By Tue Nam Thien Vu, Matt Gullotta, Abby Jiang, Alex Koban-Hogue, Steve Kong and Jacob Webster
Points International (NASDAQ:PCOM) is a micro-cap company that deals with the loyalty industry, mainly through buying and selling travel miles from loyalty programs. The company also enables airline customers to earn and redeem miles for hotels, car rentals… through its Points Travel and Platform Partners segments. Trading north of 4x EV/EBITDA, Points International is an asset-light, extremely niche (almost no direct competitor) technology company that generates significant free cash flow (20%+ FCF yield) and has a clean balance sheet (no debt). With its sustainable business model and sticky customer base, we expect the company to scale very quickly through international expansion and to effectively cross-sell existing customers with its data capabilities. Using a weighted average for an 8x EV/EBITDA exit multiples and 1.5% perpetuity approach, we believe that Points International should be trading at $15.86, implying a blended multiple of 6.7 EV/EBITDA and a 31% upside from its current price.
Points International provides loyalty e-commerce service to various partners in the loyalty industry by connecting third-party brands, loyalty programs and customers across the globe on its platform.
Operating in 3 main segments, Points International's primary stream of revenue comes from Loyalty Currency Retailing (97% of revenue), by purchasing travel points at wholesales rate and reselling them at retail rate to earn the spread (~15% gross margin). The other 2 segments are Point Travel (~2% of revenue), which is a white label platform that helps customers earn and redeem miles with travel-based industry (~97% gross margin), and Platform Partners (<1% of revenue), which is the same service but with the broader loyalty industry (~97% gross margin). For both the smaller segments, Points International earns commission per transaction basis.
Source: Company's 40F
Historically, the company generated consistent revenue at 11% CAGR for the past 5 years, as well as gross profit dollars and adjusted EBITDA.
Source: Internal Data
In term of competitive positioning, Points International deals with loyalty programs (on the left side) such as American Airlines' AAdvantage, JetBlue's True Blue… and program partners (on the right side). In fact, Points International is the only company that buys and sells miles with loyalty programs, where the main competition we see is airlines' decision between "build and buy". On the right side, where Points mainly competes with main OTAs like Expedia, Priceline.com… for deals. However, it's worth noticing that these OTAs are also partnering up with Points to directly gain exposure to loyalty industry.
Points International Ltd. operates as a player in the global loyalty industry, which is primarily comprised of the transactions between loyalty program providers and loyalty program partners. Major players in the space include airlines and banks respectively, who exchange loyalty currency, or points with one another in order to deliver it to their end consumer. As seen in the figure above, Points Intl. purchases miles at a wholesale price and takes the margin by selling the miles to the airline's customers at a retail rate. Furthermore, Points Intl. partners with Online Travel Agencies (OTAs) and service providers, ultimately taking a commission on points-made sales.
In terms of industry trends, airlines are selling more and more miles to third parties due to the lucrative revenue stream and customer loyalty that is generated. Likewise, there is an apparent shift in the way that unspent and expired miles are being viewed. Traditionally, airlines wrote them off as profit and it was viewed as a gain for the airline, but recently more and more companies are viewing this as a missed opportunity to engage with the customer. Lastly, consumers are becoming disinterested with the current redemption options that loyalty providers offer, demanding more places and services where they can redeem their hard-earned credits.
In the loyalty industry, the loyalty program provider can act as both the supplier and the consumer. As suppliers, they lack the incentive to markup prices since they're ultimately receiving services from the same company, leading to low supplier bargaining power in the industry, but as consumers, loyalty program providers have more leverage since they have the option to consolidate and use the generated scale to pursue in-house substitutes. Generally, substitutes are not a significant threat since they are severely outclassed in terms of features and performance by pre-existing loyalty solutions providers. Furthermore, for a company to disclose information regarding its customer base, which is required for loyalty solutions to be effective, it would require the loyalty program provider and partner to have had a strong history and developed relationship. New firms would be incapable of penetrating this market with just venture funding, causing the threat of new entrants to be low.
