Excerpted from Whitney Tilson’s latest email to investors.
1) The airline sector as a whole has fallen a bit, led by United (UAL) and Spirit Airlines (SAVE). I added to my Spirit position recently, for reasons I outlined in this post this in late July to the SAVE message board on ValueInvestorsClub.com, responding to some other comments:
I pitched this at $36.83 in Nov. 2015 (see: www.tilsonfunds.com/SAVE.pdf; after the slides are three articles I published) and was feeling pretty good about it until yesterday. I’m not worried about the pilot slowdown and negotiations – this will get resolved – nor about the terrible customer service ratings because: a) there’s lots of low-hanging fruit to improve in this area, which new management is making good progress on; and b) with the rise of basic economy among the majors, customers are increasingly accustomed to a la carte pricing (for more on this topic, see slides 39-42).
Rather, if you read the conference call (https://seekingalpha.com/article/4091473-spirit-airlines-save-q2-2017-results-earnings-call-transcript), what spooked investors is the concern that United is engaged in what I call a “spanking action” to punish Spirit for opening a gate with a handful of flights at Newark airport, one of United’s primary hubs. Here are some excerpts from CEO Robert Fornaro’s comments:
“Turning to our forward outlook, there has been a developing change in the pricing backdrop over the last few weeks. In late June, which started out as a slightly more competitive environment in just a few select markets has quickly spread to a larger number of markets at deeper discount levels than we have experienced yet this year.
…As we entered the second quarter, we were very encouraged by the advance booking trends we saw building from mid-April and into early May. Unfortunately, the recent pricing developments coupled with the lingering hangover associated with our poor second quarter operational results puts us in a position to revise our view on third quarter’s TRASM performance. We now expect Q3 TRASM will be down 2% to 4% year-over-year.
…Fortunately, if we were a higher cost carrier, it would be hard to defend, but we have the ability to compete. We have the balance sheet to compete, yeah, and so, we will. Yeah so – yeah, we have our own plan, and I think sometimes high cost carriers charge a low price. Sometimes it doesn’t work. It’s happened before. Yeah so if we go back, I think we’ve kind of weathered – we got a pretty good operation at Dallas. It’s bigger today than it was two or three years ago. And the reason is that these are expenses, when fares drop, but we have a good cost structure.
…as capacity environments changed, then airlines will react to that from a pricing perspective. And I think right now, we’re seeing some of that. And is it transitory or will it be there for longer than a little bit of time? Well, that’s not necessarily something that I can speculate on or know about.”
And here’s a key exchange with an analyst:
Jamie N. Baker – JPMorgan Securities LLC
Okay. Your implication that some of your competitors are retaliating in certain markets based on what you’ve done in other markets. I know that probably stings, maybe it doesn’t seem fair, but I think it just highlights that airlines compete in network terms. They don’t compete in spoke terms necessarily. And look, I get it, nobody likes to admit defeat, but if a single-gated Newark elicits this sort of network response, isn’t the solution to get out of Newark?
Robert L. Fornaro – Spirit Airlines, Inc.
No. I don’t think it does. This is – I think you have to look at this over periods of time. And also, a lot of things can change in this business. And quite frankly, a change that occurs in Asia could also really impact what happens in the U.S. However, those things occur, again, I’ve lived through many of them.
And a couple of years ago, we experienced a lot of activity, we went through it. I think we came out pretty good. The reality is (46:31) Newark the price to Fort Lauderdale was pretty high. And I think there’s actually an opportunity.
But eventually, again if you react or overreact to every one of these situations, I think the outcome is bad. We’re not stubborn. We pick a route, that doesn’t work out. We’ll leave. I think we don’t stay in every route. I think if you go back over the last four or five years, probably 10% to 13% of the routes that we go in don’t work; this could be – that the market dynamics don’t end up as we would plan. But I think we see opportunity there, and over time I think the situation will improve, but we’re not going to create learned behavior because…
My take is that this is pretty much exactly what happened starting three years ago, when Spirit encroached on American’s turf, triggering retaliation that caused the stock to tumble from ~$83 to ~$35 from late 2014 to late 2015. Importantly, however, note that during this period Spirit’s BUSINESS didn’t tumble: while ticket revenue per passenger declined from $80 to $68 (see slide 23), non-ticket revenue was flat, overall revenue continued to grow, and margins remained stable.
