““CEOs go to their vacation homes just after companies report favorable news, and CEOs return to headquarters right before subsequent news is released. More good news is released when CEOs are back at work, and CEOs appear not to leave headquarters at all if a firm has adverse news to disclose. When CEOs are away from the office, stock prices behave quietly with sharply lower volatility. Volatility increases immediately when CEOs return to work.” —David Yermack, a New York University finance professor, whose recently released study shows a correlation between when CEOs take their private jets on vacation and movements in their companies’ stock price ”
The Fractional Market
AMERICA'S ECONOMIC DOWNTURN has dealt a crippling blow to the fractional-share industry. Rapidly declining used-aircraft prices and fewer flying hours over the past year have forced fractional operators to defer aircraft deliveries, cut staff and explore new ways to keep flying. The situation has gotten so bad that some pundits are questioning whether the fractional-ownership business model is broken.
The rapid change in fortunes that has occurred among the fractional operators was dramatically brought to light when Berkshire Hathaway released second-quarter financial results for its NetJets subsidiary in August. Compared with the first six months of last year, NetJets revenues fell $550 million or 43 percent in the first half of 2009, reflecting an 81-percent drop in aircraft sales and a 22-percent decline in flight operations. Berkshire Hathaway has since stated that the fractional provider "owns more airplanes than is required for its present level of operations." NetJets has announced staff reductions of 5 percent and implemented other cost-cutting moves.
So is the fractional business model in fact broken? It is, according to Michael Riegel, a former Bombardier executive who now runs AviationIQ, a consulting group for shareowners. "There are a lot of irate consumers monitoring what's going on," he said, noting that net sales of fractional shares have been declining steadily, went negative in 2008 and dropped quickly in 2009. "The decline has been going on for seven years," said Riegel, who added that he believes the fractional industry's problems go deeper than the fallout from the recession. "Can the business model be fixed?" he asked. "Yes, but changes are needed."
The fractional industry could be compared with real estate timeshares, which suffered from a reputation for being bad investments long before the current recession started. While fractional shares of aircraft may be at risk of developing a similar reputation, the fact remains that many people still need to fly privately.
But at a time when costs arguably ought to be dropping, shareowners are facing a variety of price increases. The amount that they receive for their used shares when they exit programs is much lower than it used to be, due to rapidly dropping used-aircraft prices. Hourly fees are also rising. "A lot of owners are saying it's become too expensive and they don't want to keep doing this," Riegel said. "The industry has dug itself into a hole."
A main attraction of the fractional industry has always been that it offered lower barriers to entry for new business aviation users and an easy way to add lift for companies and owners that didn't need another full airplane. Fractional providers delivered better service than many charter operators, but with fractional costs rising, many travelers are shifting to high-quality charter providers.
In the case of NetJets, some of its problems can be linked to the fact that it "has tried to be all things to all people," Riegel said. The company's Marquis jet card program and the need to buy charter to fulfill fractional flight requests layered in additional costs, he noted, "and it's not surprising they dived into the red. The only way to dig out is to try to make money by selling shares." But for many fractional providers, share sales are virtually nonexistent.
Although NetJets' Marquis jet card sales offset some of the shareowner departures, "card activity creates as many problems as it solves," Riegel said. In the fractional industry, he explained, there is an average of nine to 10 owners per airplane, and each of those owners places demand on each airplane. Marquis jet card buyers, however, average about 20 per airplane. "The more card business you do, the more people can demand the airplane," he said.
NetJets' losses for the first six months of this year translate into nearly $700,000 per airplane. "Those are terrifying numbers," Riegel said. "Almost anything they do [to fix the problem] is going to take years."
There remains a need for the fractional concept, but major providers have to revise their business models. NetJets has too many airplanes to serve its customers and, in Riegel's view, should cut its fleet to around 170 airplanes versus the 500 it has now.
NetJets is allowing some owners to idle their shares by stopping flying, letting them keep the shares without paying the monthly management fee. Riegel said he expects these aircraft-which he estimates number approximately 160-to sit idle for a few months before NetJets asks the owners to resume paying management fees or sell their shares. "Many will pull the plug," he said of owners who have held their shares in the hope that used aircraft prices would recover. "[That would] worsen the problem for the fractionals."
