Las Vegas – NetJets Inc., Warren Buffett’s biggest headache, has mended its ways and is finally making money, and its rivalry in the fractional ownership of jets with Bombardier Inc.’s Flexjet is as tough as ever.
Fractional ownership has seen its ups and downs since way before the 2008 crisis, which hammered the rest of the business aviation industry.
Both companies said in interviews at the 64th annual National Business Aviation Association last week that business is still in the doldrums, very much in lockstep with the rest of business aviation.
NetJets, a subsidiary of the Berkshire Hathaway investment firm, has accumulated $157 million in losses since the Oracle of Omaha bought it in 1998, prompting Buffett to call it his biggest problem two years ago.
It seems to define the mysterious magnetism that gleaming, wing-swept soaring machines hold even for hard-nosed money-men like Buffett, who would never tolerate such losses in any of his other businesses.
NetJets actually began life in 1964 as a charter operation with actor and aviation buff James Stewart and U.S. general Curtis LeMay – the model for Dr. Strangelove – among the initial investors, and invented the fractional ownership model in 1986, when Goldman Sachs partner Richard Santulli bought the company.
Buffett fired him eventually and brought in David Sokol, who cut staff and cleaned up the company’s balance sheet in short order, just before exiting last year in a mini scandal over controversial stock purchases.
“Like everyone else, it’s been difficult since late 2008,” said Jordan Hansell, a lawyer who once clerked for U.S. Supreme Court Justice Antonin Scalia and who was recently appointed chairman and CEO of NetJets. “But since then, it’s been a slow and steady, and we’re pleased by that.”
Bruce Peddle, the new vice-president of sales and marketing for Flexjet, said that “we saw a significant retraction in our business in the downturn, and three years on, it’s still flat – and somewhat declining. In August, we were down about nine per cent from August 2010. We’re treading water right now.”
The two companies have an estimated combined market share of roughly 80 to 85 per cent, 63 per cent for NetJets, according to Hansell – although Peddle pegged his competition at closer to 57 per cent, and about 22 per cent for his own Flexjet. But he notes that the 22 per cent is of a much shrunken market since 2008, when its market share was closer to 12 per cent.
The other two main players are CitationAir and Flight Options. Cessna Aircraft Co., which owns CitationAir, cancelled an interview with company president Scott Ernest and Flight Options, owned by private equity firms, was not available.
Commonly called fractional ownership, the model actually refers to three different types of buying time on private jets; the pure fractional model, or buying a share in a plane – sold in 16ths for 50 hours a year, in Bombardier’s case; card programs that give customers a set number of flying hours; and charter. NetJets also does fleet management – managing aircraft owned by others.
At daggers drawn for many years, the relationship changed in March, when NetJets placed the first order in its 25-year history for Bombardier business aircraft – the first because Bombardier, oddly, refused to sell planes to their competitor, perhaps wary of feeding a rival.
And quite the order it was. At a list price of $6.7 billion U.S., NetJets called the deal for up to 120 Global large-cabin jets “the largest aircraft purchase agreement in the history of private aviation.” Indeed it was, even if NetJets will pay far less than the $6.7 billion after discounts.
It was a double win for Bombardier if Hamzah Mazari is right. The Wall St. analyst for Crédit Suisse AG said in a note to clients in March that “we believe Bombardier beat out Gulfstream (Aerospace Corp., a major rival aircraft maker)” for NetJets’ favour.
Hansell said that “we really like the Globals” on several fronts, but hinted at significant throw-ins. “We got better terms for maintenance. We got a good deal, and we think they did, too.”
The two compete ferociously to capture as many wealthy individuals and corporate customers as possible around the world, so it’s not on record if Bombardier Business Aircraft president Steve Ridolfi gagged when he called NetJets “the worldwide leader in private aviation” at the signing ceremony.
But in fractional ownership, at least, the numbers are indisputable.
NetJets operates 776 aircraft – much more than many airlines. In fact, it is in the top 10 companies in North America in terms of fleet size. It has 4,000 share owners and 3,500 card customers for its Marquis brand. It employs 6,400 people, more than a quarter the workforce at Air Canada.
Flexjet has 84 aircraft, about 30 of them Challenger 300s, 356 pilots and about 800 employees. Peddle said it has 590 fractional customers and 1,000 clients in all.
Hansell would not provide figures, but Peddle said that using a 2007 Challenger 300 – Flexjet’s workhorse aircraft type – as a benchmark, a share would cost $850,000 U.S., with monthly management fees of about $12,500 and an hourly flight rate of $7,800.
But numbers are misleading, Peddle said.
“We have the youngest fleet in the industry by far, and our retention rate is 75 per cent,” referring to people who sign up again.
“And the majority of the other 25 per cent left because of under-utilization of the aircraft” rather than dissatisfaction, he said.
That’s not how Mike Riegel sees it.
“There are a lot of angry and dissatisfied customers out there. The industry is nowhere near where it was before (2008),” the president of AviationIQ Consulting said.
In fact, a pox on both their houses, said Riegel, for causing their own misfortune.
“How do you think Sokol was able to stem losses after years in the middle of a major downturn and turn a profit?” asked Riegel, a former Bombardier executive who has seen the industry from the inside as one of Flexjet’s founders and early manager more than a decade ago.
“These fractional providers made a lot of money on (the soaring price of) fuel,” and the plummeting value of their shares far exceeded what they had been told when buying.
“A NetJet or Flexjet or whoever would tell them they would typically lose 30 per cent over five years. Many of my clients actually lost 70 per cent.
“As wealthy as they are, at some point they will a) stop paying or use a charter or b) cut back significantly on flying, period.
“It’s completely untrue that these people are so rich they don’t care what things cost. Wealthy people are practical, sensible people whether they can afford it or not. They do pay attention, and what they see is that fractional ownership has become very expensive.”
He praised NetJets for “finally waking up to reality” by buying Bombardier aircraft – a move that will pay big dividends in fuel costs. The Global brand will cut fuel expenses by about 20 per cent compared to NetJets’ aging Hawker Beechcraft and other planes.
He said NetJets must also cut down from the 15 aircraft types it flies to “about five or six, and it looks like they’re doing that.” As with airlines, maintaining different aircraft types is a hugely expensive proposition, he noted.
Riegel predicted that the fractional model may experience the same upheaval that rocked the airline industry – a low-cost fractional provider might push disabused customers back into the fold.
The next order from NetJets will eclipse even Bombardier’s 120-plane order in March, Riegel said.
The firm is negotiating with Bombardier and Brazil’s Embraer, from which NetJets purchased 125 Phenom 300 light jets last October.
“That order will determine a lot for the future industry,” Riegel said, “basically that providers will have to focus on operating costs, not just growth.”
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