A Spinoffs Study Applied to the Airline Industry by Erika Kutscher B.Sc., Engineering Sciences Universidad Cat6lica de Chile, 2006 Industrial Engineer with a diploma in Electrical Engineering Universidad Cat6lica de Chile, 2007 SUBMITTED TO THE SYSTEM DESIGN AND MANAGEMENT PROGRAM IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF Master of Science in Engineering and Management ARCNES at the MASSACHUSETTS INSTITTE Massachusetts Institute of Technology OF TECHNOLOGY July 2012 AUG 20 2013 LIBRARIES ©2012 Erika Kutscher. All rights reserved. The author hereby grants to MIT permission to reproduce and to distribute publicly paper and electronic copies of this thesis document in whole or in part in any medium now known or hereafter created. / I A uth o r's sig nature ............................................................................... :............................................ Erika Kutscher System Design and Management Program C ertifie d by .................................................................................. Re Richard de Neufville Professor, neering Systems Division, MIT Thesis Syervisor A ccep ted b y ....................................................................................... .... .... ..V . OF Senior Lecturer, Engineering Systems Division Director, System Design and Management Program I (Page intentionally left blank) 2 A Spinoffs Study Applied to the Airline Industry by Erika Kutscher Submitted to the System Design and Management Program on July 24, 2012 in Partial Fulfillment of the Requirements for the Degree of Master of Science in Engineering and Management Abstract Airlines have been recently debated the management of some of their non-core divisions, such as the Frequent Flyer Program (FFP).A spinoff is a form of corporate contraction that many companies have recently chosen. Through a spinoff, both the parent company and the divested subsidiary can each focus on their own activity, which translates into a better performance of both entities. This thesis studies the circumstances in which a spinoff is a good strategy to pursue, along with some important issues that must be considered when reaching agreements. Spinoffs are basically a "downsizing" of the parent firm; therefore, the smaller firm must be economically more viable by itself than as a part of its parent company. The motivation for analyzing this particular topic comes from a question of current interest: Under what circumstances is it advantageous for an airline to spin off its Frequent Flyer Program, or other divisions that are not related with the airline's operation? In this thesis, an extensive literature review introduces the reader to the different forms of corporate contraction and their performance under different circumstances. Three cases related to the airline industry follow: the spinoffs of TripAdvisor from the web agency Expedia, of Air Canada's FFP Aeroplan, and of American Airline's distribution system Sabre. These three cases illustrate some of the key issues that must be carefully considered when spinning off a subsidiary. The thesis concludes that spinoffs are a smart strategy when the focus of the spun off division is different from that of the parent company. However, to safeguard future business relationships, the two entities must negotiate detailed agreements that are robust enough to perform successfully in all foreseeable circumstances. Thesis Supervisor: Richard de Neufville Title: Professor, Engineering Systems Division, MIT 3 Acknowledgments I would like start by thanking Professor Richard de Neufville, my supervisor, for his vital guidance and mentorship throughout my thesis. His experience and knowledge were the key factor for bringing together all my research and analysis in a successful manner. Next I would like to thanks the System Design and Management (SDM) Program Director, Pat Hale, for always being available to give me guidance. I would also like to thanks all of the SDM program staff for their great work on running such an outstanding program. I specially want to thanks Chris Bates, Bill Foley, Amal Elalam and Melissa Parrillo. I am very grateful for the patient help of MIT's writing and communication center and of my cousin Lynda. Thanks to them I was able to write this thesis properly and also learned a new skill that I know will be of great use. I am also grateful for the guidance provided by my former employers. They gave my motivation to develop this topic and provided very interesting ideas. Last, but not least, I would like to thank my husband Matias for his love and support through this amazing journey. 4 Table of Contents A b stract..................................................................................................3 A cknow ledgm ents......................................................................................4 T able of C ontents.......................................................................................5 L ist of Figures..........................................................................................6 L ist of T ables...........................................................................................6 L ist of A bbreviations..................................................................................6 Chapter 1: Introduction........................................................................7 1.1 M otivatio n ..................................................................................... 7 1.2 G oal of the T hesis.............................................................................8 1.3 Structure of the Thesis...................................................................... 9 Chapter 2: Literature Review...................................................................10 2.1 The different forms of Corporate Contraction........................................... 10 2.2 H istorical T rends..............................................................................15 2.3 R esults........................................................................................ 18 2.4 Sources of V alue.............................................................................. 23 2.5 C oncerns...................................................................................... 26 Chapter 3: Case Studies........................................................................29 3.1 Introduction.................................................................................. 29 3.2 Expedia spins off TripAdvisor............................................................. 31 3.3 Air Canada spins off its Frequent Flyer Program, Aeroplan........................... 37 3.4 American Airlines spins off its Distribution System, Sabre........................... 52 Chapter 4: Conclusions............................................................................66 Appendix: Bibliography........................................................................70 5 List of Figures Figure 1: US Mergers and Acquisitions v/s Divestitures.......................................16 Figure 2: World Airline Net Profit 1989-2010.................................................... 29 Figure 3: Expedia and TripAdvisor web pages.................................................32 Figure 4: Stock price of Expedia, TripAdvisor and the sum after spinoff..................... 35 Figure 5: Accumulation and Redemption functional diagram................................. 43 Figure 6: Stakeholders interactions Architecture diagram.................................... 47 Figure 7: Stock price of ACE, Air Canada and Aimia v/s S&P500 index................... 50 Figure 8: Systems Architecture Diagram.........................................................59 Figure 9: Stock price of American Airlines and Sabre v/s S&P500 index.................... 62 List of Tables Table 1: classification of the four types of corporate contraction............................... 14 Table 2: Mayor Mergers and Acquisitions of the 21st century............................... 17 Table 3: Mean returns of common stock for spinoffs and parent firms.........................20 Table 4: Returns of focus and non-focus increasing spinoffs after different time periods.... 22 List of Abbreviations M&A: Mergers and Acquisitions IPO: Initial Public Offering LBO: Leveraged Buy-Out FFP: Frequent Flyer Program GDS: Global System Distribution IATA: International Air Transport Association 6 Chapter 1: Introduction 1.1 Motivation Managing the airline industry poses many challenges; intense competition, large fixed costs and strong suppliers of goods and services complicate the situation. This hostile environment forces airlines to push the boundaries and come up with creative ideas to improve the business. Corporate restructuring is commonly used in this sector; Mergers and Acquisitions (M&A) have been used extensively to generate synergies in costs and networks. M&A are front- page events in newspapers worldwide, and a large number of academic studies cover this topic. Corporate contractions such as spinoffs occur far less frequently and receive much less attention despite the fact that they unlock significantly more value for the shareholders than M&A do. In the airline industry, spinning off a Frequent Flyer Program (FFP), for example, can be very controversial. FPPs improve the profitability of the industry in two very important ways: first, they generate a massive amount of information that boosts the capacity of the airline to forecast passenger demand; and second,