It's important to understand why the market is mis-pricing Points International. The common view is that the loyalty industry has complicated mechanics and there are not a lot of significant players, thus receives very little coverage. In addition, Points International, who's the only player competing in the space, is a micro-cap company, and due to its size, there are only 2 analysts on coverage. However, we believe that the loyalty industry is huge, with a market size of nearly $50B - almost the same size as the gaming industry but nowhere near in term of attention. Hence, as major players like Expedia or Priceline start to move to the space, evidently by Expedia's partnering with its competitor Points International to get some exposure to travel miles, we expect analysts to be more aware of the industry.
More importantly, up until 2018, management has been using the revenue as the wrong metric to give forward guidance, which gives no visibility to analysts and investors who are already unfamiliar with the industry. By the end of 2018, for the first time, Points' management gives out 5-year long term guidance on gross profit dollars and adjusted EBITDA, which very well align with management's incentive. Consequently, as the company continues to hit its target guidance, investors should realize its value proposition and expect multiple expansion.
Loyalty Programs' Need for Points International - A Sustainable Business Model
Points continues to experience top-line growth by riding with the attractive and favorable trends of loyalty programs, specifically in the hotel and airline industry. Points offers compelling services to these programs, namely in liability management and revenue creation. Points' business model is set up to support liability management capabilities, efficiently churning over the miles quicker than loyalty programs can do themselves. In further detail, by nature, Airlines & Hotels are very capital intensive thus they require debt financing. Interest payments are contingent on Debt/Equity Ratio, which become a significant burden if there are outstanding loyalty points and miles. Every point or mile that is loaded into a member's account, this will be recorded as a liability on the balance sheet, commonly through deferred revenues. Therefore, Airlines are willing to give up the transaction-level margin to Points to facilitate this service, for Points has demonstrated that they are able to increase more transaction to be enacted, reducing the number of outstanding miles in circulation. This reduces the liability number and makes the balance sheet look more attractive. As seen in the chart below, the following airlines have loyalty programs that have significant accrual miles, and therefore, represent a significant number of total liabilities.
Source: Company's Filings Q3 2019
From a revenue generation perspective, Points help entice members to redeem points, so revenue flows straight to earnings for the loyalty programs, adding essentially no marginal increase in cost. Reasons being, for these businesses, profitability from selling a discounted room/ticket is far profitable than leaving the spot vacant. Airlines and hotels are captive to high fixed costs and subject to variable vacancy rates. For airlines, it costs the same to fly a plane across the country whether its half or full. For hotels, the cost of leaving the room vacant is far greater than issuing a promotion. Points can help entice members to redeem points last minute, and revenue flows straight to earnings for those companies, with essentially no marginal increase in cost.
Points' business model is also sustainable in a number of different ways. Points Intl. can efficiently allow airlines' customers to extract and redeem their miles/points through many more avenues than a single airline can, namely through the retail and financial services space. For example, members can use their points or miles earned from their Lyft trips to redeem at the Hilton Hotel.
To airlines, guaranteed revenue that Points offers is an attractive proposition. The company guarantees revenues to airlines depending on each airline's contract. Even if Points falls short on these guarantees, it can just purchase these unsold points and re-sell them for future uses. Moreover, it's worth noticing that on average, Points guarantees ~60% of the revenue, and it differs for each individual negotiation.
Ample Growth Opportunities Internationally
Historically, Points' management has purely relied on organic growth. However, in the last five years, they have made the transition to a more proactive, inorganic approach which includes three acquisitions and a strategic partnership with Amadeus IT Group. The three acquisitions were all made to add to Points' portfolio of travel convenience services. Accruity Inc., the PointsHound hotel booking service, was acquired in early 2014, which allows customers to book hotels from their database and earn points and miles in return for whichever loyalty program they choose. MilePoint, now known as InsideFlyer, is a "travel manager" data base and an informative, customizable dashboard for frequent flyers. Another one of recent acquisitions is Crew Marketing International, which develops online marketing applications and e-commerce solutions. All of these acquisitions add significant value to Points as they can strengthen their existing offerings, create new ones, and facilitate the process of reaching target customers.
