But after a few seconds, it was all over. The plane leveled out, the lights returned to their normal glow and the shaking stopped. To my amazement, though, the other 275 or so passengers on the plane sat completely calm during the entire process.

You see, I hate to fly. Apparently, the type of turbulence that we experienced was normal…I guess I was simply overreacting.

Luckily for the airlines, I’m one of only a few people who have a fear of air travel. Almost everyone else I know chooses air travel over any other form of travel.

According to the International Air Transport Association, the air industry handled over 2.13 billion passengers in 2006. The experts are estimating that that number will rise to 2.75 billion in 2011… That’s an increase of 29%.

So today, I’m going to share with you the name of a small-cap air services company that’s set to take advantage of that increased travel in a big way. 

One of the world’s best investors recently placed a $40 million bet on this company. And investors who bought this stock in October 2005 have already made a 240% gain on their money…

Here’s the full story on a small-cap stock you should take a further look at…

Pinnacle Airlines — Your Chance to Make 198% in the Next Three Years

Before I get started, I confess, this isn’t my idea. I first heard about this company a few weeks back while attending the Value Investing Congress in New York City. Mohnish Pabrai, famed investor, author, money manager and Warren Buffett disciple, presented the idea of Pinnacle Airlines (PNCL: NASDAQ), a small, regional air service provider to the major airlines.

Pinnacle’s business is simple. It specializes in leasing small regional planes to the major airlines, like Delta, Continental and Northwest. Its clients often sign long-term contracts locking them into years of service.

You may be wondering why the major airlines don’t just buy and run these regional planes themselves…good question. One of the conference attendees asked the same thing…

Pabrai explained that there’s not enough money in the margins of these short regional flights. The airlines would rather concentrate on running their 200-plus passenger planes. It’s easier for the majors to outsource the regional service than to worry about running it themselves. So they turn to companies like Pinnacle.

But here’s the best part… Pinnacle doesn’t care about filling the planes. The major airline companies have to worry about that. Pinnacle doesn’t have to worry about the cost of fuel, as the major airlines do. All Pinnacle does is provide the planes and the service.

But why Pinnacle? And why now?

The Q400 Turboprop Moat

To kick off his Value Investing Congress presentation, Mohnish preached about finding good companies with deep “moats.”

What’s a moat?

Basically, it’s a term Buffett uses to describe what a company that provides or produces something that’s hard to replicate has — what makes it hard for competitors to cross into the company’s territory. The deeper the “moat,” the better the company.

According to Mohnish, Pinnacle has three major factors that contribute to its deep, and deepening, “moat.” Let’s take a look at them one by one…

Moat #1: It’s Not Dependent on the Amount of Passengers on a Plane!

Unlike what the name implies, Pinnacle Airlines isn’t your normal airline company. It leases its jets and services to the big boys. The contracts are worked out and signed for terms of a few years or more… So Pinnacle isn’t dependent upon filling the plane. It could not care less about the amount of people on board. By that time, it’s already got the contract and it’s generating guaranteed cash…

Furthermore, it doesn’t care about the price of fuel. The big boy airlines still have to cover those costs. Pinnacle just provides the regional air service and plane.

Moat #2: It Can Fly for Multiple Companies!

Pinnacle isn’t limited to one company that it can fly and lease planes to. It’s inked deals with Northwest, Delta and Continental. Its revenue is split multiple ways, so the company doesn’t depend on one client for its entire revenue.

Moat #3: It’s Got the Right Kind of Plane!

The cost of fuel is rising. You and I know that. The airlines know that, too. Every day, it’s becoming harder and harder for them to break even on jets that fly 50 or fewer passengers. The airlines know that their “sweet spot” to break even and turn a small profit is in the 70-120 passenger plane. So the demand is growing for the 70-120-seat planes — and Pinnacle has just the plane for them.

It’s called the Q400, and it’s a 75-passenger turboprop plane. But it’s not just any turboprop… It has submarine technology installed that allows it to operate quieter than a typical jet…the cost of ownership is the same as a 50-person jet (so you can fly 25 more passengers essentially for free!)…it cruises at a speed just about as fast as a normal jet…it’s got a 1,500-mile range…and best of all, it requires less fuel. 

In the next few years, the demand for Q400s will be growing, and Pinnacle’s got ‘em…

So according to Pabrai, Pinnacle’s moat is deep…

But what’s it worth — and what can you make from it?

Pinnacle ended up with just over $54 million in free cash flow (the money that could potentially be pulled out of the business) for 2006. Pabrai told us that he believes that this will increase to $95 million or so in 2010.

Should Pinnacle decide to sell its business in 2010, a fair value, based on competitive analysis, would be somewhere in the range of 10-15 times that free cash flow number. 

If you slapped the 10 times multiple on the $95 million number and then divided it by the number of outstanding shares, you’d have a stock worth $46.77 per share.

Right now, you can pick up shares for just $15.67 a pop. That’s at least a 198% gain in the next three years…

Thanks for the tip, Mr. Pabrai.

To your wealth,
Joe Schriefer
December 26, 2007

P.S.: Pinnacle isn’t the only company selling for less than it’s worth. We’ve found four more just like it… Unfortunately, for space reasons, I can’t tell you about all four of them in this alert.