Mohnish Pabrai’s Mistake with Pinnacle Airlines
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 (NYSE: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.
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