth
• Progress toward 2022 goals