TIP851: HEICO Vs. TransDigm: Whose Aerospace Monopoly Is Better? w/ Kyle Grieve & Shawn O'Malley

The Investor's Podcast (We Study Billionaires) - The Investor’s Podcast Network

Kyle Grieve and Shawn O'Malley conduct a detailed comparative analysis of HEICO and TransDigm, two dominant aerospace components manufacturers known for their durable competitive

Key takeaways

• TransDigm relies on a sole-source monopoly model, allowing it to aggressively raise prices on critical aircraft parts with no direct alternatives.
• HEICO competes by engineering FAA-approved aftermarket components priced 30-50% below OEM rates, building customer loyalty through cost savings and reliability.

Main topics

• Aerospace components industry economics
• Sole-source vs. aftermarket discount business models

Notable quotes

"I don't like that way of making money. It's just too brutal. They figure out something that has a little monopoly due to the defense department regulations, and they raise the price 10 times."

Conclusion

The episode provides investors with a nuanced framework for evaluating high-quality aerospace

Transcript preview

Speaker 1 (0:02) Welcome Speaker 3 (0:02) back to the Investors Podcast, episode 851. Today, we're pitting two of the best businesses in the entire aerospace industry against each other, Heiko and Transdime. We'll look at these two businesses mainly from two angles in quality and Speaker 2 (0:14) value. Coming into this episode, I assumed one of them would very much be the obvious choice for coming out on top. But really, the more I researched, I realized these businesses are a lot closer in terms of quality than I initially thought. Right. And I think it even got close enough Speaker 3 (0:29) that we really had to nitpick at some of these more subtle nuances of these businesses just to come to some sort of conclusion. But I will admit the tiny edges here and there do really add up. But I think there's actually one place where these businesses aren't that close at all. And that's in the price that you have to pay for them. That's right. Speaker 2 (0:45) And one of them trades like the market already knows it's a much better business. And the other is priced like it's just fine. So the real question today isn't only which business is better. But which business would make the better buy today? Let's find out. Speaker 1 (1:02) Since 2014, with more than 200 million downloads, we have interviewed the world's best investors, studied deeply the principles of value investing, and uncovered many compelling investment opportunities. We focus on understanding businesses and intrinsic value, investing accordingly, and sharing everything we learn with you. This show is not investment advice. It's intended for informational and entertainment purposes only. All opinions expressed by hosts and guests are solely their own. and they may have investments in the securities discussed. Now for your hosts, Sean O'Malley and Kyle Grieve. Speaker 3 (1:49) If you caught our YouTube live stream on Sierra Choirs last month, you caught a sneak peek of where this video today is headed. So we concluded in that conversation that Heiko was a higher quality business than Transign. But we didn't really dig into specifically why that is. And given that both of these companies are very, very good businesses, I thought it'd be a great exercise to examine these two aerospace monopolies in much greater detail. Speaker 2 (2:10) So we've covered TransTime on the show before, and I definitely saw why the company is beloved in many quality investing spaces. But I admittedly have not looked into Heiko with as much detail. And I think just generally, I've seen the aerospace industry as being probably well beyond my circle of competency. And that's certainly no excuse, though, for not trying to better understand it, especially when you have some great companies like TransTime and Heiko in it. Yeah. And to be honest, I think I've held a very, very similar bias to you there, Speaker 3 (2:42) Sean. One of the first publicly traded companies I ever bought was Air Canada. And while I still actually use that business very heavily today because of all the points that I get with them, I actually have zero regrets about selling that business at a profit because as you already know, airlines for the most part are simply just not good businesses. But when it comes to these businesses like Heiko and TransLam, I think I probably allowed that bias to maybe bleed into the entire aerospace industry, which is definitely a mistake because, man, many of these businesses that make and maintain planes and their parts or components, they're just cash cows. So three of Heiko's named competitors are General Electric, Pratt & Whitney, and Rolls-Royce. And they are all just minting cash because they are the three companies that really make jet engines for the entire aerospace industry. GE Aerospace has 27 % profit margins in the last six months, just to give you an idea of just how profitable the industry is. And both Heiko and Transdyn has very nice profit margins as well. Not quite as high as GE Aerospace, but still very solid with Heiko coming in around 18 % and Transdyn producing profit margins of about 21%. Speaker 2 (3:49) So I think the message here is pretty clear. The margins on these businesses making airplane engines or parts is clearly very high, and it doesn't resemble what actual airlines earn economically. So I think I can speak for both of us when I say this is an industry that definitely deserves a closer look than we've been able to give it. Well, I Speaker 3 (4:12) don't think we should beat ourselves up too badly after all. There's only so much time in the day. And I guess if I'm being completely honest here, if I had to attempt to tell you what parts there are inside of an aircraft engine or how it works, my answer would approximately be, I haven't got a clue. So I just want to be upfront about that. If there's one thing that I've learned about investing over the