A year ago the U.S. changed its corporate tax law. A look at the impact on travel tech giant Sabre may show, by example, the benefits to many U.S. businesses broadly. The reform appeared to give the company added financial flexibility in 2018.
Last year’s cut in the headline U.S. federal tax rate for corporations from 35 percent to 21 percent affected many businesses. Sabre, a travel technology giant based in Southlake, Texas, is a case in point.
On Tuesday Sabre reported its earnings. In 2018, Sabre’s management-adjusted results included $117 million of tax expense in 2018, versus $162 million in 2017.
The drop in its effective tax rate was from 29.5 percent to 21.6 percent, reflecting a reduction in a U.S. statutory tax rate due to U.S. tax reform.
The savings appeared to give the company more financial flexibility last year. On a call with analysts Tuesday, Sabre’s executives said that its earnings per share increased 6 percent in the quarter, driven by operating income growth and a lower tax rate due to the impact of U.S. tax reform.
A caveat: Sabre’s tax rate and tax expense reflected on its income statement were not equivalent to actual cash taxes handed to Uncle Sam.
Sabre has not been a U.S. cash taxpayer since its initial public offering (IPO) in 2014. The explanation is net operating loss carryforwards related to pre-IPO assets, primarily the online travel agencies like Travelocity and LastMinute.com that it divested. It is now reaching the end of these net operating losses and will begin to pay U.S. cash taxes in 2019, and it expects to become a full U.S. cash taxpayer in 2020. In other words, one impact of U.S. tax reform has been to pull forward usage of the net operating losses.
Sabre reported $59 million in cash taxes in 2018, a year-over-year increase of 256 percent. The company also owed a $47 million one-time transition tax related to the enactment of tax reform that it expensed in 2017 but is paying out in cash over a decade.
Before 2014, Sabre was a private company, with private equity firms as its controlling shareholders. The company had a Tax Receivable Agreement (TRA) with its pre-IPO shareholders that is not considered part of its net debt. The agreement doesn’t drive any impact on its tax rate, reported income statement taxes, or amount of cash taxes it pays.
The company will enjoy a non-forecasted $59.6 million reduction in its Tax Receivable Agreement in payments to pre-IPO shareholders.
“We now expect to put [the TRA payments] behind us a year earlier than [we expected a year ago],” said Douglas Barnett, executive vice president and chief financial officer, during a call with investors on Tuesday. “Due to the changes driven by U.S. tax reform, we expect to pay out the remaining balance in 2020.”
Overall, the tax savings represent only a slice of the company’s revenue picture. But the tax savings likely provided some of the cash to enable Sabre to make its acquisition of tech vendor Farelogix for $360 million last November.
For the full-year 2018, Sabre boosted its revenue by 7.5 percent, to $3.87 billion. Its management-adjusted net income was $428 million, representing growth of 9.6 percent last year.
A Commercial Win
On Tuesday, CEO Sean Menke reported a major win for the company. JetBlue Airways agreed to renew its contract to use Sabre’s operational software, called a passenger service system.
The renewal had been jeopardized by incidents in October and November 2016 when JetBlue was one of several Sabre central reservation system customers who experienced glitches that interrupted operations and interfered with passenger booking and boarding.
JetBlue executives rang alarm bells that Sabre may have under-invested in its technology system and that the carrier might be in safer hands with a competitor like Amadeus, said two sources.
In a statement Tuesday, Michael Stromer, vice president technology and digital products at JetBlue, said that “Sabre laid out a seamless plan to modernize our PSS technology footprint.” In addition to a passenger service system renewal, JetBlue will upgrade to the Sabre Commercial Platform that was announced in the second-half of 2018.
Two years into his tenure as president and CEO, Menke appears to be making progress in changing the perception among some airline executives that Sabre’s technology team had become been too influenced by its largest airline customers, American and Etihad, to care about its other clients.
On the conference call, executives noted that Airline Solutions has been through a very large renewal cycle over the last two years:
“One thing that I believe was under-appreciated by investors is the concentrated renewal cycle that Airline Solutions went through in 2017 and 2018,” said Sean Menke, president and CEO of Sabre. “We successfully renewed 94 percent of our total contract value up for renewal over the period. After emerging from this heavy renewal cycle, we have 75 percent of total Airline Solutions revenue through 2023 under contract.”
Since 2014, Sabre’s IT solutions services have been losing market share to Amadeus, despite the unit’s lower profitability compared to its closest peer, according to an equity research report last month by investment bank Berenberg.
For all of their software businesses, Berenberg estimates that Sabre spends 20 percent less on research and development (R&D) than Amadeus. One caveat: It takes Sabre’s capital expenditure as a proxy of R&D, and it makes an unverifiable assumption that 75 percent of Amadeus’s total declared R&D spend relates to its software business.
Sabre clearly needs to win renewals of its other airline IT clients.
Last year, Sabre won renewal of Aeromexico, which had been under pressure by Delta, one of its major investors, to switch to Delta’s passenger service system, AIR4. Delta moved Virgin Atlantic to its system a few years ago. In 2017, Southwest and Air Canada each switched parts of their software operations to the systems of tech rival Amadeus.
To be clear, both Southwest and Air Canada were competitive losses for Sabre, but neither moved off of SabreSonic, its passenger service system. Southwest was on a legacy reservation system that it inherited from the carrier Baniff that Sabre helped it maintain until the carrier moved to a modern system. Air Canada is on a homegrown IBM system and has picked Amadeus Altea as its future passenger service system, but has not yet converted.
A Legal Loss
On February 1, the Supreme Court of Texas ruled in favor of Lufthansa Group against Sabre in a dispute about whether state courts have the authority to review one of Lufthansa’s disputes with the Texas-based company.
The Texas high court ruled that state courts are allowed to hear Lufthansa’s case. Sabre lost its argument that state courts would exceed their authority if they weighed in on the contract dispute due to its reading of federal laws.
The court published the decision online.
Lufthansa alleges that, in response to the carrier adding an $18 surcharge on tickets booked through Sabre and its peer companies, Sabre allegedly began encouraging travel agents to breach their contracts with the airline. It accuses Sabre of directing agents to book flights through Lufthansa’s direct connections, where there is no surcharge, and then enter the itineraries into Sabre’s reservation system. Sabre then collected an administration service fee for so-called passive bookings. Lufthansa alleged the fees are not billable under the contract terms.
In the past, Lufthansa, like many airlines, had agreed to let Sabre charge a small courtesy fee for these passive bookings but the assumption was that it would be rare for agents to have to do this.
Once Lufthansa began reservations in Sabre more expensive by adding an $18 charge per booking, the airline appears to have changed its mind about passive bookings.
Sabre hasn’t yet said if it will ask the U.S. Supreme Court to review the case.
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Photo credit: A view of the relatively new Tel Aviv office for Sabre Travel Network, the tech giant's distribution arm. Sabre reported its fourth-quarter and full-year 2018 earnings on Tuesday. Auerbach Halevy Architects