DBRS Downgrades Aimia Inc. to BB (low), Trend Changed to Negative

DBRS Limited (DBRS) has today downgraded Aimia Inc.’s (Aimia or the Company) Issuer Rating and its Senior Secured Debt rating to BB (low) from BBB (low), and has assigned a recovery rating of RR4 to the Senior Secured Debt. DBRS has also downgraded the Company's Preferred Shares rating to Pfd-5 (high) from Pfd-3 (low). The trends on all ratings have been changed to Negative from Stable. This rating action removes the Company’s ratings from Under Review with Negative Implications where they were placed on May 11, 2017, when Aimia announced that it had received a notice of contract non-renewal from Air Canada after the agreement’s expiration in June 2020. Since then, DBRS has had business and financial update meetings with management and reviewed the operational data released in the Company’s Q2 2017 results to update DBRS’s opinion of Aimia’s credit risk going forward.

The three-notch downgrade reflects Air Canada’s significance to Aimia as a coalition partner, combined with DBRS’s previous expectation that the non-renewal of the agreement with Air Canada was a low-probability scenario. DBRS believes that the loss of Air Canada as a coalition partner will result in lower engagement in the Aeroplan program, accelerated reward redemption as well as lower magnitude and significantly reduced predictability with respect to the Company’s gross billings, adjusted EBITDA and free cash flow profile going forward.

In its review, DBRS focused on Aimia’s: (1) evolving business risk profile without its largest redemption partner post-2020; (2) liquidity, including refinancing/repayment of upcoming 2019 and 2020 maturities; and (3) financial risk profile, including financial management intentions.

(1) Business Risk Profile

Air Canada is one of Aimia’s largest customers, representing approximately 13% of gross billings in Q2 2017 and 11% in 2016 (the Company’s gross billings were $0.5 billion in Q2 2017 and $2.3 billion in 2016). More importantly, Air Canada, including other Star Alliance partners, is by far the Company’s largest redemption partner, representing approximately 59% of the total cost of rewards in Q2 2017 and 47% in 2016. Air Canada’s importance as a redemption partner will likely affect gross billings from other accumulation partners in the Aeroplan program, such as Toronto-Dominion Bank, Canadian Imperial Bank of Commerce and American Express Company (Aeroplan accounted for $1.3 billion of gross billings in 2016). While DBRS notes that the existing agreement, along with Air Canada's purchasing commitments to Aimia, remain in place until June 2020, the loss of Air Canada as a coalition partner could have an immediate negative effect on mileage accumulation in the Aeroplan program. Mileage accumulation increased 5.4% year over year (YOY) in Q1 2017 and only 1.2% YOY in Q2 2017. Going forward, DBRS is concerned that mileage accumulation could deteriorate at an accelerating rate as 2020 approaches. Furthermore, consumers’ uncertainty about the long-term viability of the Aeroplan program could incite competitors to adopt more aggressive promotional strategies in an effort to take market share.

(2) Liquidity

While reduced gross billings have a negative effect on Aimia’s cash flow, the impact of increased reward redemptions can be much more significant. The Company receives cash from coalition partners when program members earn miles (gross billings), but it does not incur costs (i.e., cash and accounting expenses) until members redeem those miles. DBRS notes that, at June 30, 2017, Aimia had a redemption liability (unused reward miles) of approximately $3.2 billion (including unbroken miles), which has been relatively stable since 2013 when the most recent breakage rates were set. If consumers redeem miles at an increased rate to take advantage of Air Canada reward availability, it would have a significant effect on Aimia’s cash flow and liquidity. Consumers’ reaction to the loss of Air Canada as a coalition partner led to an immediate impact on redemptions, which decreased by 8.6% YOY in April and then increased by 11.9% YOY in May and by 2.4% YOY in June. DBRS expects that redemptions will accelerate further as the Air Canada agreement expiry nears in 2020. Aimia has not been a material free cash flow-generating company after dividends and before changes in working capital over the last two years. DBRS notes that, in its Q2 2017 release, Aimia announced the cancellation of its common dividend, which consumed approximately $120 million in 2016. That said, increasing pressure on operating cash flow would result in greater risk in the Company’s ability to repay the $250 million of Senior Secured Notes due May 2019 and the $210 million outstanding on the revolving credit facility, which matures in April 2020, with internally generated cash flow. The risk of Aimia’s ability to economically refinance these maturities has also heightened, reflected in the increased cost of capital in both the debt and equity markets. Other sources of capital that the Company could use to address its liquidity requirements include: (a) a cash balance of $273 million at June 30, 2017; (b) an Aeroplan Miles redemption reserve of $300 million; (c) non-core asset sales, including Aimia’s interest in PLM Club Premier, Cardlytics, Think BIG and its Global Loyalty Solutions business; (d) any internally generated free cash flow; and (e) $90 million available on the Company’s revolving credit facility.

