Warren Buffett (Trades, Portfolio)'s right-hand man, Charlie Munger (Trades, Portfolio), made the following comments at Berkshire Hathaway's (BRK.A, Financial) (BRK.B, Financial) 2010 annual meeting of shareholders:
"If we buy 30 big businesses and generally let the people who run them successfully and before run them with very little interference from headquarters, and it works out 95% of the time very well, and we have one episode when the basic franchise was protected but we lost profit opportunities for a while, it's not a big failure record."
The investor was referring to the conglomerate's NetJets business, which had been losing money hand over fist since Berkshire had acquired it 12 years prior.
A bad deal
Buffett agreed to buy NetJets for $725 million in cash and stock in July 1998. The company was an early starter in the fractional private jet ownership market, which was originally pioneered by aircraft manufacturers. Founded in 1986, the group grew rapidly and owned more than 130 aircraft by the time of the acquisition.
It was planning further expansion at the time of the deal. When Berkshire made the offer, it had $2.6 billion of aircraft on order. The 129 planes the group ordered in 1997 accounted for 31% of corporate jet sales that year.
According to reports, Buffett was introduced to Executive Jet (the parent company) when his wife acquired a quarter share in a NetJets aircraft. He is likely to have used Berkshire's ownership of business-aircraft training provider FlightSafety International to help him get to grips with the business model. The conglomerate acquired FlightSafety in 1996, and NetJets was its largest customer.
Unfortunately, owning the private jet business was not an immediate success. It lost $711 million in the 11 years after the deal.
This is one of those rare examples of a Buffett mistake. Considering the size of the losses, I do not think it is unreasonable to say that the company could have collapsed without Berkshire's backing.
The mistake the company made was paying too much for new jets. As Buffett explained in 2010:
"But the mistake, the biggest mistake made with NetJets is essentially we kept — we were buying planes at prices that were fictitious, in terms of the price at which we would later be able to sell them...we didn't properly prepare for what was obviously happening. And we lost a lot of money, a good bit of which was attributable to the write-down of planes...where we bought them at X and we couldn't sell them at X or 90% of X."
Thanks to the efforts of ex-Berkshire executive Dave Sokol, NetJets' performance improved in the early 2010s. In fact, at the time of the Berkshire meeting, the company had just reported a pre-tax profit of more than $50 million in the first quarter.
Buffett and Munger explained at the meeting that the NetJets scenario is an example of what can go wrong with an investment. The acquisition did not work out for the reasons outlined above, but it was just one of many deals that incurred losses. Many others proved to be hugely profitable.
This is something every investor will have to deal with at some point. No investor has a 100% track record of success. It is just not possible. Dealing with losses is the hard part. And more often than not, it's not possible to send in an experienced executive to take care of the situation. Investors just have to move on.
The best strategy is to copy Buffett and Munger's route and focus on the winners while moving past the losers. Losses will happen. That is just part of the game. It is far more important to concentrate on the winners as this is where the profits will come from over time. Doubling down on a losing investment can only lead to further losses.
