NetJets -- What Do We Actually Know?
One of the helpful guideposts about NetJets is simply to piece together what is actually known about the company and its results. Following is a history of what has transpired, based purely on publicly available information. In this history I've tried to add some industry context to what has been reported.
> Berkshire typically provided extensive, albeit frequently changing, disclosures about NetJets until 2007. These included revenue and earnings comparisons as well as details of important elements of these figures.
> At the beginning of 2007, concurrent with the acquisition of TTI, the flight services segment became other services, which also included businesses like the Pampered Chef. By the third quarter, Berkshire had stopped making most quantitative disclosures about NetJets. Coincidentally, sales and the installed base of the fractional jet industry peaked, after which the UBS business jet market index, a widely used indicator of market conditions, began to drop.
> The UBS fractional market index of sales plunged throughout 2008 and bottomed in the fourth quarter of 2008. Berkshire made no specific disclosures about NetJets during 2008 except to announce a fourth quarter writedown because of margin pressure. For the first time since it was purchased in 1998, Buffett did not mention NetJets in the shareholder letter.
> Moving into 1Q09, Berkshire disclosed that NetJets’ sales were down 80% and reinstated a disclosure of earnings for the first time in five quarters, saying that NetJets had a pretax loss of $96 million versus a profit of $45 million in 1Q08. Buffett blamed NetJets’ losses on the global economic downturn and linked them to similar, but less sizeable problems, in Berkshire’s other businesses.
> In 2Q09, a massive writedown and restructuring program began under NetJets CEO Rich Santulli. Berkshire disclosed that NetJets produced pre-tax losses of $253 million, which included asset writedowns and other downsizing costs of $192 million. The earnings comparison to 2008 that had been reinstated in the first quarter was removed, however. Berkshire instead reinstated a quantification of NetJets’ revenues, disclosing their dramatic decline -- $550 million (43%) for the second quarter and $474 million (41%) for the first quarter. Lastly, Berkshire stated that the aircraft inventory was in excess of needs and further downsizing would be required, a clear signal that more writedowns were coming. As context, the 10-Q and its disclosures for this quarter were completed after David Sokol arrived at NetJets, but the financial statement numbers were “baked” before he took over.
> In the third quarter of 2009, NetJets took $181 million of writedowns and writeoffs, roughly equal to its $183 million pre-tax loss. Revenue trends were essentially unchanged. At the time, according to UBS, business conditions in the fractional market as a whole had slightly worsened, with sales down and redemptions flat. Berkshire made a prediction that NetJets would operate at a modest profit for 2010, “absent any further deterioration in the U.S. economy or negative actions directed at the ownership of private aircraft.”
> In the fourth quarter of 2009, media notice of dissension at NetJets began to surface with a New York Times article by Geraldine Fabrikant, among others. Buffett wrote extensively about NetJets in the shareholder letter, saying among other things, “In the eleven years that we have owned the company, it has recorded an aggregate pre-tax loss of $157 million. Moreover, the company’s debt has soared from $102 million at the time of purchase to $1.9 billion in April of last year. Without Berkshire’s guarantee of this debt, NetJets would have been out of business. But, luckily, I have been bailed out. Dave Sokol, the enormously talented builder and operator of MidAmerican Energy, became CEO of NetJets in August. His leadership has been transforming: Debt has already been reduced to $1.4 billion, and, after suffering a staggering loss of $711 million in 2009, the company is now solidly profitable.”
> Many people might assume from this statement that Sokol’s transformative leadership reduced the debt to $1.4 billion, although it does not literally say that if read closely. Betty Liu of Bloomberg News asked Sokol in her interview whether it was true that, instead, most of the debt reduction occurred before he arrived at NetJets. He did not answer the question directly, but rather referred to the people who made the debt reduction rather than the timing in which it occurred. It could be inferred that most of the debt reduction did happen before he arrived at NetJets. It also is not clear whether NetJets’ debt soared or shrank more or less than its revenues or assets or fleet size or market share or installed share base.
> There is more context for the $157 million cumulative loss. Of this, $711 million occurred in 2009 and consists mostly of noncash charges and writedowns. NetJets’ loss for 2009 excluding the charges would have been $35M and its cumulative earnings without any of the writedowns would have been $573 million. None of these numbers suggest a stellar return on capital. Beyond that, there isn’t a recent basis for comparison for the 2009 losses other than the $143 million earned by NetJets in 2006; Berkshire did not disclose NetJets’ full year earnings in either 2007 or 2008.
> In the first and second quarters of 2010, Berkshire increased its level of disclosure to say that first quarter revenues increased 18% and second quarter revenues increase 16%. From this, it is possible to calculate that they remain 33% and 32.5%, respectively, below the level of 2008. NetJets earned $171 million in the first half of 2010, which compares to a loss of $102 million excluding the impairment and restructuring writedowns in 2009. Although 2010 can’t be compared to 2008 because these earnings were never disclosed, NetJets earned $109 million in the first six months of 2007 and $29 million in 2006. In recent months, UBS notes the risk of a "muted recovery" because there is a significant oversupply of aircraft, the fractional business is particularly weak, and the European market outlook has grown more cautious. The installed share base numbers for fractionals appear to be at an all-time low of any period in which the industry could be considered mature and still dropping.
While incomplete, it should be clear from this history that it is very difficult to draw much in the way of meaningful conclusions about NetJets from what has been disclosed. However, the numbers and disclosures do tell something of a story if compared to the industry's trends. For one thing, even with cost-cutting and writedowns, the earnings turnaround has been very rapid considering the revenue numbers and the industry's continuing woes. In addition, it's hard to avoid the conclusion that numbers that emphasize whatever point Berkshire wants to make are disclosed and those that do not emphasize this point are omitted. As a former analyst, I certainly can say as a simple matter of fact that these are some of the least consistent disclosures I have ever analyzed.
Of course, I am writing only about NetJets here because that is the topic at hand. If you analyze other Berkshire subsidiaries whose fortunes have been "mixed," however, you will find exactly the same pattern. This is not an isolated example.