(3) Financial Risk Profile

In its last rating action, DBRS stated that the adjusted debt-to-EBITDA ratio of 2.0 times (x) was appropriate for a BBB (low) rating. For the last 12 months (LTM) ended June 30, 2017, the Company’s gross billings and adjusted EBITDA have deteriorated moderately to approximately $2.3 billion and $225 million, respectively, from approximately $2.5 billion and $232 million in 2015. The adjusted debt-to-EBITDA ratio, which had previously been a key credit metric for Aimia, stood at 2.0x for the LTM ended June 30, 2017, in line with historical levels. That said, given Aimia’s substantially weaker business risk profile as well as the uncertainty and variance in its gross billings, adjusted EBITDA and free cash flow going forward, the relevance of this credit metric is substantially reduced. Instead, DBRS is now more focused on near- to medium-term cash flow and liquidity profiles. Aimia’s cost-cutting program and dividend elimination should enable it to generate approximately $150 million of free cash flow for at least the next year. The BB (low) rating, however, reflects DBRS’s concern that this will be insufficient to repay maturing debt, particularly with accelerating redemptions.

OUTLOOK
The Negative trend reflects continued uncertainty and concern about further declines in the Company’s revenue, adjusted EBITDA and free cash flow going forward. DBRS will continue to monitor Aimia’s customer engagement, reward redemptions and the competitive environment on a quarter-by-quarter basis. While the Company could use capital-conserving measures and/or asset sales to improve credit metrics through debt reduction, the revision of the trend to Stable would be more influenced by greater visibility in operating income and free cash flow as well as increased confidence in Aimia’s ability to meet its funding requirements, including the first debt maturity in May 2019. DBRS believes that the Company’s International Coalitions segment will be relatively unaffected by the loss of Air Canada as a partner, but does not expect a material increase in earnings from this segment to compensate for the expected decrease from the Americas Coalitions segment. DBRS expects Aimia to seek out other coalition partners to offset some of the effects from the loss of Air Canada. DBRS notes that the Company has not made any material announcements in this regard to date, but will evaluate the impact of any agreement if/when it is reached. Should mileage accumulation decrease and/or redemptions accelerate more than revised expectations, in the absence of new partnerships, divestitures and/or capital raises, further downgrades could result.

DBRS notes that an Issuer rating of BB (low) typically maps to a Preferred Shares rating of Pfd-4 (low). In this case, however, since Aimia did not pay its last declared preferred share dividend, DBRS further discounted the Preferred Share rating to Pfd-5 (high). DBRS notes that the Company was prohibited from paying the preferred share dividend because of the failure of a capital impairment test in the Canada Business Corporations Act, not because of insolvency.

Aimia’s ratings are based on the quality of the Company’s brands and its relationships with remaining key commercial partners. The ratings also consider the consumer response following the announcement of the termination of the Air Canada agreement, a heightening competitive environment and the significant degree of revenue concentration.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The principal methodologies are Rating Companies in the Consumer Products Industry, DBRS Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers and DBRS Criteria: Recovery Ratings for Non-Investment Grade Corporate Issuers, which can be found on dbrs.com under Methodologies.

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.