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Mohnish Pabrai’s Mistake with Pinnacle Airlines

April 12, 2012 | About:

Holly LaFon

267 followers
Warren Buffett has famously spurned airline stocks. After writing down 75% of his $385 million investment in US Airways (LCC) in 1995, he declared in an interview that the airline business in the U.S. has “made no money,” and even morbidly joked that it would have benefited capitalism if someone had offed Wilbur Wright at Kittyhawk. Prominent investor Mohnish Pabrai, a Buffett disciple, ignored Buffett’s warnings against airline stocks when he bought Pinnacle Airlines Corp. (PNCLQ).

Pabrai’s investment in Pinnacle Airlines predates the second quarter of 2007, when the stock traded for over $17. He had amassed 1,378,538 shares that quarter, and began adding more shares the next three quarters as the price dropped several dollars per share.

Pinnacle today is a $1 billion airline based in Memphis, Tenn., with subsidiaries that operate 1,540 daily flights to 188 cities and towns in the U.S., Canada, Mexico and Belize.

In 2007, it operated approximately 770 daily departures to 115 cities in 36 states and four Canadian provinces. It also acquired Colgan in 2007 as its platform for turboprop operations, which had about 270 daily departures per day.

Pinnacle is slightly different from a normal airline. It leases small regional plans to major airlines, often with clients signing long contracts. In 2010, however, 77% of its regional airline services revenue came from contracts with Delta. Another 18% came from United, 3% from US Airways and 2% from Essential Air Service.

As Pabrai was accumulating shares in 2007, he gave a presentation in at the Value Investing Congress on why he liked Pinnacle Airlines. He presented three main points about the company’s competitive advantage – No. 1: It was not dependent on finding passengers to fill the planes nor the price of fuel; No. 2: It could fly for multiple companies, meaning it had multiple streams of revenue; and No. 3: It had planes with the 70-100 passengers seats required to break even with the rising cost of fuel at that time.

Though the company’s revenue increased at a rate of 12.3% annually in the last ten years and earnings had stayed positive for nine out of ten years, the company’s debt mounted quickly over the decade. Long-term liabilities and debt were $1.4 billion at the end of the third quarter 2011, with $125 million in cash on its balance sheet.

It also saw operating expenses rise rapidly, causing operating income to shrink from $80.7 million in 2009 to $62.5 million in 2010. The extra expenses were from $10.9 million in signing bonuses for pilots, higher maintenance costs on its airplanes, higher pilot and flight attendant wages because it hired new ones before launching its new airplane service, and higher fuel costs.

On April 1, Pinnacle filed for Chapter 11 reorganization bankruptcy. Its stock closed at $0.43 per share on the Pink Sheets on Thursday. At Thursday’s price, Pabrai lost approximately 97.6% on average on his Pinnacle Investment.

“Quite simply, our current business model is not sustainable, as increasing operating expenses, liquidity constraints, business integration delays and difficulties associated with combining our operations have hindered our ability to maximize our growth potential,” said Sean Menke, president and CEO of Pinnacle.

A statement from the Association of Flight Attendants on the bankruptcy said otherwise: “…Mismanagement is responsible for poorly running Pinnacle and squandering the millions of dollars in revenue generated by Mesaba prior to the merger.”

The “merger” the flight attendants referenced was the company’s acquisition of Mesaba Aviation Inc. from Delta Air Lines (DAL) in July 2010 for $62 million.

Pabrai had been reducing his holding of Pinnacle each quarter since the second of 2008 to the fourth quarter of 2010. He had not made any other moves with the stock until he reduced 7.98% of his holding on April 3 – the day after it filed for bankruptcy. He now has 1,827,438 shares of the company, which plans to implement a turnaround plan. Pabrai has returned about 18% annually since 2000.



See Mohnish Pabrai’s portfolio here. Also check out the Undervalued Stocks, Top Growth Companies and High Yield stocks of Mohnish Pabrai.


Rating: 4.4/5 (18 votes)

Comments

traderatwork
Traderatwork - 2 years ago
. Parai checklist new no. 1 : Is this an airline company?
ramands123
Ramands123 - 2 years ago


I think he admitted this in one of his Columbia seminars. I think he said that it went wrong because Pinnacle was making money when its customers were losing money. So there is a checklist item to ensure that business model is good for eco-system. That's why he is does not buy tobbaco because these companies make money on expense of its customers health.
glavacem
Glavacem - 2 years ago


Traderatwork,

That was a funny comment, it made me laugh.

MYDemaray
MYDemaray premium member - 2 years ago
The real issue here, as you will discover in the bankruptcy docket -- was not the business model per se, but poor contract negotiation under the prior CEO Phil Trenary. Specifically:

1.) Most importantly, when Phil Trenary and team negotiated for the acquisition of Mesaba, they failed to either remember or provide for a set-off arrangement in a prior Delta contract which allowed Delta to "set-off" any amount due to PNCL against any amount due from PNCL. The end result was a liquidity crisis for PNCL where Delta was threatening to set-off the Mesaba acquisition price against an $18M reimbursement that PNCL needed. This pushed PNCL to file. However, it's not clear that PNCL's new management didn't want to file to deal with the collective bargaining agreement and to shed unprofitable flying.

2.) Certain flying agreements that were "cost-plus" neither anticipated nor provided for inevitable wage increases. A recently negotiated collective bargaining agreement with ALPA left PNCL exposed to increased costs. Negotiated under Phil Trenary.

paulwitt
Paulwitt - 1 year ago


It looks like Pinnacle wants to come out of bankruptcy soon. I bought a few shares in bankruptcy but after further research I think the equity is going to zero.

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