years, it's that you don't necessarily have to be a PhD in the inner workings of a business just to understand if the business would make an actually good investment. So what you really need to know is whether that business can sell more and more products and services in the future. And I think that when it comes to aerospace components business, we can build a knowledge base to kind of understand whether these businesses will make more or less money Speaker 2 (4:54) in the future. I certainly agree with you there. And all of that really comes down to one thing. And if you want to sell parts that go on an aircraft, it's not easy to do. Every single part, including the screws or seatbelts, That has to go through very strict regulations and reviews. And the bodies that govern that, such as the FAA in the US, of course, they take that job very seriously because it's literally a life or death decision to allow a certain part or not onto an aircraft or to be put into an aircraft. And so I couldn't just order a bunch of screws from overseas and then start selling them to plane manufacturers as replacements because they're cheaper. I'd have to go through years of certification to ensure the safety and specifications of something as innocuous as literally just a screw. That's right. But Speaker 3 (5:45) perhaps the best part about businesses like Transteim and Heiko is kind of the pricing power that they have for these parts. So since this isn't really a commodities industry due to the heightened regulations, like you just pointed out, Sean, and since every single part is very, very specifically engineered to very specific specifications, These parts can be sold for prices that, to be honest, might sound completely mind-boggling. So while researching this episode, I used the book, The Compounders, which I'd highly recommend, by the way, to learn more about Heiko. So in that book, they told a really, really good story about meeting the Mendelssohn brothers who run Heiko. Now, during this meeting, they were asked to guess the price of a small bag of screws used in the airline industry. So they knew the price would be high. So they guessed $10,000. Why not? The Mendelssohn's went on to tell them they were way off and the actual price was at $90,000. So I think this is just a really, really good story to show that a company clearly cannot sell a bag of screws for that kind of price if it has thousands Speaker 2 (6:40) and thousands of different competitors out there. Robert Speaker 3 (6:42) Leonardu Getting Speaker 2 (6:42) to that point, I do think we should discuss the business models for both of these businesses. Daniel pitched TransTime to me about a year ago. So I can maybe start us off there as we do the comparison. So Transteim is a designer, producer, and supplier of highly engineered components that are essentially critical parts of commercial and also military aircraft. But what I think is probably most interesting about Transteim is actually their founder, a gentleman whose name is Nicholas Howley. And he no longer leads the business, but he still is the chairman of the board. the gist of why he founded the business was that a large percentage of an aircraft's components were made by a single certified manufacturer like GE Aerospace, and that manufacturer would remain the sole legal source of those parts throughout the aircraft's entire life cycle. So that sounds like a pretty good business model to be in, right? And that life cycle can last 30 years plus. So Howley recognized that if he could be a supplier of these parts, he would have a very long-lived asset and entrenchment into this industry since the parts would need to be continuously purchased throughout the aircraft's lifecycle. And so instead of approaching this by trying to engineer the parts himself and going through these lengthy regulatory hurdles, he built a conglomerate around acquiring the suppliers that already had their toe dipped into this space. Speaker 3 (8:13) Yeah. I mean, getting an annuity like RevenueStream from these businesses is just a great idea, right? So we really love businesses that we can forecast well into the future. And I think a business like Transdime really gives you that. But it's worth noting that Transdime specifically has three value drivers in which the company was built on. So in Howley's view, the only three things that can increase the intrinsic value of a company are to either decrease costs, increase prices, and win new business. That's pretty much the DNA that Transdime was built on. And I think Transdime has done a great job on all three of those value drivers, which is why they've compounded revenue at 17 % and EBITDA at 18 % for over two decades. Speaker 2 (8:50) I know Transdime is very diligent about the acquisitions they make because they want to ensure that they are truly proprietary and the sole source before acquiring. And so Hallie mentioned that many of the businesses that they're trying to acquire claim to be proprietary, but actually a lot of the time they weren't. Right. And Speaker 3 (9:09) I think that he found that to be kind of a real bottleneck, at least for the beginning part of the business. Because if you want to have pricing power, which is one of TransDyme's key tenets, then you need to have that monopoly-like angle to really get there. We'll address this much more later in the episode though. So I just really want to make sure that our listeners understand how TransDyme works because it's really important. So when a new plane is built, much of the value accrues to the aircraft manufacturer, whether that's Boeing or Airbus. Then on the engine side, that would be handled by companies like GE Aerospace, Pratt & Whitney, and Rolls-Royce. So these businesses are all referred to as original equipment manufacturers or OEMs. So Transdime does offer parts that do go into brand new aircraft. So they'll offer parts that do go into engines. But where Transdime and also Heiko really shine is kind of in this aftermarket