SOME STATISTICS SUPPORT the prevailing view that the industry is slowly improving. According to FlightAware, a flight-tracking service, fractional flying activity dropped 7.6 percent in September versus August 2009, although compared with the previous September the fractional segment's activity was down 13.4 percent. ARG/US's TraqPak evaluation of business aircraft activity reflects a lesser drop in fractional activity during September 2009 versus September 2008, with a 7.7-percent decline, a substantial improvement from a 17-percent decline in July.
Most fractional operators are either not large enough parts of their publicly traded parent companies to warrant release of detailed statistics or are privately held and don't share such information. Publicly traded Avantair does release relatively detailed data, at least compared with NetJets, Bombardier-owned Flexjet and Cessna-majority-owned CitationAir (formerly CitationShares). Flight Options, Executive AirShare and PlaneSense are privately held. None of the major fractional operators divulges detailed fleet information.
France-based researcher Pierre Parvaud analyzes the activity on the public FAA Registry to determine what is happening to the fleets of the major U.S.-based fractional operators. According to him, 2009 was a bad year for most of the fractionals. During the first half of last year, according to Parvaud's statistics, the five national U.S. fractional operators-Avantair, CitationAir, Flexjet, Flight Options and NetJets-broke even in terms of number of shareowners added and lost. Thus, while sales efforts delivered 216 new shareowners during that period, the same number left the programs.
In the second half of last year, the effects of the recession hit home, and while the five fractional operators managed to sell shares to 168 new owners, 360 owners were lost. In the first half of 2009, the trend accelerated, with 402 owners lost versus 84 added, for a net loss of 318.
Most of the fractional operators added aircraft during the first half of 2009 but, except for Avantair and Flexjet, they disposed of more than they added. The total of negative 14 aircraft added during the first half contrasts markedly with the 18 and 22 net aircraft added to the five operators' fleets during the same periods in 2007 and 2008, respectively.
Overall, however, the major fractionals' total fleet numbers have remained relatively stable, when comparing the end of June 2008 to the end of June 2009.
While the numbers for the first half of this year are dismal, the fractional share industry remains a key component of general aviation, accounting for a significant portion of the overall fleet, thousands of jobs and hours flown and an important entry point for new consumers of business aviation travel. As such, the fractional business model is arguably not so much broken as it is in need of adjustment to reflect the reality of the current economic downturn.
"The fractional business is a marginally workable business model when times are good," aviation consultant Brian Foley said. "Look how long it took NetJets to become profitable. The fractional model doesn't work so well in a downturn."
Part of the problem, Foley said, is that the many startup air-taxi and fractional companies were weak links in the order chain. Indeed, news last August that European fractional startup Jet Republic had run out of funding and canceled its order for 110 Learjet 60XRs underscores Foley's observations.
THE FRACTIONAL BUSINESS suffers from having too many players in a small marketplace, according to Foley. "The demand for fractional shares might have been overestimated," he said. "It may even be analogous to VLJs, where early providers talked up the market to the point where others decided to get in on it, but core demand wasn't there."
In North America, Foley said, "We've largely met that demand." Even though the fractional industry points out that many companies and wealthy individuals could afford to own a fractional share, he added, "I fall back on the data. Fractionals ramped up quickly in the late 1990s, then started smoothing out. Lately, the fleet hasn't increased at all. That tells me a lot of the current demand has been satisfied."
Foley said he believes that the fractional providers need to learn how to operate more efficiently in a mature industry that isn't growing. When the industry was growing, providers bought aircraft at discounts, sold them at list prices and used the difference to subsidize operations. If fractional providers are to survive, they need to improve their efficiency and charge enough to shareowners so that when a downturn occurs they still make money, or at least lose less, Foley said.
"There's a big shakeup coming," he predicted. "Fractionals will survive, but there will be fewer players, which is better for those remaining." There will always be a need for some owners to keep their use of business aircraft "under the radar," he said, "and fractionals are a great way to do that, but eventually they have to find a way to remain profitable while in the mature stage."