IP Research Roundup: Transdigm, Loar, HEICO, FTAI

For nearly a decade, we’ve been studying the commercial aerospace market. Aerospace OEMs have attractive characteristics including high switching costs from strict FAA certifications, slow product life cycles, and exposure to the aftermarket of aircraft platforms that can last ~50 years. This simple TDG chart is illustrative of the aftermarket attractiveness:

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We’ve focused our internal research on understanding the nature of the aftermarket profit pool, OEM bargaining power with airframers, and durability of OEM and PMA earnings. We list our published research below and explain why and how we’ve covered these specific angles:

1. Boeing, TransDigm & Commercial Aerospace: An Inverted Pyramid: history of commercial aerospace and relationship between Boeing / Airbus and suppliers.

2. TransDigm: Boeing vs OEM Supplier Bargaining Power: how and why TDG has power over airframers, how Boeing looked to combat TDG pricing power, and potential risks to TDG from airframers

3. Topicus, Transdigm and Value-Based Pricing: compares TDG and CSI / TOI value-based pricing techniques and pricing power of PMAs vs vertical market software

4. TransDigm's Product Innovation, Howley, & TDG 10-year equity returns: explores TDG approach to new product development and operational excellence

5. TransDigm Group: IP Learning Journey curating all our work on TDG including TDG bargaining power vs Boeing, value-based pricing techniques, operational strategy post-acquisition, shipset model dynamics, risk from PMAs, case study of Korry Electronics.

6. Loar Holdings: IP Company Learning Journey curating all our research on LOAR and compares the underlying operating assets to TDG at its 2006 IPO.

7. HEICO: PMA vs OEM Power: how airlines make decisions between OEM, PMA, DER, and USM parts, strategies OEMs use to combat PMA adoption, and other risks to PMAs

8. HEICO: Wencor Acquisition Synergies and Analysis: how Wencor assets fit into HEI portfolio across PMA, distribution, and MRO, and why ABOM strategies are important for HEI

9. HEICO: Flight Support Group: IP learning Journey curating all our work on HEI including structure of commercial aero aftermarket, OEM vs PMA certification process, value of HEI vertical integration across MRO, distribution, and PMA, Wencor acquisition and the strategic value of ABOM strategy.

We also list a handful of interviews that explore CFM56 sales and MRO process and parts distribution:

1. CFM International: 37 Years Selling Aircraft Engines

2. Wencor, Seal Dynamics, & Aerospace Aftermarket Distribution

3.. Boeing Propulsion: OE and Aftermarket Strategies

4. Safran: CFM56 & LEAP MRO

5. Satair & Aerospace Distribution

6. AmSafe, HEICO, & Aerospace Aftermarket Distribution

We first explored the structure of the commercial aerospace value chain and why one Former TDG executive called it an “inverted pyramid”.

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The supply chain in aerospace is actually an inverted pyramid. I recall this from early on in my career, when I was working with one of our legal partners. She said, really, aerospace contracts are an enigma to me. The way they’re written, basically, the supplier seems to be an indentured servant to the OEM. But yet, the supplier is the one that holds all the cards in the agreement so you almost want to be that indentured servant, because the OEM can’t get rid of you. Imagine, on the systems that TransDigm participates in, Boeing having to go and requalify. The qualification cost, the development of a new supplier. All of that cost and the bigger issue that people, sometimes, overlook, the risk of failing qualification. Those barriers make it very difficult for the OEMs to walk away. - Former VP at TransDigm

The history, culture, and strategic limitations of the airframer is critical in understanding the durability of component OEMs like TransDigm and Loar.

We then explored specific case studies of how Boeing has actively tried to displace TDG parts. In 2016, Boeing communicated plans to triple its Global Services businesses from $15bn to over $50bn by 2026. It combined its commercial and defense services business into a Global Services division (BGS) and specifically targeted clawing back ownership of the commercial aftermarket. Boeing went so far as sending letters demanding aftermarket royalties from OEMs:

Boeing began to assert that all the intellectual property (IP) was theirs. They were sending out letters to large and small companies alike, including Honeywell, demanding royalty payments. The direct assault was the letters stating that companies were leveraging their IP to sell in the aftermarket. In a way, they were correct. - Former EVP at Honeywell

This piece of research shares the history of Boeing and TDGs bargaining power in an attempt to understand the durability of TDG aftermarket earning power.

During our work, one similarity between TDG and Constellation Software piqued our interest: both companies believe most owners of VMS or certified aero parts systematically underprice products. This was from a Former TSS executive:

A lot of software companies, in their contract, in small print, say okay, we can change the price at the indexation rate. Indexation is maybe 1% or 2%. But they are building newer software, with more added value and that added value is actually worth money to the customer. If you do not charge them for that added value, for the new functionality into the ERP system, then you are actually giving them a present. I truly believe that most of the VMS companies are underpriced. - Former Director at TSS

We further compare pricing power techniques used by TDG and CSU and the switching costs of both types of assets.

It seems everyone focuses on the ‘value-based pricing’ tool for TDG, yet few discuss the company’s new product development. This piece of research focuses on the importance of TDG ‘shipset content’ model’:

We always looked to expand our shipset value on current and new platforms. When I was at AdelWiggins, they had a composite product line in development with Boeing. This was probably one of the neatest new business stories out of the group. This composite product was called a lightning isolator… At almost $300,000 per 787, which ramped up to 14 per month, that was a significant product line which grew from less than $1 million to almost $40 million a year. We were also able to leverage that into the military platform on the A400M and work with Airbus on the A350. That was one of the great innovative stories of a new product line introduction. - Former VP at TDG

All our work is then curated into this TDG Learning Journey which covers the following:

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We’ve also curated all our research on Loar Group in a learning journey that covers:

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During our research, we spent time understanding the FAA code of regulations focusing on Part 21 certifications and the different types of PMA certifications.

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This research piece compares PMA by license and T&C and explores the dynamic between licensed OEMs like TDG and PMA companies like HEI:

Essentially, PMA is a method for certifying airplane parts…PMA allows the FAA to give approval for certain facilities or companies to produce parts that were not certified during the initial certification of the aircraft or engine. - Former EVP, Jet Parts and Boeing

We then explore HEIs Wencor acquisition with a focus on Wencor’s ABOM strategy. We explore how HEI can leverage Wencor’s PMA portfolio and its experience combining MRO, DER, and PMA to solve airline problems:

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All of our HEI Flight Support Group research is curated into a Learning Journey which covers:

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Further Research Questions We're Exploring

1. Study of HEICOs ETG division

2. Handicap the quality of Loar’s BTP assets

3. FTAI: LEAP and CFM56 engine module swap moat?

4. FTAI / Chromalloy JV and engine PMA potential growth

5. Aircraft lessor approach to PMAs and lease contract structures