Warren Buffett’s Investing Blind Spot: Airlines
Warren Buffett doesn’t seem to have much financial luck with airline companies. The billionaire CEO of Berkshire Hathaway Inc. has decried airline investing ever since he got burned buying convertible preferred stock in USAir Group Inc. in 1989.
Berkshire eventually had to write down the $358 million investment in the commercial airline operator. In his 1996 annual letter to shareholders, Mr. Buffett wrote: “My analysis of USAir’s business was both superficial and wrong. I was so beguiled by the company’s long history of profitable operations, and by the protection that ownership of a senior security seemingly offered me, that I overlooked the crucial point: USAir’s revenues would increasingly feel the effects of an unregulated, fiercely-competitive market whereas its cost structure was a holdover from the days when regulation protected profits. These costs, if left unchecked, portended disaster, however reassuring the airline’s past record might be.” Despite the misfortunes of USAir, Berkshire sold its shares in 1998 for a “hefty gain,” according to the company’s 2007 annual report.
It was a theme he returned to in his 2007 letter, where he said that a durable competitive advantage in the airline industry “has proven elusive ever since the days of the Wright Brothers.”
“Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down,” he joked. “The airline industry’s demand for capital ever since that first flight has been insatiable. Investors have poured money into a bottomless pit.”
More recently, Berkshire-owned private-jet operator NetJets Inc. has been a source of worry for Mr. Buffett. Although NetJets operates in the private aviation market, it deals with many of the same issues as commercial airlines, including high fixed costs such as fuel, and unionized labor.
NetJets is in midst of contract negotiations with several unions representing pilots, flight attendants and other employees. Negotiations have been especially testy with the pilots’ union, which contends that cuts proposed by the jet company are “unjustifiable” at a time when business has turned around and NetJets is seeing higher revenue and earnings growth. For its part, NetJets says cost reductions “are necessary” because Berkshire requires a greater return on revenue from the company.
However, it isn’t one of Mr. Buffett’s best deals. Despite being profitable, NetJets has not managed to pay a single penny to Berkshire as a dividend in the 16 years that the conglomerate has owned it, according to a person close to Berkshire. Its net worth is also worth considerably less than the $725 million in cash and stock that Berkshire paid for NetJets in 1998. That would likely have been true for any company that Berkshire bought using its own stock, given the massive appreciation in Berkshire’s A shares. In this case, Berkshire hasn’t made its money back on the purchase even excluding the jump in its shares since 1998.The company was nearly felled in 2009 when its wealthy customers cut back on private-jet use. Mr. Buffett has said the company would have “gone broke” had Berkshire not guaranteed its $1.9 billion debt load. Things have improved since then. With the economy bounding back, customers have returned to buying shares in NetJets planes in exchange for flying hours.
(first appeared in The Wall Street Journal on Jan 5, 2015)