Buffett's Plane Envy

Author:
Publish date:

What's Warren Buffett's Berkshire Hathaway (BRKA) doing buying privately held Executive Jet for $725 million in cash and stock?

Simply extending Berkshire's investment into the air travel business, a strategy that began with

US Airways

(U) - Get Report

, then USAir, in 1989, and continued with

Flight Safety International

, which performs pilot training for both major airlines and the military. It is also consistent with Buffett's tradition of purchasing companies for which he has an affinity.

Executive Jet, based in Montvale, N.J., introduced the concept of "time-share" corporate jets in 1986, a concept that has taken flight in the 1990s. The company's "NetJets" program allows corporations and individuals to buy a fractional share of a corporate jet -- as small as a 1/16th interest -- significantly broadening the market for smaller jet aircraft. The program has made Executive Jet the largest customer for America's big three corporate jet manufacturers,

Gulfstream Aerospace

(GAC)

,

Raytheon

(RTNA)

and

Textron's

(TXT) - Get Report

Cessna Aircraft

division.

Buffett became familiar with Executive Jet in 1995 when he looked into the jet timeshare program for his family. Now his estranged wife (they're still friends) Susan owns a one-quarter interest in a jet and even his aunt Katy owns a 1/16th interest in a corporate plane. "She's 92 years old and still lives in the same house she has for the past 65 years," said Buffett in an interview, "and she's in love with the program."

"I buy companies I understand and many I have grown to love," Buffett told me at the Berkshire Hathaway shareholders meeting in May. "Many times the companies I aspire to buy are those I have been a customer of for years. When I buy, I want to be an owner for life." Similar thinking drove Buffett's acquisition of

Dairy Queen International

earlier this year (blame it on the sundaes), and

See's Candy

(known for its chocolate) in 1972.

While at first blush, Executive Jet may not appear fit the mold of a traditional "value" play, it does boast dramatic growth potential. While the privately held company will not disclose its financials, CEO Richard Santulli did say the company has seen growth of about 35% annually over the past several years. Buffett said he expects Executive Jet to generate about $900 million in revenue for 1998.

New Deal Structure

The Executive Jet purchase is also one that required Berkshire to issue stock (as did the FlightSafety International and

General Re

(GRN) - Get Report

deals, the latter for $23.5 billion).

Executive Jet shareholders can elect to receive up to 50% of the value of the transaction in Berkshire stock, with the balance in cash. In the past, Buffett has been reluctant to use stock in acquisitions, expressing concern over dilution and control as well as the thought that cash was a more efficient currency for corporate purchases. Buffett was often heard suggesting to shareholders of companies he purchased that, if they want to own Berkshire stock, they are welcome to take the cash proceeds and purchase the equity on the open market.

That ignores, of course, the fact that selling shareholders have to pay large capital gains when they receive cash (but not if they received Berkshire stock). In the General Re deal, both companies indicated that receiving stock was a prerequisite to consummate the merger. In the FlightSafety International deal, a large proportion of stock was owned by founder Albert Ueltschi: perhaps the Executive Jet purchase involved the same consideration. At any rate, Buffett's relaxed position on the use of Berkshire stock may be the result of his age (68) and that of Berkshire colleague Charlie Munger (74).

More Flying to Come?

Like

TSC's

crack airline commentator

Holly Hegeman

recently told me, "Once it's in your blood, you can't get rid of it," referring, of course, to her love of the airline industry. Not every airline investment has worked out to his satisfaction. Buffett initially invested $358 million in USAir preferred shares in 1989, but later wrote down a significant portion of the investment, admitting that he miscalculated the cutthroat nature of airline competition (as of the most recent annual report, Berkshire held a significant, albeit scaled-back, position in US Airways convertible securities.) But given Buffett's fondness for jet engines and cockpits, I wonder if he might have more highflying deals in mind.

If so, I suggest he take a look at

Midwest Express Airlines

(MEH)

, a Milwaukee "all-business-class" airline. It has developed a niche market among business travelers in the eastern half of the U.S, it provides a level of service that clearly differentiates itself from the competition, and it has a very easy-to-comprehend strategy, business plan and balance sheet. Furthermore, the company has posted consistent earnings growth since emerging from the corporate control of Appleton, Wis.-based

Kimberly-Clark

(KMB) - Get Report

. It also boasts some of the best financial performance ratios -- operating profit margin, return on equity, return on assets -- of anyone in the business. Moreover, the company has developed a secondary hub in Omaha, the Oracle's hometown.

You're in the Money

A Buffett postscript. The July issue of

Money

magazine has a well-written article on the Oracle from Omaha penned by Joe Nocera. It also has a decidedly

TSC

twist. For the first five readers who correctly identify the link by zapping me an

email, a small

TSC

souvenir will be on its way! Winners will be proudly announced next week.

Christopher S. Edmonds is the president of Resource Dynamics, a private financial consulting firm based in Topeka, Kan. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, he welcomes your feedback at

invest@cjnetworks.com.