In summary, investors in Spirit need to understand that it’s highly likely that there will be periodic “spanking actions” by the majors (the big four are each 7-10x Spirit’s size), which won’t be much more than a speedbump for Spirit’s business, but can really whack the stock, as we’ve seen now twice in three years.
So perhaps, for those of you who are better traders than I, the best strategy is to buy in the $35-$40 range and sell in the $55-$60 range. Personally, I don’t want to get too cute, especially since I haven’t changed my long-term investment thesis – that Spirit is the next Ryanair (but I do wish I’d trimmed more at the stock’s recent highs!).
My view is that from today’s price, barring a recession or other external shock, there’s ~$5 of downside and ~$20 of upside, which is pretty attractive. That said, the stock could be dead money for a while – the horror!
2) My partner in Value Investor Insight and SuperInvestor Insight, John Heins, published the attached article, Birthday Wishes for Warren Buffett, in honor of his 87th birthday on Aug. 30th. Enjoy! Excerpt:
No tribute to Buffett would be complete without his own words. Some of my favorites:
- On what he looks for in businesses: “I want a very valuable castle, with a duke in charge of it who is very honest and hardworking and able. Then I want a moat around that castle.”
- On what he looks for in managers: “We look for three things: intelligence, energy, and integrity. If they don’t have the latter, then you should hope they don’t have the first two either. If someone doesn’t have integrity, then you want him to be dumb and lazy.”
- On why he doesn’t invest in gold: “You could take all the gold that’s ever been mined, and it would fill a cube 68 feet in each direction. For what that’s worth at current gold prices, you could buy all—not some—of the farmland in the U.S. Plus, you could buy 16 Exxon Mobils, plus have $1 trillion of walking-around money. Or you could have a big cube of metal. Which would you take? Which is going to produce more value?”
- On the necessity for adaptation: “When we took over [Berkshire Hathaway] in 1965, its risks could have been encapsulated in a single sentence: ‘The northern textile business in which all of our capital resides is destined for recurring losses and will eventually disappear.’ That development, however, was no death knell. We simply adapted. And we will continue to do so.”
3) I really enjoyed the hour-long documentary, Steve Jobs: The Lost Interview, filmed in 1995, 10 years after he’d been fired from Apple, when he was running NeXT, which was acquired by Apple the following year, which led to Jobs’ triumphant return on July 9, 1997, when Apple was ~90 days from filing for bankruptcy. It’s available on Netflix for free or $3-$4 on YouTube, iTunes, Amazon Video, and Google Play.
4) We just passed the 10th anniversary of a major quant fund meltdown in Aug. 2007. Michele Celarier explores whether there could be another one: The Next Quant Meltdown, http://www.institutionalinvestorsalpha.com/Article/3741667/The-Next-Quant-Meltdown.html.
5) Good to see, On Insider Trading, an Appeals Court Comes to Its Senses, www.nytimes.com/2017/09/14/business/insider-trading-court.html. Excerpt:
The court could have stopped there. But it took the unusual step of overturning much of the Newman opinion, citing an intervening Supreme Court ruling that had also chopped away at Newman, and held that its requirement that there be a “meaningfully close personal relationship” between tipper and tippee was “no longer good law.”
Mr. Martoma will most likely seek a rehearing by the full court and, if that fails, appeal to the Supreme Court. But the odds of his prevailing have turned drastically against him.
At this juncture, his case essentially restores insider-trading law to where it was before Newman roiled the waters. Absent a much-needed — but unlikely — congressional statute that would clarify many confusing aspects of insider-trading law, that’s probably as it should be.
“The problem with Newman,” Ms. Kolhatkar said, “is that it completely misunderstood the way the world actually works.”
6) With my fund having a crappy year, I’ve been feeling guilty about taking some time for R&R this summer (though my idea of R&R may be different from others’ – see my description of my Alps climbs two weeks ago at: www.tilsonfunds.com/TilsonAlps17.pdf), so I liked this article. Burned Out at Work? Learn How to Vacation Like J.P. Morgan, http://fortune.com/2017/08/18/j-p-morgan-vacation.