Month: May 2019

In recent times, there have been multiple startups that went IPO with a lot of hype – Lyft, Uber, Zoom, Pinterest, and China’s own Luckin Coffee were at the forefront of the news.

Now, while many may claim that Lyft and Uber received their come-uppance by ending up below their IPO valuation very quickly, they still managed to unload a lot of shares at a decent valuation. Luckin has fared much better with an initial spike in valuation. What unites these 3 companies? None of them has ever made a profit and none of them (if you read between the lines a bit) claims any possibility of doing so. While Lyft and Uber have many years of loss making history behind them, Luckin has very smartly gone public before it has too much of this kind of history.

Lyft has additional woes as its investors sue it over alleged misrepresentation in its IPO.

Zoom, on the other hand, has been hailed as “the profitable unicorn” which, ironically, highlights how few unicorns are profitable.

I don’t think anyone is buying Uber stock in the expectation that it will pay out in the longer term, with dividends, stock splits and the like. Most investors seem to be buying it in the hope that the valuation will go up and they can sell at a profit. Somehow the way in which the pre-IPO valuations of these companies kept multiplying seems to make people think that will continue long enough for them to make a killing.

Here’s the sad news folks – the people who were going to make a killing on Uber have already done so. They’re all the folks who bought in early and fuelled the hype. Each round of investors bought in hoping there would be a next round at an even higher valuation – but that cycle ends with the IPO.

You want to make money from a startup going public? Buy into their shares long before they go public. Or better still, start your own company.

Here’s some thought provoking links on the subject of recent IPOs.

Overview on recent IPOs

Lyft gets sued by investors

Beware of Luckin IPO

Not all unicorn IPOs are bad, obviously. Zoom has come to market after several years, working patiently to establish a working model for a viable company.

Zoom expected to break even for last quarter

The thing is, the mentality in today’s investment market is that you just have to ensure there’s one layer of suckers left to buy stock from you at a higher valuation than you paid. That may continue for a while longer but as the majority of startup IPOs lead to sharp drops in investor value, the entire startup / IPO route will start becoming questionable. Hark back for a moment to the symbols of solidity from 20 years ago, the blue chip companies as we called them. P&G for instance, where if you held stock for a long time, they kept paying dividends and issuing stock splits so that, as the fable goes, many a secretary from the early days ended up a millionaire.

Isn’t that the story we should be seeking to live out – support a company in its early days, and over time, see it deliver value to customers and shareholders. I don’t think Uber, Lyft or Luckin particularly care about their shareholders apart from seeing them as a convenient source of cash or as a way for the VCs and funds to unload their shares at a profit.

It reminds me of an O’Henry story (A Tempered Wind) where a pair of grafters hatching a Ponzi scheme get an attack of conscience when they realize their investors are all poor people, and get them lined up to return their money. (The illustration above is from the story) One of them admonishes the people in the line as he returns the money – “Salt away that chicken feed in your duds, and skip along,” says Buck. “What business have you got investing in bonds? The tea-pot or the crack in the wall behind the clock for your hoard of pennies.” While that may not be the advice I give I’d certainly advocate that you invest your hard-earned money in companies that are going to be around a long time and generate a profit and dividends over their lifetime. “What business have you got investing in unicorns, the blue chip that’s been around the last 50 years for your hoard of pennies” I’d say, to paraphrase Buck Skinner.

Aviation is having one of it’s best decades in a long time, with the traditionally wafer thin margins improving a little bit as per IATA’s 2018 data.

So, the question is, why are so many airlines still losing money? And why are budget airlines, in particular, often on the brink (or over the brink) of shutting down and stranding their passengers?

As a recreational pilot who runs businesses for a living, there were 3 times in my life when I contemplated starting an aviation related business. First, I explored starting a flying school in China about 15 years ago. Then, I considered a private charter service between Singapore and key South East Asian destinations that were important for specific industries but not well served by airlines (Balikpapan in Indonesia, for instance). Finally, at one point I had an invitation to invest in a FBO (Fixed Based Operator) business in Senai Airport, Malaysia.

On all 3 occasions, I decided against taking the plunge because, to summarize rather summarily, there were too many factors outside my control which could impact cost – thus making it very hard to assess the viability of running such a business.

The most fundamental cost in aviation is the cost of the airplane. When I owned a plane, it cost me a fixed amount of money. Whether I flew it or not, I paid insurance and hangarage and had to pay engineers to do an annual inspection. I’d worked out a dry operating cost per hour on the assumption that I’d fly about 100 hours a year and realized at that time that if I rented it out and got it to fly 200 or more hours a year, my cost per hour would come down drastically.

The same is true of the airlines. Apart from the plane, airlines have other fixed costs as well that look better when amortized over more hours. Pilots get a base wage, so a pilot who flies to the legal maximum every month delivers more value than one who does less hours.

For airlines, one of the things that helps them get the most out of their planes and pilots is standardizing things as much as possible. Successful budget airlines try and fly just one aircraft type. They’ll pick it for maximum efficiency and profitability on a small number of routes and steadfastly avoid other routes that don’t make sense for this plane. This is why when budget airlines start trying to fly long-haul, they get themselves into trouble – because then they have to buy longer range aircraft and impair the efficiency of their model.

Everyone thinks budget airlines make money by charging you for sandwiches, water and checked in bags – while that helps recognize the real costs of these services it’s not usually a revenue earner. The core of profitability in budget airlines is getting the most out of fixed cost assets like pilots and planes (pilots are kind of a fixed cost asset in the sense that once you have one, you need to use them for the maximum legally allowed flying hours per month and year).

So, here’s the question – is that something that only budget airlines can do? Clearly not – there are enough airlines that attempt to limit the diversity of their fleet, are very choiceful about routes, avoid unnecessary costs and maximize their flying hours per aircraft and pilot. In fact, surprisingly, a look at the world’s most profitable airlines shows very few of the budget persuasion. (Data is from a Forbes report for 2017)

What’s interesting there is the low margins for most companies – Southwest being the only one in double digits. From an investor’s point of view that’s a pretty low ROI.

Separately, all kinds of things can affect an airline’s ability to maximize the annual hours for each of it’s aircraft. Take the impact of the 737 Max crashes that have led to the entire fleet being grounded worldwide – we can expect every airline that flies these planes to have some problems this year. Planes sitting on the ground cost money – hangarage, maintenance contracts, bank loan repayments and so on. Pilots trained on these planes will have less to do but will still make their base salaries. It’s certainly possible for the airlines to make up a lot of the missed flights using the rest of their fleet but that’s not the optimal arrangement so the impact on P&Ls may be larger than the overall flight cancellations indicate. It may be that the airlines are able to recover some of these costs from Boeing or their insurance companies but unlikely that they will recover all of them.

Overall, this is a hard business to make money in even when everything is in your control, which clearly is not the case.. Between aircraft problems, weather and government control over airspace, there are many unpredictable factors that might make it a challenging business to be in, even for those who appear to be succeeding at it.