Buffet on 20 years of owning NetJets: From “huge potential” to “I failed you” and “these problems are behind us”

NetJets Embraer Phenom 300

Warren Buffet’s annual letter to shareholders are deservedly famous. Both entertaining and insightful, each year’s offering is read by hundreds of thousands of people.

Here are the highlights of what he has had to say about NetJets, the world’s largest corporate jet fractional ownership company. Berkshire Hathaway acquired it in 1998 and the letters show the ups and downs the business has been through in the last 20 years.

The last significant mention was in 2011. Although most years Buffet tells shareholders attending the Berkshire AGM to: “Come by bus; leave by private jet. Live a little.”

2011 “Without Berkshire’s support, NetJets would have gone broke.”

“Jordan Hansell took over at NetJets in April and delivered 2011 pre-tax earnings of $227 million. That is a particularly impressive performance because the sale of new planes was slow during most of the year. In December, however, there was an uptick that was more than seasonally normal. How permanent it will be is uncertain.

2010 “I can’t overstate the breadth and importance of Dave Sokol’s achievements”

A huge story in this sector’s year-to-year improvement occurred at NetJets. I can’t overstate the breadth and importance of Dave Sokol’s achievements at this company, the leading provider of fractional ownership of jet airplanes. NetJets has long been an operational success, owning a 2010 market share five times that of its nearest competitor. Our overwhelming leadership stems from a wonderful team of pilots, mechanics and service personnel. This crew again did its job in 2010, with customer satisfaction, as delineated in our regular surveys, hitting new highs.

Even though NetJets was consistently a runaway winner with customers, our financial results, since its acquisition in 1998, were a failure.

In the 11 years through 2009, the company reported an aggregate pre-tax loss of $157 million, a figure that was far understated since borrowing costs at NetJets were heavily subsidized by its free use of Berkshire’s credit. Had NetJets been operating on a stand-alone basis, its loss over the years would have been several hundreds of millions greater.

We are now charging NetJets an appropriate fee for Berkshire’s guarantee. Despite this fee (which came to $38 million in 2010), NetJets earned $207 million pre-tax in 2010, a swing of $918 million from 2009.

Dave’s quick restructuring of management and the company’s rationalization of its purchasing and spending policies has ended the haemorrhaging of cash and turned what was Berkshire’s only major business problem into a solidly profitable operation.

Dave has meanwhile maintained NetJets’ industry-leading reputation for safety and service. In many important ways, our training and operational standards are considerably stronger than those required by the FAA.

Maintaining top-of-the-line standards is the right thing to do, but I also have a selfish reason for championing this policy. My family and I have flown more than 5,000 hours on NetJets (that’s equal to being airborne 24 hours a day for seven months) and will fly thousands of hours more in the future. We receive no special treatment and have used a random mix of at least 100 planes and 300 crews. Whichever the plane or crew, we always know we are flying with the best-trained pilots in private aviation.

[Sokol left the company in March 2011.]

2009: “I failed you in letting NetJets descend into this condition”

“The major problem for Berkshire last year was NetJets, an aviation operation that offers fractional ownership of jets. Over the years, it has been enormously successful in establishing itself as the premier company in its industry, with the value of its fleet far exceeding that of its three major competitors combined. Overall, our dominance in the field remains unchallenged.

NetJets’ business operation, however, has been another story. In the eleven years that we have owned the company, it has recorded an aggregate pre-tax loss of $157 million. Moreover, the company’s debt has soared from $102 million at the time of purchase to $1.9 billion in April of last year. Without Berkshire’s guarantee of this debt, NetJets would have been out of business. It’s clear that I failed you in letting NetJets descend into this condition. But, luckily, I have been bailed out.

Dave Sokol, the enormously talented builder and operator of MidAmerican Energy, became CEO of NetJets in August. His leadership has been transforming: Debt has already been reduced to $1.4 billion, and, after suffering a staggering loss of $711 million in 2009, the company is now solidly profitable.

