Buffett's Baby Is Taking a Bumpy Ride

[Weasil]

By GERALDINE FABRIKANT -NY TIMES
Published: June 25, 2006
CHOWING on salads and sipping San Pellegrino water at the Santa Monica, Calif., airport two weeks ago, a well-heeled group of travelers compared notes on a fleet of spiffy Hawkers, Gulfstreams and Citations that NetJets, which peddles fractional ownerships in private jets, had assembled for their inspection.
Lee Iacocca, the 81-year-old former chairman of Chrysler, and Howard Grossman, a principal at GLWG Inc., a business and wealth management firm in Los Angeles, were among those reviewing the fleet and deciding whether to spend, say, $406,250 to own a sixteenth of a Hawker 400XP or $2.625 million for a sixteenth of a Gulfstream 550. Convenience and speed sell, of course, but Mr. Grossman spoke more directly about one of the other primary lures of having a high-priced airsteed at one's beck and call — even if only on a part-time basis.
"It is a status symbol," he said. "It's the best toy known to man."
NetJets is also one of the best toys known to Warren E. Buffett, the storied Omaha investor, whose holding company, Berkshire Hathaway, bought it from the maverick entrepreneur Richard T. Santulli in 1998. Mr. Buffett, who became a multibillionaire and one of the world's richest men by ferreting out undervalued companies, acquired NetJets on the assumption that demand for part-time jets would take off among the rich and famous who were desperate to avoid commercial flights and enamored of jet travel's luxurious perks.
As has so often been the case, Mr. Buffett's hunch, inspired by Mr. Santulli's own early appreciation of jet ownership, was prescient. Demand for part-time jet ownership has boomed over the last several years. Along the way, however, NetJets itself has endured a bumpy financial ride, calling into question the company's prospects for delivering the growth that Mr. Buffett expected — and illustrating the frustrating vagaries faced by many small companies that get an early and seemingly insurmountable head start in a promising field.
Mr. Buffett has had a longstanding and successful penchant for buying companies run by skilled, passionate managers who can exercise nearly monopolistic control over prices in their markets. Although NetJets is by far the leader in its industry, the company lost $80 million last year, after scratching out a profit of $10 million in 2004. (It also lost money in 2001, 2002 and 2003, according to the company.)
Mr. Buffett declined to be interviewed, but he noted in his most recent letter to Berkshire Hathaway shareholders that while he had thought that NetJets would be profitable last year, he had been "dead wrong." Mr. Santulli, the chairman and chief executive of NetJets, who agreed to telephone interviews, had a more colorful observation of his company's problems in 2005 — induced, he said, by haggling over a new pilots' contract, increasing and budget-busting demands on its domestic fleet, and a number of continuing problems in its efforts to build a European presence:
"It was horrible, horrible," Mr. Santulli said. "I was embarrassed."
Still, ever the optimist, he also said he saw clearer skies ahead. "We will have an excellent year and we will make money this year," he said. "We have the critical mass we need."

 

[Weasil]

