In the investment business, you spend an awful lot of time focusing on numbers and their meaning. Although I've always smiled at the old saw, "In God We Trust -- everyone else brings numbers," I've also noted many times in this column the necessity to focus on the human equation to be a successful investor.
Some of the same thinking creeps into valuation methodology, no matter how much you try to remain pure to the analysis. I've often said in client meetings that we try to ignore the headlines, avoid the macro guessing games and stick to finding good businesses, run by smart people, that sell at reasonable prices. If all three of those stars align, we buy -- regardless of how ugly the newspaper headline is that morning. But when you see a press release heralding
for $5.3 billion, the giant anecdotal antennae start to quiver, and you begin to wonder -- numbers aside -- is this a sign of the beginning of the end?
That Was Then . . .
Before we talk about the Gulfstream deal, we need to step back into the late 1980s and early 1990s for a few paragraphs. Things were fairly punk for much of corporate America back then because the economy was mired in low growth and a lingering fear of the 1987 crash, and an abysmal real estate market held many consumers hostage. The American public and the financial media were using prominent corporations as public-relations punching bags because of those companies' "downsizing" efforts, and corporate jets were being sold left and right because shareholders held them out as classic examples of country-club, fat-cat management teams insensitive to the shareholders' needs. Stock-option incentive packages of $100 million were just a gleam in a consultant's eye. Heck,
had flat earnings and sold at 13 times earnings!
In short, business was miserable for the corporate-jet maker set. So miserable, in fact, that in the early 1990s the one and the same General Dynamics sold its Cessna business-jet division to
as part of a massive restructuring, at a price approaching a fire sale.
On the other side, the merchant banking firm of
took business-jet maker Gulfstream private in a 1990 leveraged buyout. As someone who has a keen appreciation of the fine line between being early and being wrong, I felt for Forstmann, which had to put another $100 million into the operation a short time after the deal's close because the red ink was hemorrhaging at rates previously unimagined.
. . . This Is Now
Fast-forward to 1999. The
is now insatiably tethered to what are often stock-option giveaway programs in which the personal benefits would be staggering at 5% stock appreciation rates. But at 20% compounded for the past few years, the money has runneth freely. Real estate is off the charts, making the formerly ridiculous peak of the late 1980s look like child's play. Unemployment is at a postwar low, and the Internet stock craze has created $250 billion of puffy paper profits. The American public has miraculously been invested in a mostly up market for the better part of the past five years. In other words, people have money; or at least they act like they do. And now we have General Dynamics buying a corporate-jet business for $5.3 billion -- and Forstmann Little realizing a $3 billion-plus gain.
Which brings us to the corporate-jet market and Gulfstream. Needless to say, business is good. Very, very good. In addition to the avalanche of cash available for jet purchases and corporations' distinct lack of embarrassment over the accumulation of business jets, the industry has benefited from the conceptually more stable stream of orders from the fractional share industry. This has been championed by none other than the great American shill,
bought the largest fractional share company,
Taking a cue from Wall Street financial innovation, corporate jets can now be bought en masse and effectively securitized, with flight hours sold piecemeal in small tranches. This has greatly broadened the jet-worthy market to include a multitude of
and has stimulated orders for jets. What I fail to see is, why can't any number of ambitious, mini-empire builders do this? (I have, in fact, been approached by a homegrown venture that would be willing to let relative small fry like me buy a $25,000 lot of flight hours.)
Although not just anyone can build a national fleet overnight, there appears to be a number of new entrants serving regional pockets of wealth and stimulating a questionably sustainable increase in demand for corporate jets. It has become a natural progression to quit your stupid day job to start daytrading Internet stocks, and then reinvest the proceeds in private jets to Vegas and Pebble Beach.
But Gulfstream is more than a 50% market-share leader with a now-stunning $4 billion backlog. It is
corporate-jet maker, with its average sale north of $30 million, depending on how many cup holders a plane has and what endangered animal species is killed for the upholstery. Gulfstream is a state of mind. It's the gleam in the eye of every new eight-figure net-worth exec. If you arrive in a Gulfstream V, you'll impress the heck out of anyone.
Apparently, General Dynamics is thinking along those lines as well, because it's shelling out $5.3 billion for a business that generated only $225 million in net income last year. Expectations are for 25% earnings growth for as far as the eye can see -- or as long as the backlog holds up. But as
has found out in the past few years, there's a funny thing about backlog: It doesn't always translate into "frontlog," and thus cash. Things change and orders get canceled. Surely it's tempting to hypothesize that demand for corporate jets closely correlates with the health of corporate America and the health of the stock market. Therefore, it's not irrational to surmise that a $4 billion backlog built upon the well-deserved hubris of the past few years can disappear in a hurry if things don't go so swimmingly in the future, or if class warfare issues resurface in the next election.
The collective wisdom of the market seems to agree, because General Dynamics fell 10% on news of the deal -- a pretty decent-sized post-announcement thud. General Dynamics' management is rationalizing the purchase on the fact that Gulfstream isn't out of its sphere of expertise. After all, GD owned a similar business and sold it at the bottom of the cycle.
General Dynamics also is touting the deal as earnings accretive -- which, as I have noted in this space many times, is completely irrelevant. Earnings accretion is a fact of life when a company with a high P/E buys a company with a lower P/E -- and the fact that General Dynamics has a higher P/E than Gulfstream is not necessarily a sign of General Dynamics' brilliance. Very simply, if we assume that depreciation and amortization equals capital expenditures for the next five years, Gulfstream needs to earn $530 million for General Dynamics to earn 10% on its investment, a minimum benchmark for management competence. If Gulfstream hits its numbers, that goal wouldn't be reached until 2003 -- a date that seems far, far away with the
Call me a cynic, but it rings a bell when a firm that sells at the bottom buys even larger at the top, while a perceived smart guy takes the opposite end of the trade. Yes, I was wrong on the premium cigar trend and its correlation to stock market cycles. But this seems like another anecdotal sign that those who are flush with money are indiscriminately throwing their munificence around in areas that have little chance of achieving reasonable returns on investment.
When too many are at work in this endeavor, things tend not to go very well. I know it will end, and I know it will end badly. And in my mind, this deal is a sign that the end is closer than it was a week ago.
Jeffrey Bronchick is chief investment officer at Reed Conner & Birdwell, a Los Angeles-based money management firm with about $1 billion of assets under management for institutions and taxable individuals. Bronchick also manages the RCB Small Cap Value Fund. At time of publication, RCB was long Berkshire Hathaway, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Bronchick appreciates your feedback at