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The conceit and failure of airline upstarts
By Vaughn Cordle, CFA / December 2008
In phase one, it's all sales (the money pitch) but little beef when it comes to what happens later, in
phase two, as the silly Simpson video highlights. It's in phase two that the ugly reality of market
conditions, tough competition, and the flawed business plan rears its ugly head, and this leads to phase
three: bankruptcy and write offs all around.
The lure of becoming the next big-time airline CEO or captain of industry is too strong for many to resist,
and they get high on jet fuel fumes and their own hubris. The fundamental problem is that small upstarts
have too many years of money-losing growth ahead of them before they can achieve the economies that
only give them a shot at ever becoming profitable. The odds are that they eventually fail to earn their cost
of capital over the longer term, regardless of size. Bad industry fundamentals is the name of the game in
the airline industry.
The life cycle of an airline is becoming ever shorter, even as the business cycle becomes longer.
Life cycle, from an analyst perspective, is based on firm value growth and whether the business creates
or destroys wealth. Almost all airlines, including former Wall Street darlings Southwest and Jetblue,
destroy wealth over the longer term.
So—and this is what I advise when paid for an opinion—the upstarts’ investors need to plan their exit
strategy up front so that they, when they roll the dice, they at least understand the potential payoff and that
the odds of winning the game are slim to none. The smart entrepreneur is thinking about the exit
strategy, the IPO or buyout, from day one. Let the other suckers, the retail investors who provide liquidity,
cash them out at inflated and over-hyped share prices; if they are dumb enough to pay pie-in-the-sky
valuation multiples, well, it’s their own fault for not having the common sense to understand the
underlying business and industry fundamentals.
The primary focus in phase one is to raise capital, and the core conceit is that the
founder/entrepreneur/initial investors are smarter than everyone else. They’re kind of like the mutual fund
managers, very few of whom ever outperform the market but who get rich on other people’s investments.
I say, let 'em keep coming; it keeps folks like me in business.
There are exceptions to the rule, of course, and even a handful of success stories. Southwest,
WestJet, Ryan, Jetblue and Allegiant come to mind as successful upstarts. Of course, a good question
is “what defines success?” and I guess that depends on who is doing the defining. But, for this analyst,
in the great game of business, success should be defined as earning a normal rate of return.
Unfortunately, for many of the airline upstarts, the founders tend not to fully understand the rules of the
game until after the initial investors are wiped out.
By Vaughn Cordle, CFA / December 2008
In phase one, it's all sales (the money pitch) but little beef when it comes to what happens later, in
phase two, as the silly Simpson video highlights. It's in phase two that the ugly reality of market
conditions, tough competition, and the flawed business plan rears its ugly head, and this leads to phase
three: bankruptcy and write offs all around.
The lure of becoming the next big-time airline CEO or captain of industry is too strong for many to resist,
and they get high on jet fuel fumes and their own hubris. The fundamental problem is that small upstarts
have too many years of money-losing growth ahead of them before they can achieve the economies that
only give them a shot at ever becoming profitable. The odds are that they eventually fail to earn their cost
of capital over the longer term, regardless of size. Bad industry fundamentals is the name of the game in
the airline industry.
The life cycle of an airline is becoming ever shorter, even as the business cycle becomes longer.
Life cycle, from an analyst perspective, is based on firm value growth and whether the business creates
or destroys wealth. Almost all airlines, including former Wall Street darlings Southwest and Jetblue,
destroy wealth over the longer term.
So—and this is what I advise when paid for an opinion—the upstarts’ investors need to plan their exit
strategy up front so that they, when they roll the dice, they at least understand the potential payoff and that
the odds of winning the game are slim to none. The smart entrepreneur is thinking about the exit
strategy, the IPO or buyout, from day one. Let the other suckers, the retail investors who provide liquidity,
cash them out at inflated and over-hyped share prices; if they are dumb enough to pay pie-in-the-sky
valuation multiples, well, it’s their own fault for not having the common sense to understand the
underlying business and industry fundamentals.
The primary focus in phase one is to raise capital, and the core conceit is that the
founder/entrepreneur/initial investors are smarter than everyone else. They’re kind of like the mutual fund
managers, very few of whom ever outperform the market but who get rich on other people’s investments.
I say, let 'em keep coming; it keeps folks like me in business.
There are exceptions to the rule, of course, and even a handful of success stories. Southwest,
WestJet, Ryan, Jetblue and Allegiant come to mind as successful upstarts. Of course, a good question
is “what defines success?” and I guess that depends on who is doing the defining. But, for this analyst,
in the great game of business, success should be defined as earning a normal rate of return.
Unfortunately, for many of the airline upstarts, the founders tend not to fully understand the rules of the
game until after the initial investors are wiped out.
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