But some analysts and shareholders are not as sanguine as Mr. Santulli and voice concerns about NetJets' ability to turn itself around. "They can't charge enough to where they can make money on the ongoing part of the business," said David Strauss, an airline industry analyst at UBS Securities. "And complexity is overwhelming the benefits of size. They have a lot of model types and a lot of different customers."
MR. SANTULLI, a former investment banker at Goldman Sachs, took over a middling charter airplane company, Executive Jet, in 1984. In 1986, he introduced the concept of NetJets, the private-jet business's first fractional ownership venture. For most of the next decade he had the field to himself, eventually inviting Mr. Buffett's attention. (The company did not change its name to NetJets until 2002.)
Mr. Buffett, as well-known for his frugality as he is for his wealth, has famously pooh-poohed expensive cars, fast boats, sprawling estates, gleaming baubles and other trappings of wealth in favor of much more modest accouterments — except for jets, which he has made no secret of adoring. Private jet travel, Mr. Buffett has said, is worth much more than a large home or a fancy car. Zipping about in jets, he said, can change the quality of your life.
Mr. Buffett discovered the joys of fractional jet ownership as a NetJets customer, and was so enthusiastic about Mr. Santulli's business that he paid $725 million in stock and cash to buy it. "Rich and I believe that the potential of fractional ownership has barely been scratched," Mr. Buffett wrote in his 1998 letter to Berkshire shareholders, saying that if thousands of fliers wanted to buy their own jets, then "there must be a large multiple of that number for whom fractional ownership works."
Skip to next paragraph It was a compelling insight, but one that other operators came to share. Since Mr. Buffett bought NetJets, Bombardier, which makes Learjets as well as Challengers, started Flexjet. Raytheon, the military contractor, merged a fractional business it controlled with Flight Options, which was then an independent company and is now a wholly owned subsidiary of Raytheon. And Textron and TAG Aviation jointly own CitationShares.
Despite NetJets having what Mr. Buffett referred to as an "armada of planes positioned throughout the country," critics say that he and Mr. Santulli underestimated how quickly competition would ramp up, putting pricing pressure on the entire industry. They also say that in a business in which thousands of finicky, pampered customers are guaranteed access to planes within hours after they request one, execution is, to say the least, complex.
"NetJets is not as protected an investment as Berkshire initially thought," said Thomas A. Russo, whose investment firm, Gardner Russo & Gardner, owns 3.245 million Berkshire shares for clients. "NetJets does not have as free a hand at pricing as they would have liked."
Mr. Russo said that NetJets' initial game plan was to offer faster service, less turnaround time and more highly trained pilots than other operators so "there would be no competitive alternative, because no one could afford to mount a similar complete offering." But competitors have managed to surface and thrive.
Mr. Santulli has battled other challenges as well. Intense contract negotiations with pilots last year led, Mr. Santulli asserted, to some of them "not giving 100 percent." Bill Olson, president of Teamsters' Local 1108, which represents the NetJets pilots, said the union was anxious to resolve the contract talks and that pilots have worked hard.
Still, a pilot shortage last year forced NetJets to charter other aircraft.

 

[Weasil]