Most important, none of the changes wrought by Dave has in any way undercut the top-of-the-line standards for safety and service that Rich Santulli, NetJets’ previous CEO and the father of the fractional ownership industry, insisted upon. Dave and I have the strongest possible personal interest in maintaining these standards because we and our families use NetJets for almost all of our flying, as do many of our directors and managers. None of us are assigned special planes nor crews. We receive exactly the same treatment as any other owner, meaning we pay the same prices as everyone else does when we are using our personal contracts. In short, we eat our own cooking. In the aviation business, no other testimonial means more.”

[Santulli launched helicopter lessor Milestone Aviation in 2010. He sold it to GE in 2015.)

2008: No mention

2007: “If you were to pick someone to join you in a foxhole, you couldn’t do better than Rich.”

“Flight services set a record in 2007 with pre-tax earnings increasing 49% to $547 million.

Corporate aviation had an extraordinary year worldwide, and both of our companies – as runaway leaders in their fields – fully participated.

At NetJets, the inventor of fractional-ownership of jets, we also remain the unchallenged leader. We now operate 487 planes in the U.S. and 135 in Europe, a fleet more than twice the size of that operated by our three major competitors combined. Because our share of the large-cabin market is near 90%, our lead in value terms is far greater.

The NetJets brand – with its promise of safety, service and security – grows stronger every year. If you were to pick someone to join you in a foxhole, you couldn’t do better than Rich. No matter what the obstacles, he just doesn’t stop. Europe is the best example of how Rich’s tenacity leads to success. For the first ten years we made little financial progress there, actually running up cumulative losses of $212 million. After Rich brought Mark Booth on board to run Europe, however, we began to gain traction. Now we have real momentum, and last year earnings tripled.”

2006: “NetJets is now operating profitably in Europe.”

“A much improved situation is emerging at NetJets, which sells and manages fractionally-owned aircraft. This company has never had a problem growing: Revenues from flight operations have increased 596% since our purchase in 1998. But profits had been erratic.

Our move to Europe, which began in 1996, was particularly expensive. After five years of operation there, we had acquired only 80 customers. And by mid-year 2006 our cumulative pretax loss had risen to $212 million. But European demand has now exploded, with a net of 589 customers having been added in 2005-2006. Under Mark Booth’s brilliant leadership, NetJets is now operating profitably in Europe, and we expect the positive trend to continue.

Our U.S. operation also had a good year in 2006, which led to worldwide pre-tax earnings of $143 million at NetJets last year. We made this profit even though we suffered a loss of $19 million in the first quarter.

Credit Rich Santulli, along with Mark, for this turnaround. Rich, like many of our managers, has no financial need to work. But you’d never know it. He’s absolutely tireless – monitoring operations, making sales, and travelling the globe to constantly widen the already-enormous lead that NetJets enjoys over its competitors. Today, the value of the fleet we manage is far greater than that managed by our three largest competitors combined.

…Once you’ve flown NetJets, returning to commercial flights is like going back to holding hands.”

2005: “Our U.S. operation dipped far into the red”

“In flight services, earnings improved at FlightSafety as corporate aviation continued its rebound… Operating results at NetJets were a different story. I said last year that this business would earn money in 2005 – and I was dead wrong.

Our European operation, it should be noted, showed both excellent growth and a reduced loss. Customer contracts there increased by 37%. We are the only fractional-ownership operation of any size in Europe, and our now-pervasive presence there is a key factor in making NetJets the worldwide leader in this industry.

Despite a large increase in customers, however, our U.S. operation dipped far into the red. Its efficiency fell, and costs soared. We believe that our three largest competitors suffered similar problems, but each is owned by aircraft manufacturers that may think differently than we do about the necessity of making adequate profits. The combined value of the fleets managed by these three competitors, in any case, continues to be less valuable than the fleet that we operate.

Rich Santulli, one of the most dynamic managers I’ve ever met, will solve our revenue/expense problem. He won’t do it, however, in a manner that impairs the quality of the NetJets experience. Both he and I are committed to a level of service, security and safety that can’t be matched by others.”

