Consumer Funded Growth
The 2000's and 2010's are marked by companies with negative capital needs, fueling growth based on consumer spending. This is big in SaaS companies, who take upfront payments for contracts which funds R&D, marketing, sales, etc. Salesforce, Netflix, Adobe, and Meta have all used consumer funded growth.
Let me double click on this idea. The reason these companies are worth Trillions is because of a concept of negative working capital. Here's an example. Salesforce sells a $1,200,000 software contract and the customer pays up front.
The $1,200,000 goes to Salesforce on January 1st and recorded on the balance sheet as cash. They recognize the revenue over the life of the 1 year contract. While it may look like they're making $100,000 per month, they've actually had $1.2m of cash since January 1st. Software has a unique characteristic, though, in that the marginal cost of additional customers gets closer to zero as the business scales. Therefore, all revenue can go directly towards overhead and growth.
In the event that all the money is not paid up front, a business may choose to pull forward those future revenues through a receivables debt facility, paying an interest premium on some portion of the future generated cash flows.
Software has the "Magnificent Seven," well Private Aviation has the "Fabulous Four" (I made up this term). These four companies have engaged in consumer funded growth, but the form and function of this growth strategy is a bit different.
A Tale of Two Strategies
If you'll remember back from the last article, Power Laws and Private Jets, that Wheels Up and VistaJet are what we might refer to as hyper-scalers. They poured on the gas to achieve growth-at-all-costs, because in capital markets (especially during 2020/2021) you are judged on CAGR (compounded annual growth rate) and expected to deploy capital at a rapid pace. Access to capital is critical to business growth.
There's two distinct business models with the Fabulous Four. The first is pure-play charter, focused on prepaid jet card hours and memberships, and the other is fractional ownership. Both are forms of consumer funded growth.
Consumer Funded Charter Growth
Charter fliers are fickle. It's the least committed way to fly private, leaving many companies unable to scale because revenue is unpredictable. That is where jet cards and memberships come in, to help create stability and predictable cash flows.
Remember back to our previous example about software. We took the 1 year prepaid contract and amortized it over 12 months, showing $100,000 of revenue per month. Jet cards are also prepaid, but they are recognized in a much lumpier manner. Take the made-up example above. A $1,200,000 jet card is purchased, and the customer takes 8 flights over a period of, let's say, 4 months. They still are owed future recognized revenue of $831,905 because they paid for it.
The jet card provider is able to use that up front cash how they see fit. Companies like VistaJet and WheelsUp used that prepaid cash for growth, trying to reach hyper scale status. The problem? These two numbers are way above the EBITDA line, and charter companies that own their fleet have a lot of "I" and "DA" that will go below it. More on that later.
These future recognized revenues allows these companies to go to public bond markets (or IPO) and continue to grow.
The Problem
You have to keep feeding the beast for this continue as an ongoing concern. Look at VistaJet, for instance. They went to the public bond market and tried to raise $800M in debt. Now the offering is at $600M, and there still isn't a definitive deal.
The customer funded growth, which is seen as negative working capital, has now created a large future liability since flights will be delivered at some point in the future. By pulling forward all of the growth and recognized revenue, the company is caught. Apparently, VistaJet doesn't need to raise capital but I believe you don't retry a bond offering at a lower amount if you don't at least want to raise it.
Consumer Funded Fractional
Fractional companies are, by definition, consumer funded growth. When a FlexJet Praetor 600 pulls up on the ramp, you can see the FAA records of who owns the aircraft. Its not owned FlexJet, nor Kenn Ricci. The capital cycle of fractional ownership makes the capital intensive piece (buying the airplane) the duty of the owners (like members of the country club.) This makes the cash cycle incredibly efficient, and allows for fractional companies to grow without needing to take on significant debt leverage to grow. Let's use our $1.2m example again.
In this scenario and using round numbers, the cash cycle is quick because the $1.2M is received for the asset, and then they turn around and buy the asset on behalf of the customer. Both are now the provider's balance sheet and onto the customer's balance sheet.
Now, fractional companies make margin on the sale of the asset to customers, but there isn't nearly as much finance-y math happening in their cash conversion cycle. They then have monthly management fees, and when customers fly per-hour, they extend 30 day terms and then are paid for those flights, recognizing that revenue and margin quickly.
The cash conversion cycle is far more efficient in this model compared to the jet card or membership model. They are using their customers capital to then grow their business, because as the fleet grows their revenue grows, but the fleet growth is paid for by the customer. In exchange, the customer gets a predictable experience and they are able to take the tax depreciation because they actually own the asset.
It also means these companies have far less "I" and "DA" expense with their EBITDA, so comparing EBITDA numbers side-by-side to asset heavy charter operators is completely different. The EBITDA falls to Net Income with a lot less "PLINKO" than in pure charter plays.
Why Customers Should Care
I can hear you saying to yourself while reading this: "why should I care? I want to pay dollars and fly private."
The reason you should care about the financial model of your selected private aviation provider is directly tied to the risk premium you have with your private jet provider.
For those that don't live in the world of finance, a risk premium is the increased return you get for putting your capital at risk. For instance, buying US treasuries is seen as the safest way to invest cash, so the returns are lower.
The reverse logic can be seen in private aviation.
You, the consumer, are funding the growth of these companies by putting money out upfront. Otherwise, you can just pay one-off charters and not put any capital at risk up front.
If you put your investor hat on instead of your consumer hat, you can see that there is a risk premium that you are "collecting" by selecting a provider. The large charter providers have a strong balance sheet that offers you some protection, maybe even dubbing them as "too big to fail." WheelsUp has a publicly traded company backstopping them.
Smaller providers, though, don't have this luxury. Look back at what happened with JetSuite. It was good until it wasn't, and the prepaid charter customers were now unsecured creditors and received 15 cents on the dollar (a few of them read this newsletter).
In exchange for fronting the growth of a fractional provider, you're collateralized by your share on the asset. Divesting that asset can be a hassle, and you may not get the full dollar amount you invested, but the risk premium is not nearly as steep for you.
And this is why its very hard to compare the two business models. We only have publicly reported financials from a few of the largest charter providers and none for the fractional providers, but the concept holds true in large companies and small.
Private jets are not software. The marginal cost of another hour of jet flying is far from zero. So applying software math to private jets just never works.
Until next week,
Preston Holland
P.s. Send this to a friend who flies private and is considering a jet card or fractional purpose. Then ask them if you can Plinko your way into a seat on their jet the next time you're going golfing.
