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United's Avolar Idea Was a Day Late and a Dollar Short
By Vaughn Cordle
Published: March 11, 2002
Starting a luxury flex-jet and charter operation at the end of a 10-year economic expansion just
didn't make sense.
Reviewing the existing competitors in that segment reveals a cutthroat business that has
declining profits. Profits for the segment are declining because the intensity of rivalry is
increasing, there are more competitors, and corporate profits are down sharply from the peak
years of the late 1990s and 2000.
In the past seven years, 57 companies have set up fractional operations, 51 have gone out of
business. The biggest threat to this segment's profitability is the manufacturers themselves,
which are clearly looking to boost business jet sales. Bombardier's Flexjet unit and Raytheon's
TravelAir both sell fractional time and have a competitive advantage in their vertically integrated
executive charter businesses.
Warren Buffet's NetJets' operating profits peaked in 1998 at 21%, fell to 12% in 1999 and then 9%
in 2000. Last years operating profits may be even less, although Sept. 11th have boosted sales
because of security concerns. Knock off interest expense, taxes and the cost of equity capital and
the real returns are even less attractive. Warren Buffet has a strategic and resource fit between
his Executive Jet, Flight Safety and NetJets businesses. NetJets as 558 planes on order, worth
$18 billion and is no doubt the king of the hill in this business. Annual growth has been in the
high 30% range for the company.
He also has a blue-chip credit rating and a very low cost of equity capital. In other words, the
required rate of return on an investor's dollar of retained earnings in NetJets will be significantly
less than an investor's required rate of return in United's Avolar. Warren Buffet's companies have
over $30 billion in equity which is ten times that of United's and NetJets has been in the executive
charter business for a very long time.
United's costs would have been too high and it would have taken too long to achieve scale
economies. United would have introduced union level wage levels into a non-union segment and
the operation would have been too small to effectively compete with the more established
operators. Current operators are lean, mean and experienced. As of Friday, Avolar had 306 aircraft
on order which represented 20% of the 1566 private jets ordered through 2006. As we have
learned in the airline industry, increasing capacity does not increase profitability and upstarts
have significant disadvantages relative to established incumbents.
UAL's Avolar was advertising that it would be the "best in class" in terms of offering five-star
service. Unfortunately this would not have been enough to overcome the cost disadvantage and
the glut of private jets. Yes, United does have extensive business travel intelligence and it would
make sense to tie-in the charter business with the mainline airline. Avolar's ex-president, Stuart
Oran, has said that they would not go after United's high-margin first-class business traveler.
However, surveys by the NBAA show some 85% of the business-aviation passengers are
middle-to-senior management, and the last time I checked, these were the same folks that
accounted for as much as 65% of United's revenue.
Moreover, shifting the $4 billion in aircraft loans off-balance sheet does not change the fact that
United Airlines is still on the hook for the loans. The reality is that United is a borrower who cannot
cover its own costs, and Avolar is a subsidiary which would ultimately steal the airline's most
profitable passengers. Perhaps a better approach would have been to focus on improving United
Airlines' value proposition for the business traveler by fixing the pricing structure and improving
reliability and service quality. Alliances with existing executive charter operators is the way to go.
Moreover, increasing corporate leverage and starting new businesses while the company is
facing bankruptcy does not make sense.
Borrowing billions of dollars to start a new business that steals business from yourself, while
taking bailout money from the government and laying off 20,000 employees is hard to reconcile. It
reflects a company that cannot manage its primary business properly and a company that is
chasing illusionary earnings. A company desperately in need of a new board of directors and a
major restructuring.
This piece originally appeared in Aviation Oracle in February 2002.
By Vaughn Cordle
Published: March 11, 2002
Starting a luxury flex-jet and charter operation at the end of a 10-year economic expansion just
didn't make sense.
Reviewing the existing competitors in that segment reveals a cutthroat business that has
declining profits. Profits for the segment are declining because the intensity of rivalry is
increasing, there are more competitors, and corporate profits are down sharply from the peak
years of the late 1990s and 2000.
In the past seven years, 57 companies have set up fractional operations, 51 have gone out of
business. The biggest threat to this segment's profitability is the manufacturers themselves,
which are clearly looking to boost business jet sales. Bombardier's Flexjet unit and Raytheon's
TravelAir both sell fractional time and have a competitive advantage in their vertically integrated
executive charter businesses.
Warren Buffet's NetJets' operating profits peaked in 1998 at 21%, fell to 12% in 1999 and then 9%
in 2000. Last years operating profits may be even less, although Sept. 11th have boosted sales
because of security concerns. Knock off interest expense, taxes and the cost of equity capital and
the real returns are even less attractive. Warren Buffet has a strategic and resource fit between
his Executive Jet, Flight Safety and NetJets businesses. NetJets as 558 planes on order, worth
$18 billion and is no doubt the king of the hill in this business. Annual growth has been in the
high 30% range for the company.
He also has a blue-chip credit rating and a very low cost of equity capital. In other words, the
required rate of return on an investor's dollar of retained earnings in NetJets will be significantly
less than an investor's required rate of return in United's Avolar. Warren Buffet's companies have
over $30 billion in equity which is ten times that of United's and NetJets has been in the executive
charter business for a very long time.
United's costs would have been too high and it would have taken too long to achieve scale
economies. United would have introduced union level wage levels into a non-union segment and
the operation would have been too small to effectively compete with the more established
operators. Current operators are lean, mean and experienced. As of Friday, Avolar had 306 aircraft
on order which represented 20% of the 1566 private jets ordered through 2006. As we have
learned in the airline industry, increasing capacity does not increase profitability and upstarts
have significant disadvantages relative to established incumbents.
UAL's Avolar was advertising that it would be the "best in class" in terms of offering five-star
service. Unfortunately this would not have been enough to overcome the cost disadvantage and
the glut of private jets. Yes, United does have extensive business travel intelligence and it would
make sense to tie-in the charter business with the mainline airline. Avolar's ex-president, Stuart
Oran, has said that they would not go after United's high-margin first-class business traveler.
However, surveys by the NBAA show some 85% of the business-aviation passengers are
middle-to-senior management, and the last time I checked, these were the same folks that
accounted for as much as 65% of United's revenue.
Moreover, shifting the $4 billion in aircraft loans off-balance sheet does not change the fact that
United Airlines is still on the hook for the loans. The reality is that United is a borrower who cannot
cover its own costs, and Avolar is a subsidiary which would ultimately steal the airline's most
profitable passengers. Perhaps a better approach would have been to focus on improving United
Airlines' value proposition for the business traveler by fixing the pricing structure and improving
reliability and service quality. Alliances with existing executive charter operators is the way to go.
Moreover, increasing corporate leverage and starting new businesses while the company is
facing bankruptcy does not make sense.
Borrowing billions of dollars to start a new business that steals business from yourself, while
taking bailout money from the government and laying off 20,000 employees is hard to reconcile. It
reflects a company that cannot manage its primary business properly and a company that is
chasing illusionary earnings. A company desperately in need of a new board of directors and a
major restructuring.
This piece originally appeared in Aviation Oracle in February 2002.