2004: “A modest amount in the U.S. last..largely offset by losses in Europe”
“FlightSafety’s number one customer is NetJets, our aircraft fractional-ownership subsidiary. Its 2,100 pilots spend an average of 18 days a year in training. Additionally, these pilots fly only one aircraft type whereas many flight operations juggle pilots among several types. NetJets’ high standards on both fronts are two of the reasons I signed up with the company years before Berkshire bought it.

Fully as important in my decisions to both use and buy NetJets, however, was the fact that the company was managed by Rich Santulli, the creator of the fractional-ownership industry and a fanatic about safety and service. I viewed the selection of a flight provider as akin to picking a brain surgeon: you simply want the best. (Let someone else experiment with the low bidder.) Last year NetJets again gained about 70% of the net new business (measured by dollar value) going to the four companies that dominate the industry. A portion of our growth came from the 25-hour card offered by Marquis Jet Partners. Marquis is not owned by NetJets, but is instead a customer that repackages the purchases it makes from us into smaller packages that it sells through its card. Marquis deals exclusively with NetJets, utilizing the power of our reputation in its marketing.

Our U.S. contracts, including Marquis customers, grew from 3,877 to 4,967 in 2004 (versus approximately 1,200 contracts when Berkshire bought NetJets in 1998). Some clients (including me) enter into multiple contracts because they wish to use more than one type of aircraft, selecting for any given trip whichever type best fits the mission at hand.

NetJets earned a modest amount in the U.S. last year. But what we earned domestically was largely offset by losses in Europe. We are now, however, generating real momentum abroad. Contracts (including 25-hour cards that we ourselves market in Europe) increased from 364 to 693 during the year. We will again have a very significant European loss in 2005, but domestic earnings will likely put us in the black overall. Europe has been expensive for NetJets – far more expensive than I anticipated – but it is essential to building a flight operation that will forever be in a class by itself. Our U.S. owners already want a quality service wherever they travel and their wish for flight hours abroad is certain to grow dramatically in the decades ahead. Last year, U.S. owners made 2,003 flights in Europe, up 22% from the previous year and 137% from 2000. Just as important, our European owners made 1,067 flights in the U.S., up 65% from 2003 and 239% from 2000.”

2003: “The European loss is painful.”
“NetJets, our fractional-ownership operation lost $41 million pre-tax in 2003. The company had a modest operating profit in the U.S., but this was more than offset by a $32 million loss on aircraft inventory and by continued losses in Europe.

NetJets continues to dominate the fractional-ownership field, and its lead is increasing: Prospects overwhelmingly turn to us rather than to our three major competitors. Last year, among the four of us, we accounted for 70% of net sales (measured by value).

The $32 million inventory write-down we took in 2003 occurred because of falling prices for used aircraft early in the year. Specifically, we bought back fractions from withdrawing owners at prevailing prices, and these fell in value before we were able to remarket them. Prices are now stable.

The European loss is painful. But any company that forsakes Europe, as all of our competitors have done, is destined for second-tier status. Many of our U.S. owners fly extensively in Europe and want the safety and security assured by a NetJets plane and pilots. Despite a slow start, furthermore, we are now adding European customers at a good pace. During the years 2001 through 2003, we had gains of 88%, 61% and 77% in European management-and-flying revenues. We have not, however, yet succeeded in stemming the flow of red ink.

Rich Santulli, NetJets’ extraordinary CEO, and I expect our European loss to diminish in 2004 and also anticipate that it will be more than offset by U.S. profits. Overwhelmingly, our owners love the NetJets experience.

NetJets will become a very big business over time and will be one in which we are preeminent in both customer satisfaction and profits. Rich will see to that.”

2002: “The company again lost money.”

“At NetJets, our fractional-ownership operation, we are the runaway leader of the four-company field.

FAA records indicate that our industry share in 2002 was 75%, meaning that clients purchased or leased planes from us that were valued at triple those recorded by our three competitors combined.