"On the days when we were very busy, I had to go the charter market, and they kill you with pricing," Mr. Santulli recalled. "I should have hired 300 pilots, but no one knew what their contract would be. So I had airplanes and no pilots." The shortage is now over, NetJets said.
NetJets typically makes money several ways. As a volume buyer, it can buy jets at modest discounts and then sell fractional interests that add up to more than the cost of the plane. After owners buy a fractional interest, they also pay NetJets an hourly flight fee as well as monthly management fees. The Hawker 400XP, for example, carries an hourly fee of $1,554 and a monthly fee of $6,820; a Gulfstream 550 has an hourly fee of $3,476 and a monthly fee of $19,355.
Five years after buying an ownership stake in a jet, a customer can sell back the stake at market value, and NetJets can then resell it yet again for a small profit. This can be a perilous path: three years ago, NetJets wrote down $32 million in jet inventory that fell in value before it could resell the planes.
In a move that helped attract new customers who wanted to put up less money for private-jet travel, NetJets struck a deal in 2001 with Marquis Jet, an independent company. For as little as $115,900, Marquis sells cards that are good for a fixed number of hours' use of NetJets planes. Competitors of NetJets then created their own jet-card businesses.
The Marquis customer base offered a new source of income for NetJets, but in 2005, at least, it also meant operational headaches, because it placed greater demand on the same number of planes. Mr. Santulli said he spent $200 million last year chartering extra jets to meet increased demand from existing customers and Marquis Jet members. He expects the cost to drop below $100 million this year.
Analysts say that demand for jets may be plateauing as well, causing pricing to become more strained. Humbug, counters Mr. Santulli, who said that NetJets raised its monthly management fees 10 percent in January without resistance. "People who understand what we provide are prepared to pay our costs," he said.
Certainly, NetJets remains the leader. As of April, it had 2,232 shareholders, compared with 1,174 at Flight Options, its largest competitor, according to JetNet/Avdata, an aviation market research firm. The firm estimates that among the four leading fractional companies, NetJets caters to about 49 percent of the owners. Flight Options, which said it lost money in 2005, now plans to offer fewer aircraft choices to cut down on operating costs.
Other companies face hurdles as well. Bombardier said Flexjet was profitable last year for the first time, but declined to be specific.
At the end of the day we are running an unscheduled airline," said Nathalie Bloomfield, director of marketing for Flexjet. "Someone can call you with only six hours' notice, and you don't know where you are leaving from and where you want to go." She said that the biggest challenges faced by her company were reducing the number of flights without paying passengers (known in the industry as "deadheading") and staffing jets properly.
Skip to next paragraph THE share-a-jet companies also cater to people accustomed to exclusivity and high-end service, breeding a challenge of finding new ways to burnish corporate images. NetJets, for example, said that one NetJetter, Barbra Streisand, agreed last year to entertain 350 other members at the home of the composer David Foster, an event that would be any marketer's dream.
Elite parties and great service do not prevent sophisticated customers from price-shopping, analysts say. Still, NetJets appears to have been able to avoid some of the more drastic discounts that other companies are offering.
"We have seen companies like Flight Options handing down 50 percent discounts," said Mike Riegel, a consultant to fliers who buy fractional ownerships or jet cards. "NetJets does not usually grant concessions."
Along with its aversion to discounts comes a commitment to service. If a NetJets client is an hour late, for example, NetJets will hold the plane without charging more.
And if a customer wants to leave from the Santa Monica airport but the plane is sitting at the Van Nuys airport nearby, NetJets will happily bring the jet to the owner.
The company, meanwhile, has been trying to work through the headaches of transplanting its services to Europe.
Building an overseas business has proved very expensive because of the cultural differences and the logistical intricacies of flying over so many countries, each with its own set of air regulations and tariffs. "There is a greater reluctance on the part of European companies to use corporate jets, and even when people use them, they may not brag about it as much as in the U.S., so word-of-mouth is not as strong," said Gerald Khoo, an analyst at Oriel Securities in London.
Nonetheless, Mr. Santulli says that he and Mr. Buffett agree that it is crucial to offer customers access to Europe. Of Mr. Buffett's long-term view, Mr. Santulli said: "He said, 'If you can guarantee me that we will control the market in Europe, then we will invest in Europe.' "
NetJets is a tiny part of Berkshire Hathaway's overall operations. Last year, Berkshire's flight services sector, which includes NetJets and a flight safety business, generated $3.6 billon in revenue. Berkshire as a whole posted revenue of $81 billion.
Despite NetJets' current difficulties, Mr. Buffett's patience — and Berkshire's deep pockets — may mean that the company will eventually outlast all of its competitors.
"They have a very understanding owner," said Richard L. Aboulafia, vice president at Teal Group, an aerospace consulting firm. "They have established themselves as the biggest player with critical mass, so if anyone has a chance, it's them."
Unlike some of NetJets' critics, Mr. Aboulafia advises looking beyond the immediate horizon when assessing the company's prospects. "The important thing is that they have not been hemorrhaging, and it is only in the past few years that they have hit cruising altitude, so you have to give them a chance to smooth out the wrinkles," he said. But he adds, challenges remain.
"No one has a monopoly," he observed.

 

[temcgrew]

I had a passenger who had talked with Buffett about NetJets future and his whole attitude is that he will be the last man standing among the frac's. Sounds like his ego is the only thing keeping it going right now. How many other B.H. companies have lost money like NetJets? The flip side is that FlightSafety is making money, but how much of that is from NetJet's training?

 

[RJ Bum]

good read, thanks for posting.

 

[SCT]

It looks like Uncle Warren is giving part of his money away:

Warren Buffett gives away his fortune
FORTUNE EXCLUSIVE: The world's second richest man - who's now worth $44 billion - tells editor-at-large Carol Loomis he will start giving away 85% of his wealth in July - most of it to the Bill & Melinda Gates Foundation.

