Tag Archives: Jonathan Tepper

Friendly Skies — For Airline Investors, Not Passengers

One of Warren Buffett’s few unsuccessful investments was buying convertible preferred stock of USAir in the late 1980s. For decades after that episode, Buffett would characteristically make fun of himself, while decrying the entire airline industry for its capital requirements and onerous competition.

As he put it in an interview, “If a capitalist had been present at Kitty Hawk back in the early 1900s, he should have shot Orville Wright. He would have saved his progeny money. But seriously, the airline business has been extraordinary. It has eaten up capital over the past century like almost no other business because people seem to keep coming back to it and putting fresh money in. You’ve got huge fixed costs, you’ve got strong labor unions and you’ve got commodity pricing. That is not a great recipe for success. I have an 800 (free call) number now that I call if I get the urge to buy an airline stock. I call at two in the morning and I say:

“My name is Warren and I’m an aeroholic.’ And then they talk me down.”

But Buffett seems to have changed his mind lately, and maybe so should other investors. In a Berkshire Hathaway filing from September 2016, almost three decades after the USAir debacle, three of the four airlines – Delta Air Lines, UnitedContinental, and American Airlines – appeared among the firm’s publicly traded holdings. By the final filing of that year, Southwest, the fourth in what Jonathan Tepper’s The Myth of Capitalism calls an oligopoly that now dominates the industry, appeared on the holdings list. All four have been there ever since, and it’s not because he 88 year-old Buffett has lost his marbles.

Somehow, a fragmented, intensely competitive industry plagued by unions and underfunded pensions, has become insulated enough from competition that Warren Buffett wants to own the major players. It’s not simply that Buffett now owns an airline. It’s that an investor whose calling card has been finding a company with a durable competitive advantage now owns four major players in an industry that are virtually indistinguishable from each other except for their ability to dominate hubs and routes and seemingly divide the industry among themselves against smaller competitors.

As Robert Kuttner wrote in the New York Times after an overbooking debacle made headlines, “air travel is far from a free market.” That because airlines, once heavily regulated, competed so hard after deregulation that they all went broke. In the 40 years and more than 40 mergers since deregulation in 1978, carriers divided up “fortress hubs,” maximizing pricing power and crushing smaller competition that tried to break into a hub. “An industry that is not naturally competitive went from being a regulated cartel, to a brief period of ruinous competition, and then to an unregulated cartel. . . . [restoring] profitability, but at awful costs both to customer convenience and to economic efficiency as well,” says Kuttner. The solution is regulated competition, according to Kuttner, but the Justice Department now prefers “concentration and collusion” to regulated competition, according to another Times piece.

Airline profitability is also now evident in the numbers. After mostly burning capital from 2004 through 2010, Delta has settled into a remarkably stable mode of posting positive margins and posting respectable returns on assets year-in and year-out.  The same general pattern exists for the other big three in the industry.

If you’re concerned that the Justice Department will start to take a harder look at all the mergers that have occurred over the past 40 years, this investment isn’t for you. If you think the Justice Department will continue to remain asleep at the switch, then the airlines are eminently investable. Profits and returns on assets are not mind-blowing compared to some information technology companies, but they have turned positive for the foreseeable future. Oligopolies and the collusion — even if tacit — that usually occurs within them usually make for a healthy investing situation. It’s probably best to follow Buffett and own the whole group though.

Own The Company That Dropped Its “Don’t Be Evil” Motto

Most investors know what the “FAANG” stocks are – Facebook, Apple, Amazon, Netflix, and Alphabet (parent of Google). These stocks have had big runs over the last few years, and they’ve struggled more than the market over the past few months. That’s typical behavior for growth or glamor stocks – higher than the market when it goes up, and lower when it goes down.

Of these stocks, which one has the best long-term prospects? If you had to own one for the next 10 or 15 years, which one would it be? I think all of them, except for possibly Netflix, have strong business models, but I would pick Alphabet (Google). Here’s why.

Although I’m not sure he means to, Jonathan Tepper lays out the case for owning Google in his recent book, The Myth of Capitalism: Monopolies and the Death of Competition. When I was reading this book, I found myself enraged at how the tech giants have managed to become monopolies, but also wondering how much of my money I could stuff into their stocks. Google stood out to me as being a particularly bad actor, but also one whose future profits the selfish part of me wanted to own.

Tepper begins his story about Google by reciting what the search juggernaut did to a firm called “Foundem.” Foundem gave users the ability to search for the best price on a desired product. Somehow, although Foundem enjoyed an initial wave of success with shoppers rushing to use the site, “suddenly, after the second day, users never came back,” as Tepper tells it. It turned out that by the second day Foundem had dropped 170 pages down when shoppers searched for it after being at the top of the search list initially. Google removed Foundem from its organic search results and also prevented Foundem from purchasing ad placements via Google AdWords. Google “disappeared” Foundem, the way people get disappeared in totalitarian regimes. Google had its own product search service that it wanted to promote, and Foundem presented unwanted competition.

Google has done similar things to other companies in its ambition to grow its basic search business through ancillary “verticals” or searches in specialized areas – real estate listings, local business directories, legal filings, price comparisons, images, etc…., according to Tepper. For example, Google noticed that searches like “where’s the best nearby steakhouse” were becoming popular, so it decided to appropriate Yelp’s reviews. That meant Google users could see the Yelp reviews on Google, and bypass Yelp entirely. Yelp complained, eventually to the F.T.C., but Google’s response was that Yelp’s only alternative was to remove its content from Google altogether, according to this NYTimes article.

Google did similar things to other review sites such as TripAdvisor, and Cityserach, and it also allegedly provided pressure on cellphone manufacturers Samsung and Motorola to prevent them from using a navigation system in their phones called Skyhook. Google also adjusted how it displayed images so that its users could see and download Getty Image’s photographs without going to Getty’s website. The Times article quoted Getty’s attorney, Yoko Miyashita, saying he received a response from Google to Getty’s complaint that basically argued, “’Well, if you don’t agree to these terms, we’ll just exclude you.’” Miyashita said that wasn’t really a choice because if you’re not on Google, you basically don’t exist.

Over the past decade, Tepper calculates that Google, Amazon, Apple, Facebook, and Microsoft have collectively purchased 436 companies, mostly without antitrust interference.  It’s possible that the tide is turning against Google, and that it won’t be able to do to rivals in the future what it has done to them in the past – buy them, appropriate their content, or prevent them from appearing in searches. But, according to Tepper, Google already controls nearly 90% of search advertising. Advertisers want to be there because that’s where search is happening. Searchers want to be there because that’s where they’ll find what their searching for.

So far, Google has managed the neat trick of censoring or manipulating what people search for without offending them or incurring the wrath of the Justice Department. At some point the firm gave up its “Don’t be Evil” motto, perhaps realizing it couldn’t live up to that. But that means if you want to bet on one FAANG stock for the next decade, and you can swallow your moralism, Google probably has the best shot at continuing to deliver high returns.