At the end of 2018, Points International announced their strategic partnership with Amadeus IT Group, one of the top travel IT providers for the global travel industry, located in Madrid, Spain. Through this partnership, Points can leverage their global positioning and relationships, integrate their services into Amadeus' offerings, and to co-develop new services with Amadeus. The new services from the partnership won't be released to the public until the end of the first quarter of 2020, so we can expect the release to be a potential catalyst driving the company's performance.
Finally, Points has a significant opportunity to expand geographically, which is accelerated by their new verticals in financial services and retail. In North America and Europe, where Points is the most established, the main focus is on cross-selling their new service verticals with existing partners. In the Middle East, Points is growing their footprint with more and more large carriers signing on to join their partner base. There, they see a growing opportunity in their financial services vertical. In both the South America and APAC regions, Point's sees a significant opportunity in both their retail and financial services verticals.
In addition to the optimistic future, Points International has a proven past, with an average of five new partners and twelve cross sells per year over the last five years. In addition to their +95% partner retention rate, Points continually proves their existing strength and potential for new growth and expansion.
Data Capabilities to Add Value
Points' data capabilities are a significant driver and moat for the company going forward. They have relationships with 60+ of the largest loyalty programs in the world, giving them unprecedented access to back-end data from loyalty members across these platforms. The access to this data gives them an edge over potential entrants in the space since significant amount of data is required to drive marketing models and decision-making process. With every additional program partner added, Points' data-led marketing becomes more effective and efficient. New entrants would not be able to replicate the scale and capabilities that Points has developed with their long-lasting relationships with the world's largest airlines. Additionally, Points has also made a concerted effort to develop and expand their data science capabilities over the past few years to truly take advantage of the opportunity they have. The benefits of this have truly been two-fold as Points has been able to offer solutions to airlines that are no longer purely transaction in nature while also favorably benefiting their product mix with higher margin services.
In-House Loyalty Services
The services that Points International offers are extremely unique and valuable to customer and investors alike. There is, however, a possibility of individual airlines and major alliances implementing similar services and systems. Currently, the major alliances, One World, SkyTeam and Star Alliance allow the transfer and redemption of points in between partner airlines. This is a very similar service to those offered by Points. In addition, individual airlines not in alliances offer other attractive services when it comes to their points. Nevertheless, many airlines and alliances end up preferring Points' services because it allows for a guaranteed revenue stream and because the services are better/more specialized. Moreover, over the past 20+ years of alliances like Star Alliance, we have not seen this risk being a major issue to Points.
In addition, one risk discussed was the threat of increased data privacy regulations. PCOM currently operates and falls in line with many different robust regulations. This only serves as a threat if regulations are either increased or decreased.
For valuation, we mainly use management guidance as a proxy for our estimates. In FY2018 press releases, management guided gross profit dollars north of $90M, adjusted EBITDA around $40M and effective margin ranging from 31%-40% by 2022. Assuming no margin expansion and an annual growth in gross profit dollars of 6% (which is slightly below the historical CAGR of 10%), we arrive at gross profit dollars ~$68M, adjusted EBITDA ~$21M and effective margin ~31% by 2022, which is way below management's estimates.
Source: Internal Model
We chose 8.0x exit multiple from the closest competitor - Expedia, though we can argue whether Expedia is a real competitor or not. Historically, Points trades from 4x - 8x range, where its highest point is ~10x, so we believe 8.0x EV/EBITDA is justifiable.
Source: Internal Model
Using a weighted average of trading comps, discounted cash flow using perpetuity and exit approach, we arrive at $15.86 per share, implying a 31% upside and a multiple expansion to 6.7x EV/EBITDA. Conservatively, we didn't push any assumptions to reach management's numbers; however, management has historically met guidance, if not, even raised guidance, evidently in Q2 2019, target was raised for their 2022 plan, which means any excess amount of gross profit and adjusted EBITDA will only bring about additional upside from our current valuation.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.