By Carol J. Loomis, FORTUNE editor-at-large
June 25, 2006: 12:48 PM EDT

NEW YORK (FORTUNE Magazine) - We were sitting in a Manhattan living room on a spring afternoon, and Warren Buffett had a Cherry Coke in his hand as usual. But this unremarkable scene was about to take a surprising turn.

"Brace yourself," Buffett warned with a grin. He then described a momentous change in his thinking. Within months, he said, he would begin to give away his Berkshire Hathaway fortune, then and now worth well over $40 billion.





Warren Buffett gives it away
An interview with Buffett
How the giveaway will work
The force called the Gates Foundation
From the FORTUNE archives
Should you leave it all to the children?
If you do, you may not be doing them a favor. But if you want to, there are sensible ways of passing on what you have without depriving the kids of a feeling of achievement. (more)
Letters from Buffett
As part of his plan, Warren Buffett is sending letters to each of the five foundations that will be receiving his gifts. The letters may be found on Berkshire Hathaway's Web site. (See the letters)
This news was indeed stunning. Buffett, 75, has for decades said his wealth would go to philanthropy but has just as steadily indicated the handoff would be made at his death. Now he was revising the timetable.

"I know what I want to do," he said, "and it makes sense to get going." On that spring day his plan was uncertain in some of its details; today it is essentially complete. And it is typical Buffett: rational, original, breaking the mold of how extremely rich people donate money.

Buffett has pledged to gradually give 85% of his Berkshire stock to five foundations. A dominant five-sixths of the shares will go to the world's largest philanthropic organization, the $30 billion Bill & Melinda Gates Foundation, whose principals are close friends of Buffett's (a connection that began in 1991, when a mutual friend introduced Buffett and Bill Gates).

The Gateses credit Buffett, says Bill, with having "inspired" their thinking about giving money back to society. Their foundation's activities, internationally famous, are focused on world health -- fighting such diseases as malaria, HIV/AIDS, and tuberculosis -- and on improving U.S. libraries and high schools.

Up to now, the two Gateses have been the only trustees of their foundation. But as his plan gets underway, Buffett will be joining them. Bill Gates says he and his wife are "thrilled" by that and by knowing that Buffett's money will allow the foundation to "both deepen and accelerate" its work. "The generosity and trust Warren has shown," Gates adds, "is incredible." Beginning in July and continuing every year, Buffett will give a set, annually declining number of Berkshire B shares - starting with 602,500 in 2006 and then decreasing by 5% per year - to the five foundations. The gifts to the Gates foundation will be made either by Buffett or through his estate as long as at least one of the pair -- Bill, now 50, or Melinda, 41 -- is active in it.

Berkshire's price on the date of each gift will determine its dollar value. Were B shares, for example, to be $3,071 in July - that was their close on June 23 - Buffett's 2006 gift to the foundation, 500,000 shares, would be worth about $1.5 billion. With so much new money to handle, the foundation will be given two years to resize its operations. But it will then be required by the terms of Buffett's gift to annually spend the dollar amount of his contributions as well as

 

[sweptwingz]

Simple math.

Does scheduled airline travel suck? Yes.
Will it continue to suck? Yes.
Will ultra high dollar passengers ride airlines? No.
Will fractionals cater to those passengers? Yes.
Will fractionals survive? Some will, count on it.

Any questions?

 

[Weasil]

Will fractionals survive?

Some will, count on it.

Any questions?

So which ones will survive. Make a prediction.

 

[Guitar rocker]

So which ones will survive. Make a prediction.

Good question there. Guess we'll have to see how NJA is going to do here and how their earnings are....CS has lost $$$ for the last 7 years as reported in the Wichita Eagle last month. Not sure how Flex and Flops are doing. With all that in mind, it could be any one of those.

 

[gunfyter]

I don't see the manufacturer backed fracs going away... Unless the manufacturer decides to stop making business jets.