section. So once the planes are in use, they need constant upkeep. And as I mentioned, They stay in service for 30, 40, or even 50 years. So this means that parts are inevitably going to wear out, they're going to break, and they have to be replaced Speaker 2 (10:10) during routine maintenance. And those aftermarket sales make up about 55 % of TransTime's business. So not trivial at all. And before we discuss Heiko's business model, I have to mention that TransTime has three primary business segments to it. There's power and control, there's the airframe segment, and then there's a non-aviation segment. And so power and control provides components that help provide planes with, well, power or control. of the other parts. So this includes things like ignition systems, specialized pumps and valves, generators, sensors, and more things in that vein. Whereas the airframe segment, that is the part that deals more with what you'd find in the fuselage of the plane. So parts that open and keep doors closed and cockpit security and washroom components and seat belts and parachutes and more stuff like that. Whereas the non-aviation segment is more of a rounding error, to be fair, for TransTimes revenue. So we probably shouldn't get into it too much, but you can see that many of the parts they already manufacture have applications in other industries as well. Seatbelts and actuators and fuel valves have pretty broad applications. So they're sold to other industries, such as ground transportation and mining and construction, and also the oil and gas industry too. So that's what that non-aviation... component of the company is all about. Speaker 3 (11:38) Yeah, there really is a very wide range of applications for what they make. And I could see some of these industries being absolutely massive, but they haven't really made growing this part of a business a priority. So I assume there's probably enough opportunities right now, at least in the aerospace components industry, for them to just not have to put too much effort into the non-aviation sector. Now, TransDyme grows both organically, driven by its value drivers, and then also through M &A. But let's now take a look Speaker 2 (12:04) at Speaker 3 (12:04) Heiko. It's not too dissimilar from Transdime. They both have organic and non-organic growth. They both made a ton of acquisitions over their lifetime. Heiko has made more than 110 acquisitions since 1996. So Heiko also makes parts for OEMs for new aircraft, but they have a very large aftermarket component as well. So if you add up Heiko's sales of aftermarket parts, as well as repair and overhaul part services, they have aftermarket revenue making about 59 % of their revenue. So also quite similar to Transdime. Speaker 2 (12:35) From the recurring revenue aspect generated by these aftermarket sales, the two businesses are definitely very similar. And I think many of our regular listeners will already know that I really like businesses with recurring revenue, which is why we own companies like Intuit and Adobe, where customers are pretty well locked into those contracts and arrangements, and the product is pretty hard to replace. So they just end up paying those two companies annually. I mean, with Adobe, for example, we use their entire suite of products for the most part pretty regularly as part of producing this podcast and our YouTube channel and everything else we do. So it's all the more attractive when a business has such a high quality business model and it falls within our circle of competence in some ways, because like with Adobe, we've become pretty well acquainted with their offerings and what they're able to do and what they're not able to do. And that for me is really the hang up I have when I think about the aerospace industry. So how about we try to zoom in more? and better understand things better for folks who are not deeply acquainted with aviation manufacturing. Speaker 3 (13:37) And Speaker 2 (13:37) so I know Heiko is broken into different segments as well. And with them, there's a segment called the flight support group that makes up the majority of revenue. So I don't know, I'll throw it over to you, Kyle, if there's anything you want to add there. Speaker 3 (13:52) Kyle Turner Yeah, that's completely correct. So as of the latest quarter, the flight support group makes up about 67 % of revenue. Now, This segment uses proprietary technology to both design and manufacture jet engine and aircraft replacement components. So they sell to commercial and military customers. But here's where they kind of separate from Transdime. So Heiko is very intentional about setting prices consistently about 30 % to 50 % below the OEM prices. But this is only the start of their competitive advantage. So another vital aspect of Heiko's business model is the regulation of its parts. As I mentioned earlier, you can't come in with a cheap replacement part and expect anyone to actually buy it from you. So in the US, the Federal Aviation Administration has a program known as the Parts Manufacturer Approval. Nearly every single component that Heiko sells has been approved specifically by the FAA. So Speaker 2 (14:39) I think the simple way to think about this is that Heiko is like maybe the generic drug company of the aerospace industry. They sell a product that is something like the functional equivalent of the original equipment manufacturer's component, but they do so for a really steep discount. And the FAA is like this governing body that decides whether their components are up to par, basically. And then this approval process can take anywhere from two to five years, depending on the complexity of the part involved. Right, exactly. Speaker 3 (15:10) I think that's the perfect metaphor. And you can get the idea there that the time that it takes is obviously a big part of Speaker 2 (15:14) the Speaker 3 (15:14) advantage as well. So the cool part about Heiko is that they don't outright copy the parts. They actually are designing it