New Info on NetJets
Buffett has some nice praise for NetJets in the annual report. Following is an analysis of the significant new elements of the report (some were repeated from last year). To begin with, “I can’t overstate the breadth and importance of David Sokol’s achievements at this company…” Let me also state at the outset that I do not want a round of anybody-bashing to begin on this comment page for the sake of venting. Please comment if you have something substantively new to add. Now let's just move on to analyzing the results.
Cost-cutting. Buffett wrote: “David’s quick restructuring of management and the company’s rationalization of its purchasing and spending policies has ended the hemorrhaging of cash and turned what was Berkshire’s only major business problem into a solidly profitable operation.” This tells you what was truly irking Buffett. He cannot stand waste, grandiosity, sloppiness or high overhead. When NetJets was making money and Buffett was having fun with it, he overlooked some things. Now, Buffett is obviously pleased about the margin numbers. He wanted NetJets’ cost structure rationalized. Yes, there is a question of whether too much cost-cutting took place. For now, however, Buffett appears happy with the profits.
Please note also what these compliments do not mention: customers and growth. Which leads us to...
Revenue increase. The annual report mentioned that revenues increased 7% because of “higher worldwide flight revenue hours and increased pass through costs, partially offset by lower management fees due to fewer aircraft in the NetJets program.” Translation:
A) NetJets customers are using a higher percentage of their purchased hours.
B) NetJets is passing along rising costs (especially fuel costs) to customers.
C) Revenue is not coming from growth. In fact, fewer aircraft are owned by customers than a year ago, resulting in lower monthly management fees.
There has been some confusion about growth. Some news articles about NetJets have cited number of customers and growth of customers, perhaps giving the impression that NetJets is growing. In addition, as Marquis customers migrate to NetJets, they might appear to be new customers even though they are using the same shares.
Berkshire was careful to disclose that the company is actually shrinking, not growing. Below you will see the numbers. NetJets has lost “whole aircraft equivalents” (i.e., if customers are slices of the pie, whole aircraft equivalents is the number of pies. If you sell pies, you care how many pies you sell, not how many slices your pies are cut into). The whole industry is down – NetJets’ competitors’ numbers are terrible, too (Flexjet, CitationAir, Flight Options). Put simply, the industry's customers are reducing owned share, moving to charter, returning to wholly-owned aircraft, and/or, giving up private aviation altogether. Nonetheless, shrinkage is shrinkage, and dividing a smaller pie into more slices is not growth. Buffett, who is always very literal and precise, was careful not to mislead in what he wrote in the report. Here are the NetJets stats for whole aircraft equivalent numbers from the industry surveyor, (confusingly named) JetNet LLC database (by the way these and the rest are US numbers, I hope to have some numbers for the rest of NetJets shortly):
Aircraft sales and valuation. Also from the annual report: “NetJets continues to own more aircraft than is required for present operations and we expect to continue to dispose of selected aircraft over time.” In 2010, for example, NetJets sold 2 Boeing Business Jets, 3 Citation Excels, 3 Citation Ultras, no Citation Sovereigns, no Citation Xs, and no Falcon 2000s. In 2011 you should expect more sales.
NetJets aircraft are flown a lot more than the average plane of same vintage & model and therefore sell at lower prices, or simply do not sell, when there is an oversupply. The average fleet age of nearly every NetJets make/model is five years old or older and many are much older. Some statistics, again from JetNet, as of January 2011.
= Citation X aircraft – 64 out of 70 in the NetJets fleet are 7 or more years old. 38 are 10 years old or older.
= Citation Ultra – 13 aircraft, all 20 years old or older.
= Falcon 2000 – all 31 are 7 or more years old; 11 are 10 or more years old.
= Citation Excel – 45 of 47 are in the 7 to 10 year category.
= Citation Sovereign – 24 of 34 are in the 4 to 6 year “bucket” and will soon tip over into the 7 to 10 year bucket.
In total, NetJets had 2,405 unique shareholders on 284.5 aircraft in use as of January 2011. (Please note that to sell a plane, you have to take back title to all 32 shares from every owner. This makes selling more complicated as the aircraft age.) For the premium price they are paying, NetJets customers expect to fly on newish planes. Also, the maintenance costs of aircraft, which must be passed along to customers, increase in a nonlinear manner -- faster with older planes.
So: more sales next year of an aging fleet means what? A lot of these aircraft have probably already been written down. It’s possible that further writedowns may be taken but just as likely that gains may be booked into income. Or, gains may offset new writedowns on other aircraft.
My best guess, in the short term, NetJets may book some gains as it finally begins to move some of these older aircraft that have been written down. In the long term, as the fleet continues to age, you may well see more writedowns.
No mention of Marquis acquisition. Recall that the Marquis acquisition took place primarily to prevent Marquis’ bankruptcy after NetJets’ began competing with it by selling 32nd shares. Marquis owned 54 aircraft as of January 2011. If I understand the situation correctly, Berkshire in effect was forced to spend a lot of money for nothing to buy these aircraft that it was already flying and which are worth far less than the debt it assumed as part of the transaction. Under the circumstances, it's likely that Berkshire took a writedown of about $200 million in purchase accounting adjustments.
How can you tell? On page 12 of annual report (Buffett letter) there is an asterisk that says manufacturing, service and retailing operations pre-tax earnings of $4,274 excludes purchase accounting adjustments. (I may be missing something but this is the only place I saw that footnote – please correct me if that is wrong.) Thus NetJets reported earnings excludes any purchase accounting adjustments related to Marquis. The writedown is maybe $80 per A share. Not that big a deal, but I have to admit curiosity.
The more interesting question is why didn't Berkshire just let Marquis go into bankruptcy? Buffet is not know for throwing money away. I suspect that it has to do with brand. The Marquis brand is so closely associated with NetJets that it could be expensive for Berkshire if Marquis filed for bankruptcy and have Kenny Dichter, Marquis's founder, running around in the media blaming Berkshire. This was most likely not a a pleasant decision. As Buffett always says, some businesses throw you one tough decision after another, and other businesses throw you one easy decision after another.