Last year, our fleet flew 132.7 million nautical miles, taking clients to 130 countries.

Our preeminence is directly attributable to Rich Santulli, NetJets’ CEO. He invented the business in 1986 and ever since has exhibited an unbending devotion to the highest levels of service, safety and security. Rich, Charlie and I insist on planes (and personnel) worthy of carrying our own families – because they regularly do.

Though NetJets revenues set a record in 2002, the company again lost money. A small profit in the U.S. was more than offset by losses in Europe. Overall, the fractional-ownership industry lost significant sums last year, and that is almost certain to be the outcome in 2003 as well. The bald fact is that airplanes are costly to operate.

Over time, this economic reality should work to our advantage, given that for a great many companies, private aircraft are an essential business tool. And for most of these companies, NetJets makes compelling sense as either a primary or supplementary supplier of the aircraft they need.

Many businesses could save millions of dollars annually by flying with us. Indeed, the yearly savings at some large companies could exceed $10 million. Equally important, these companies would actually increase their operational capabilities by using us. A fractional ownership of a single NetJets plane allows a client to have several planes in the air simultaneously. Additionally, through the interchange arrangement we make available, an owner of an interest in one plane can fly any of 12 other models, using whatever plane makes most sense for a mission. (One of my sisters owns a fraction of a Falcon 2000, which she uses for trips to Hawaii, but – exhibiting the Buffett gene – she interchanges to a more economical Citation Excel for short trips in the U.S.)

The roster of NetJets users confirms the advantages we offer major businesses. Take General Electric, for example. It has a large fleet of its own but also has an unsurpassed knowledge of how to utilize aircraft effectively and economically. And it is our largest customer.”

2001: “Sold a record number of planes last year.”

“Our NetJets® fractional ownership program sold a record number of planes last year and also showed a gain of 21.9% in service income from management fees and hourly charges. Nevertheless, it operated at a small loss, versus a small profit in 2000. We made a little money in the U.S., but these earnings were more than offset by European losses.  Measured by the value of our customers. planes, NetJets accounts for about half of the industry. We believe the other participants, in aggregate, lost significant money.

Maintaining a premier level of safety, security and service was always expensive, and the cost of sticking to those standards was exacerbated by September 11th. No matter how much the cost, we will continue to be the industry leader in all three respects. An uncompromising insistence on delivering only the best to his customers is embedded in the DNA of Rich Santulli, CEO of the company and the inventor of fractional ownership. I’m delighted with his fanaticism on these matters for both the company’s sake and my family’s: I believe the Buffetts fly more fractional-ownership hours – we log in excess of 800 annually – than does any other family. In case you’re wondering, we use exactly the same planes and crews that serve NetJet’s other customers.

NetJets experienced a spurt in new orders shortly after September 11th, but its sales pace has since returned to normal. Per-customer usage declined somewhat during the year, probably because of the recession.

Both we and our customers derive significant operational benefits from our being the runaway leader in the fractional ownership business. We have more than 300 planes constantly on the go in the U.S. and can therefore be wherever a customer needs us on very short notice. The ubiquity of our fleet also reduces our “positioning” costs below those incurred by operators with smaller fleets.

These advantages of scale, and others we have, give NetJets a significant economic edge over competition.

Under the competitive conditions likely to prevail for a few years, however, our advantage will at best produce modest profits.”

2000: “Even faster growth awaits.”

“Even faster growth awaits EJA (whose fractional-ownership program is called NetJets). Rich Santulli is the dynamo behind this business.

Last year I told you that EJA’s recurring revenue from monthly management fees and hourly usage grew by 46% in 1999. In 2000 the growth was 49%. I also told you that this was a low-margin business, in which survivors will be few. Margins were indeed slim at EJA last year, in part because of the major costs we are incurring in developing our business in Europe.

