Why NetJets Matters
Why does what is happening at NetJets matter? Sometimes it's good to step back and take a birds-eye view.
> NetJets is a flagship business for Berkshire; its customers are some of the world’s richest, most famous and influential people. Similar to Berkshire’s insurance businesses, but on a more dramatic and public scale, what NetJets really sells is trust. See’s, GEICO, and the like are associated with Berkshire, but these businesses could be sold and they would remain immensely successful and profitable. That is not true of NetJets. It would have to find a parent with similar qualities. That could be hard to do because NetJets is about more than financial strength.....
> NetJets is even more closely associated with Warren Buffett. Its reputation its wrapped up in his personal reputation for honesty and integrity. NetJets was a trusted company before it was sold to Berkshire. Buffett made himself part of the brand so long ago, however, that its hard to separate them now. He started appearing in NetJets ads before buying the company, and has done more personal marketing for NetJets than most people probably realize.
> NetJets’ sale contracts extend for five years, although they are puttable after 24 months. NetJets also leases aircraft and has long-term contracts with OEMs, FBOs, and partners such as Marquis. The business is leveraged, the industry is considerably more sensitive to the vagaries of the economy than the typical business, and the long-term nature of its manufacturing and contracting has serious consequences to both the company and its business partners if plans and forecasts are badly executed.
> Berkshire has made something of a public “stand” on NetJets. It has drawn a sharp line between results in 2009 (prior management) and 2010 (current management). The senior management of NetJets is now made up largely of people who either received major promotions from within or who were brought in from MidAmerican; Sokol has referred to this as his “young” team. Sokol is about to hand the management of NetJets over to one of them. The economy is in disarray and the business jet industry is moribund. A recent J.P. Morgan survey of the industry shows that, on an absolute basis, July fractional share sales declined 70.5% year over year, and 57.4% sequentially, and on a rolling three-month average basis, share sales decreased 58.6% and were down 24.9% compared to June. Although these are industry numbers, NetJets represents more than half the industry. There has probably never been a more challenging time to run a fractional aviation company!! (I rarely use exclamation points, but it is hard to overstress how difficult the environment for the fractional industry is today.) Anyone who is interested in the world of business ought to be fascinated by the outcome of this story. Either this team of underdogs will pull off an amazing feat, in which case they are due hero's laurels, or Berkshire's shareholders are going to be disappointed.
> The man who is running NetJets, David Sokol, is considered the front-runner as Warren Buffett’s successor. Buffett credited him with a turnaround after six months, and is predicting earnings numbers of $500 million in the future. Others have alleged that Sokol’s management decisions have harmed NetJets’ franchise. Whether he has turned around NetJets undoubtedly will influence whether he runs Berkshire Hathaway someday. No more important question could exist for shareholders of the company. This situation is the only available window into the current management style of the man who might replace Warren Buffett in running Berkshire Hathaway.
> As goes NetJets, so goes Berkshire. I mentioned the issue of trust earlier. Berkshire is in the trust business -- insurance, financing, and above all the business of buying other businesses depends on people's willingness to trust in Berkshire. As a public test of that trust, the outcome of NetJets will influence how Berkshire is perceived by its business partners and would-be business partners.
> What is happening at NetJets undoubtedly is contentious. Former employees have made loud and very extreme accusations against a member of Berkshire management who has received a strong endorsement from Warren Buffett. Yet in life and in business, there are few black-and-white stories. I and am convinced that this one contains many nuances. It is to be expected that the two sides will portray each other as villanous and wholly in the wrong, and themselves as completely in the right. Common sense tells us that it just can't be that simple. Rather than make uninformed guesses based on prior opinions about the people involved, it is time to ferret out the facts.
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Alice, I hope you can answer
Alice, I hope you can answer a few nagging questions for me regarding Berkshire Hathaway and Warren Buffett given your invaluable insight into the company and unique history with Warren personally.
Berkshire Hathaway prides itself in having acquired the finest companies and preeminent management in a portfolio, which has been personally constructed by Warren Buffett over decades. Consequently, why should Berkshire require a fix-it man like David Sokol in the first place? Previously Warren never felt obligated to deploy such a combative fix-it man during the few times corrections were necessary within a Berkshire owned company.
After an acquisition was made, the Berkshire blueprint called for Warren to remain supportive yet minimally invasive. An intervention by Warren Buffett is one thing for a Berkshire company to endure, but ending up on the receiving end of a David Sokol transformational and radical “fix” was something I’m sure no one ever bargained for.
To be fair, I’m sure there are some companies within certain industries that could benefit from David’s considerable but very narrow attributes and skills. Nevertheless, it has become noticeably apparent that David’s persona is diametrically opposed to the one so carefully forged over all these years by Warren Buffett.
At this stage of his career, does Warren Buffett really want the man touted by so many as his replacement to be somebody like David Sokol? Is there trouble brewing with other Berkshire companies and their management at a level that would necessitate unleashing a David Sokol whirlwind upon them? What would the reaction of other CEOs and management teams be if Sokol was anointed as Warren Buffett’s replacement?
great questions
These are great questions. A few thoughts (not all necessarily answers):
> There have been fixit situations before (e.g., General Re) but there's no evidence Berkshire or other parts of it are broken and require fixing;
> There's never been a contentious situation like this;
> It's neither in Buffett's nor Berkshire shareholders' interest that so much drama be taking place;
> If Sokol is the cause of the drama, it's a problem for Berkshire. If he's not, the people making accusations against him will be proven wrong. It's conspicuous that months have transpired, and none of the specific claims have been denied or disproved. I'm sure that more evidence will unfold over time;
> It amazes me that anyone would want the job of running Berkshire. Who can live up to Warren Buffett's reputation? David Sokol's personality is very different from Warren's. I don't necessarily think a more conventional businesslike a approach is bad -- you don't want somebody who is trying to be a Warren clone. Combative is not the Berkshire style, however. We shall see what transpires.