and having to engineer it themselves as well. And this probably explains why they're able to reduce the price on it while still making some very, very high margins. So the second part of Heiko's business is called the electronic technologies group. This part of the business deals more with things like niche electronics. Think of devices like laser range finders used in military targeting systems or amplifiers and antennas that send and receive radio signals, all the way to backup power supplies or even power conversion kits. They sell a very wide range of electrical components. And this part of the business accounts for the remaining 33 % or so of its revenues. Both of the segments have a large aftermarket parts business, but from what I can gather, the flight safety group offers much more in aftermarket sales compared to the electronic technology group. So with these two business models broadly expanded on, I have a question for you, Sean. Without going into much more specifics than what we've already covered so far, which business model do you think you prefer? Speaker 2 (16:14) It's a tough question because when you strip away the details, it does seem like the two businesses are remarkably alike. They both lean heavily into the aerospace parts aftermarket with well over half of Speaker 3 (16:27) the Speaker 2 (16:27) revenue coming from parts that have to be replaced during an aircraft's 30 plus year lifecycle. So a lot of overlap there. And they both kind of grow through a mix of organic growth and acquisitions. They both enjoy some regulatory protections and barrier sentry that make it hard for new competitors to come in and get a part certified. So for me, the real differentiating factor probably comes down to pricing and the really philosophy that these two companies have. Because the approach that they take is very opposite from each other. TransTime's model is built on being the sole source for a part, and then using that position to basically... justify radically higher prices in some cases over years and just to really drive most of their revenue by just pushing prices higher. Some people might call it price gouging, whereas Heiko comes in with an FAA-approved alternative, and they're basically trying to cut costs. Their prices are deliberately maybe 30 % to 50 % below the OEM. So I think I like that business model better. If I had to pick, I would probably lean toward Heiko, when your pitch to customers is the same quality at a much lower price, they're going to be very happy to keep buying from you and probably to do so for a long time. And every new part you get approved wins more business because you're saving the airline money rather than charging it more than you otherwise would. So it's kind of a win-win-win all around. And yeah, it strikes me as being much more sustainable, whereas Transdime's approach is clearly more lucrative per part. but it does kind of depend on customers really having no alternative. And I do think that makes the relationship somewhat more adversarial or parasitic over time. So with all that said, I can see the case for TransSign's pricing power being a very compelling component of the business from the shareholders' perspective, even if it's a bit predatory in some ways and more likely to attract regulatory scrutiny, which makes me think it's somewhat less sustainable. I come with my own biases. And so I'm kind of curious to see whether you see it differently. Speaker 3 (18:38) Yeah, I don't think I have too much to add from what you said there. You said it very well. I think it's still kind of hard for me to say because I obviously, similar to you, I like businesses which can provide a very, very similar product at a large discount. But most businesses that I've seen in the discount area are also in industries that sell these kind of largely commoditized products, something like a Walmart or a Costco. But the aerospace industry in which Heiko operates clearly does not sell commoditized products due to the high barriers to entry. While I do think it's compelling, I'm still not sure if it's more compelling than the pricing power advantage TransLime offers. The ability to consistently raise prices is really, really strong. Yes, the component parts will naturally have some inflation built in, but if you can price your components higher than your input costs, well, then you get this massive boost to your profits due to the effects of operating leverage. Another very important part of TransLime and Heiko's business model though is in M &A, which we have to go over in a little more detail here, as it could be part of what sets one business apart from another. Speaker 2 (19:35) Well, since the business models, as we've said, are so similar, yeah, I do think we're going to need to kind of get into the weeds here to break things apart. So looking at the M &A history of both companies, Heiko has done 113 acquisitions over about 35 years. And so that's an average pace of a little more than three acquisitions a year, which is not actually that high of a number for a business that gets labeled as being a serial acquirer. And it is worth noting that this year in particular, though, has been pretty active. So they've done six deals in 2026 already. Yeah. And kind of the point about the Speaker 3 (20:12) pace of acquisitions is really fascinating to me, just in serial acquirers in general. So the problem with most serial acquirers is that as they scale, they're forced to make larger acquisitions. So this can actually make scaling harder because you tend to face more competition from making these larger acquisitions, which can unfortunately drive up the prices. And then obviously that also reduces the prospective returns of that acquisition. Speaker 2 (20:33) So we can actually take a look at Speaker 3 (20:35) Heiko's average deal size just this year. So as you already mentioned, they bought about six businesses worth total considerations of about a billion dollars. So that puts the average deal size at