Regardless of the cost, you can be sure that EJA’s spending on safety will be whatever is needed. Obviously, we would follow this policy under any circumstances, but there’s some self-interest here as well: I, my wife, my children, my sisters, my 94-year-old aunt, all but one of our directors, and at least nine Berkshire managers regularly fly in the NetJets program.

EJA’s business continues to be constrained by the availability of new aircraft. Still, our customers will take delivery of more than 50 new jets in 2001, 7% of world output. We are confident we will remain the world leader in fractional ownership, in respect to number of planes flying, quality of service, and standards of safety.”

1999: “Modest pre-tax margins in this business can produce good returns on equity.”

“Our two aviation services companies – FlightSafety International (“FSI”) and Executive Jet Aviation (“EJA”) – are both runaway leaders in their field. EJA, which sells and manages the fractional ownership of jet aircraft, through its NetJets® program, is larger than its next two competitors combined. FSI trains pilots (as well as other transportation professionals) and is five times or so the size of its nearest competitor.

Another common characteristic of the companies is that they are still managed by their founding entrepreneurs.

Al Ueltschi started FSI in 1951 with $10,000, and Rich Santulli invented the fractional-ownership industry in 1986. These men are both remarkable managers who have no financial need to work but thrive on helping their companies grow and excel.

At EJA, in contrast, the customer owns the equipment, though we, of course, must invest in a core fleet of our own planes to ensure outstanding service. For example, the Sunday after Thanksgiving, EJA’s busiest day of the year, strains our resources since fractions of 169 planes are owned by 1,412 customers, many of whom are bent on flying home between 3 and 6 p.m. On that day, and certain others, we need a supply of company-owned aircraft to make sure all parties get where they want, when they want.

Still, most of the planes we fly are owned by customers, which means that modest pre-tax margins in this business can produce good returns on equity. Currently, our customers own planes worth over $2 billion, and in addition we have $4.2 billion of planes on order. Indeed, the limiting factor in our business right now is the availability of planes. We

10 now are taking delivery of about 8% of all business jets manufactured in the world, and we wish we could get a bigger share than that. Though EJA was supply-constrained in 1999, its recurring revenues – monthly management fees plus hourly flight fees – increased 46%.

The fractional-ownership industry is still in its infancy. EJA is now building critical mass in Europe, and over time we will expand around the world. Doing that will be expensive – very expensive – but we will spend what it takes. Scale is vital to both us and our customers: The company with the most planes in the air worldwide will be able to offer its customers the best service. “Buy a fraction, get a fleet” has real meaning at EJA.

EJA enjoys another important advantage in that its two largest competitors are both subsidiaries of aircraft manufacturers and sell only the aircraft their parents make. Though these are fine planes, these competitors are severely limited in the cabin styles and mission capabilities they can offer. EJA, in contrast, offers a wide array of planes from five suppliers. Consequently, we can give the customer whatever he needs to buy – rather than his getting what the competitor’s parent needs to sell.

Last year in this report, I described my family’s delight with the one-quarter (200 flight hours annually) of a Hawker 1000 that we had owned since 1995. I got so pumped up by my own prose that shortly thereafter I signed up for one-sixteenth of a Cessna V Ultra as well. Now my annual outlays at EJA and Borsheim’s, combined, total ten times my salary. Think of this as a rough guideline for your own expenditures with us.

During the past year, two of Berkshire’s outside directors have also signed on with EJA. (Maybe we’re paying them too much.) You should be aware that they and I are charged exactly the same price for planes and service as is any other customer: EJA follows a “most favored nations” policy, with no one getting a special deal.

And now, brace yourself. Last year, EJA passed the ultimate test: Charlie signed up. No other endorsement could speak more eloquently to the value of the EJA service. Give us a call at 1-800-848-6436 and ask for our “white paper” on fractional ownership.”

1998:  “Huge potential.”