The "Trust" Factor and "Franchise" Value
"Others have alleged that Sokol’s management decisions have harmed NetJets’ franchise."
Franchise? Really? What Franchise does NetJets have? Go back to WEB's letter of defining a franchise and it's value in pricing, profits and customer top of mind which I believe was included in the BRK annual report in the mid 1980s. There is no franchise at NetJets - only because of the ability to finance deficit operations from day one through BRKs debt backstop is there even a discussion about this company today, otherwise with out the backstop, this company would have been long gone many years ago.
"As goes NetJets, so goes Berkshire. I mentioned the issue of trust earlier. Berkshire is in the trust business -- insurance, financing, and above all the business of buying other businesses depends on people's willingness to trust in Berkshire. As a public test of that trust, the outcome of NetJets will influence how Berkshire is perceived by its business partners and would-be business partners."
Unlikely. Look at the textile business which was the original Berkshire Hathaway. Long gone. Did the shut down of that business hurt the trust factor of WEB and the other BRK businesses? Trust comes from a lot of areas, but running a business at a loss since inception? If something hadn't been done with it, I would expect the trust factor to take a hit, rather than addressing the fundamental problems of the business and the industry.
Ohhh... and GO BIG RED!
At a loss since its inception?
Steve perhaps you neglected to read Berkshire Hathaway's annual reports starting from the date it acquired NetJets. Warren Buffett himself proudly describes how many years NetJets made money. Equally outstanding were the revenue growth numbers Warren indicated the company posted year after year.
Somehow you must also have missed when Alice Schroeder so articulately described the cash NetJets has produced for Berkshire. Moreover not yet presented is the tax deferral benefit on the NetJets fleet that Berkshire has enjoyed all these years further adding to the cash value created.
Berkshire purchased NetJets for about 725 million dollars. The company went on to own almost 70 percent of the market. I'm sure Warren Buffett hopes there is some "Franchise Value" left at this point.
Whether Berkshire should continue to own NetJets is now open to serious debate and not because of the distant past. The question is based on the current condition of the company and what might the future might bring.
A reasonable question is would Berkshire purchase NetJets today? I believe most everyone knows the answer to that one.
NetJets is not just important to Berkshire
NetJets is not just important because of the reasons you list above everyone in business aviation benefits from a strong NetJets.
Compared to most other large global industries the corporate jet market is fragmented and localised. Apart from the two large trade bodies, which do a good job of bringing people together at their trade shows, there is little international cross-over.
As it grew NetJets changed this. With operations in the US, Europe and, admittedly a smaller venture, Middle East NetJets was a truly international business. (And this will continue when it sets up a Chinese or at least Asian operation in the next few years).
NetJets introduced the benefits of corporate aviation to many potential users. It helped manufacturers have the confidence to launch new aircraft and it provided a strong benchmark for competitors.
David Sokol, the CEO of NetJets, may be viewed as a villain by some but at least NetJets is still flying.
NetJets will continue to change – no doubt moving from a fractional company to more of an aircraft operator offering more charter and it will take a while to rationalise its fleet - but even its competitors should wish it well.
What is good for NetJets is good for business aviation.
"Former employees have made
"Former employees have made loud and very extreme accusations against a member of Berkshire management who has received a strong endorsement from Warren Buffett."
The reason the accusations appear "very extreme" is that Mr. Sokol has done some things at NetJets would be hard for outsiders to imagine (many appear in these very posts). The accusations also appear "very extreme" because Warren Buffett has endorsed Mr. Sokol on many occasions.
The one thing that stands out the most to me is how Sokol came in and torched the relationships that NetJets had with the manufacturers. Until Gulfstrea, Dassault, Cessna, or Hawker come out and publicly endorse Mr. Sokol or the NetJets program I have very little faith in any sort of recovery at NetJets. Sokol was warned by many around him when he initially took the post at NetJets but he didn't want to listen. I almost feel bad for him due to this naivety or lack of common sense, but at the same time it's hard to feel any "sympathy for Sokol" when everybody can say, "I told you so."
FractionalLife
Piers Brown at FractionalLife.com asked me to post the following: "FractionalLife scooped the story that Jet Republic, European fractional jet operator was ceasing to trade last year. The company which had been set up in direct competition to NetJets Europe both being based out of offices literally opposite each other in Portugal.
We know NetJets is close to Warren Buffet's heart -his face even appears on their current display advertising campaigns here in the UK for extra kudos /reassurance for Clients and potential customers I suppose.
I am a firm believer if NetJets wasn't owned by a company with deep pockets like Berkshire Hathaway,it would be owned by somebody else with comparative wealth. I don't believe the company will go away and as the economy slowly trudges out of recession I do hope profitability at NetJets happens one day.
Best wishes
Piers"
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