Picking up on all the right Points

From Monday's Globe and Mail

Consumers love their loyalty points but investors don't like Points International, or at least not as much as they used to. The stock is down more than 50 per cent from its peak.

Points earns money selling expertise and technology to loyalty programs and their customers.

In other words, it caters to a fast-growing and highly profitable industry.

Points also has hit its stride, with CEO Rob MacLean saying the first quarter saw the company reach the highest transactional activity in its history.

The beauty of loyalty programs, most of which are still linked to airlines, is summed up in a joke: People will pay anything to get a free flight.

A lot of analysts loved Points at $3, and they love it even more today. It wasn't immediately clear to me why, but I've been set straight by Tom Liston, bullish analyst at Versant Partners, and Christopher Barnard, Points' bullish president.

My first mistake was assuming Points' business was aimed at consumers.

In fact, the business solutions segment generates about 90 per cent of sales. By and large, this segment involves managing parts of a loyalty program's business with software and advice.

For example, Points will manage American Airlines swap/buy program, whereby a plan member can give his daughter some of his miles (for a fee), or where he can top up his own account by buying miles to qualify for a trip.

The beauty of these small transactions is that they create value for everyone involved. The plan member has, say, 29,000 miles that are effectively useless to him because he needs 30,000 for the flight he wants to take to Las Vegas. He doesn't view his points as an asset until he can turn them into something he wants.

But to the airline, the plan member's points are a liability.

It will generally settle this liability with a free seat on a flight. So, when a customer buys miles to top up his account and redeem for a flight, the airline gets two things: first, it eliminates a liability; second, it earns extremely high-margin cash.

Why high-margin?

Two reasons: First, the price you pay for top-up points is high compared to what a bank might pay to buy points for its credit card (think Aerogold, for example). The consumer doesn't mind paying a much higher rate, assuming he even realizes it, because in mental accounting he's getting a flight in return.

Second, there is little cost to the airline. It's already flying the seat, and usually has some empty ones. So the cash the airline gets when it starts selling top-up miles is rich gravy.

"It's the biggest no-brainer I've ever seen," Mr. Liston says.

Hard to argue with that, especially as it appears to be borne by Points' growth statistics. The top line was up 260 per cent in the last quarter.

The business solutions side actually breaks down into two parts, agency and principal.

Agency business earns a fee for every transaction earned using Points' software, and is how Points originally envisioned its business. But more recently, it started to transition to a principal arrangement, where it will buy miles or points from loyalty programs and resell them to consumers, earning a spread. One upshot of this is that Points becomes a source of revenue to the program rather than a cost.

The other side of the business is the one you might be familiar with if you signed on to Points.com, the consumer portal. It's disappointingly limited, frankly. The idea was that you could swap points or miles with other users, but it's been slow to catch on.

However, Points is beta-testing an exchange called GPX, which will, once and if it works out, function much like a securities exchange, allowing parties to trade "currency" from one program for "currency" in another. You can imagine the appeal of that to consumers, who collectively hold some $700-billion (U.S.) of unredeemed points, according to RBC Dominion Securities.

The trick is getting loyalty programs to come to terms, which can be like herding cats, but given the value to them - they'll earn a free fee and be able to better manage their liabilities - my bet is that it's going to happen.

So why is the stock down? Because of the trouble in the airline industry and the economy.

Points president Mr. Barnard says it's been harder to get customers to pay attention to at-the-margin enhancements of their loyalty programs when they face soaring fuel costs and a recession is in the air.

But the big picture looks pretty good for Points, which you can look at it as a kind of value arbitrager in loyalty points that is approaching critical mass.

The value of those points in circulation is greater than that of U.S. currency, Mr. Liston says, who has done a lot of work on the space. Points offers a marketplace where consumers can trade and buy them while putting money into the coffers of desperate airlines and other loyalty sponsors.

It doesn't look like an idea that will encounter enormous resistance.

And everyone involved in the deal is happy. If it all works out, shareholders will be, too.