“To understand the huge potential at Executive Jet Aviation (EJA), you need some understanding of its business, which is selling fractional shares of jets and operating the fleet for its many owners. Rich Santulli, CEO of EJA, created the fractional ownership industry in 1986, by visualizing an important new way of using planes. Then he combined guts and talent to turn his idea into a major business. In a fractional ownership plan, you purchase a portion – say 1/8 th – of any of a wide variety of jets that EJA offers. That purchase entitles you to 100 hours of flying time annually. (“Dead-head” hours don’t count against your allotment, and you are also allowed to average your hours over five years.) In addition, you pay both a monthly management fee and a fee for hours actually flown. Then, on a few hours notice, EJA makes your plane, or another at least as good, available to you at your choice of the 5500 airports in the U.S. In effect, calling up your plane is like phoning for a taxi.

I first heard about the NetJets® program, as it is called, about four years ago from Frank Rooney, our manager at H.H. Brown. Frank had used and been delighted with the service and suggested that I meet Rich to investigate signing up for my family’s use. It took Rich about 15 minutes to sell me a quarter (200 hours annually) of a Hawker 1000. Since then, my family has learned firsthand – through flying 900 hours on 300 trips – what a friendly, efficient, and safe operation EJA runs. Quite simply, they love this service. In fact, they quickly grew so enthusiastic that I did a testimonial ad for EJA long before I knew there was any possibility of our purchasing the business. I did, however, ask Rich to give me a call if he ever got interested in selling. Luckily, he phoned me last May, and we quickly made a $725 million deal, paying equal amounts of cash and stock.

EJA, which is by far the largest operator in its industry, has more than 1,000 customers and 163 aircraft (including 23 “core” aircraft that are owned or leased by EJA itself, so that it can make sure that service is first-class even during the times when demand is heaviest). Safety, of course, is the paramount issue in any flight operation, and Rich’s pilots – now numbering about 650 – receive extensive training at least twice a year from FlightSafety International, another Berkshire subsidiary and the world leader in pilot training. The bottom line on our pilots: I’ve sold the Berkshire plane and will now do all of my business flying, as well as my personal flying, with NetJets’ crews.

Being the leader in this industry is a major advantage for all concerned. Our customers gain because we have an armada of planes positioned throughout the country at all times, a blanketing that allows us to provide unmatched service.

Meanwhile, we gain from the blanketing because it reduces dead-head costs. Another compelling attraction for our clients is that we offer products from Boeing, Gulfstream, Falcon, Cessna, and Raytheon, whereas our two competitors are owned by manufacturers that offer only their own planes. In effect, NetJets is like a physician who can recommend whatever medicine best fits the needs of each patient; our competitors, in contrast, are producers of a “house” brand that they must prescribe for one and all.

In many cases our clients, both corporate and individual, own fractions of several different planes and can therefore match specific planes to specific missions. For example, a client might own /16 1 th of three different jets (each giving it 50 hours of flying time), which in total give it a virtual fleet, obtained for a small fraction of the cost of a single plane.

Significantly, it is not only small businesses that can benefit from fractional ownership. Already, some of America’s largest companies use NetJets as a supplement to their own fleet. This saves them big money in both meeting peak requirements and in flying missions that would require their wholly-owned planes to log a disproportionate amount of dead-head hours.

When a plane is slated for personal use, the clinching argument is that either the client signs up now or his children likely will later. That’s an equation I explained to my wonderful Aunt Alice 40 years ago when she asked me whether she could afford a fur coat. My reply settled the issue: “Alice, you aren’t buying it; your heirs are.”

EJA’s growth has been explosive: In 1997, it accounted for 31% of all corporate jets ordered in the world.

Nonetheless, Rich and I believe that the potential of fractional ownership has barely been scratched. If many thousands of owners find it sensible to own 100% of a plane – which must be used 350-400 hours annually if it’s to make economic sense – there must be a large multiple of that number for whom fractional ownership works.

In addition to being a terrific executive, Rich is fun. Like most of our managers, he has no economic need whatsoever to work. Rich spends his time at EJA because it’s his baby – and he wants to see how far he can take it.

We both already know the answer, both literally and figuratively: to the ends of the earth.”