Berkshire Hathaway
Re: Holy cow! Billion $ Jet Order

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By gamane
December 5, 2005

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What price do you think it would fetch?

I think NetJets is one of Berkshire's more exciting businesses. One of the few that is growing rapidly. I think Buffett's explanations for why it isn't producing tons of cash are perfectly reasonable.

NJ is probably unsaleable at this point in its life (for a profit) as it is still in the middle of its development phase, requiring a fair amount of cash and creditworthiness for something that has yet to be proven as a worthy investment.

I'm not sure rapid growth is all that desirable in a business that has so many variables that have to work perfectly thru each and every customer service cycle. That rapid growth cost us tens of millions in charter costs this year.

I have to admit that my own efforts at trying to define and analyze the financial part of the business model are probably prewired to the downside due to my prejudices gained from familiarity with aviation. NJ has to succeed (defined as say a long term 15% ROIC??) in a world where most of the opportunities for moat building are regulated by governments and make all participants equal. Likewise, most of the ways moats can be successfully attacked are very much unregulated and seem to be filled with people who are flush with capital and are capable of and willing to break even or even lose money while they pursue their love of aviation.

Profitability at NJ has so far been very thin and somewhat intermittent and, IMO, will continue to be intermittent unless Santulli's algorithms for scheduling and locating aircraft get better than current performance or pricing power is somehow established (and that takes me back to the track record of aviation and its ability to attract and consume enormous amounts of capital from people with lots of money and a love of flying).

As a shareholder, I hope I am missing something that will give me the opportunity to eat lots of crow about NJ. But right now, IMO, NJ seems to be almost the definition of the kind of business that WEB usually avoids. Lots of capital or credit commitments, fractious labor, government control of key areas of potential differentiation (commodity?), no benefit of scale, new and rapidly changing markets, etc.

Our major suppliers (Cessna, Bombardier and Raytheon) are also our largest competitors and they have no driving interest in making money in their fractional ownership businesses, just keeping their production lines full (and I would argue, keeping any single customer - like NJ - from becoming too dominant). Break even in the fractional business would be great for them as long as the business consumes airplanes at a faster rate. And the more they can help support people trying to get into niches in the fractional ownership business the better they preserve their pricing power with NJ.

Local FBO's are re-examining their bizjet charter business models and getting pretty good at profitably serving local one-time and repetitive demand that doesn't need the scale and coverage of NJ. NJ doesn't count these FBO's as competitors because they are not, by definition, in the fractional ownership business. But they profitably serve a lot of potential NJ customers and thus are truly a growing competitor. And I would bet that it is the FBO's regularly repetitive business that is NJ's most profitable segment of their fractional ownership business model. It would be interesting to analyze what percentage of people who travel in bizjets do so via charter or corporate owned versus the number who travel via fractional ownership models and what the trends are for each.

At the other end of the market are the corporations who have their own flight departments or want to have someday. Some have tried NJ as either an entry-level alternative or a flexible capacity subcontractor. Some still use NJ, but many who can't live with the response times have gone back to owning their own aircraft. Others, who start with NJ, often go to their own fully owned aircraft when their usage grows to where it is justified. And the corporate customers, if you can keep them, tend to be the least price conscious.

The history of destruction of capital in the bizjet owning and operating business, like its commercial aviation brother, is a long one. The innovation that supposedly will avoid that history - fractional ownership - doesn't really change the nearly zero sum game of airplane ownership and operating costs, it just spreads them out into smaller increments and adds an additional overhead cost found in NJ's scheduling operation IMO. Most of the cost of airplane ownership and all of the operating costs vary directly with hours of usage. You can't get meaningfully ahead of the cost curve, you can only speed up or slow down the costs based on usage. Being the largest fractional ownership company doesn't equate to pricing power or sustainable competitive advantage IMO. So where is the sustainable moat? Scale won't do it, government regulation won't do it, conflicted competition certainly won't do it.

The thing that gives me hope is that WEB is investing in it. Every time I stack up his record against mine I shrug in resignation and go buy some more BRK. But it sure is frustrating not being able to understand the NJ part of my investment and what WEB sees in it.

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