TDG - Transdigm

[Liberty]

New CFO:

 

http://www.transdigm.com/phoenix.zhtml?c=196053&p=irol-newsArticle&ID=2032118

 

Gotta say, the Cliffs background is a bit scary, but I'm sure they vetted him well.

 

Quite the disparity between CLF and TDG on the business quality spectrum.  What is your thinking about the COO and CFO retirements happening in such quick succession?   

 

We'll see. The guy was also a partner at KMPG. It's possible to find very talented people in all kinds of companies. Tim Cook worked at Compaq...

 

If I remember correctly, the COO is staying on the board, and the CFO is sticking around for almost two years too (until end of 2016), so they're not exactly jumping ship in haste. I think it could be kind of a cohort effect, people who have been with the company for a long time (I'd have to dig the dates up, but if they've been there since the early 90s, that's a pretty nice run) and reaching retirement around the same time.

 

It's certainly something to keep an eye on. But they seem to have a strong management culture and a well established model that is teachable, so hopefully this is a smooth transition.

[Jurgis]

I don't think the COO/CFO leaving is a smoking gun, but I do think that there is a risk for the new people to start bending the rules which might hit a levered company much more than unlevered one if something blows up.

 

It's not a significant risk: I agree with Liberty that new people might be great and they might integrate well. But something to keep in a corner of the mind for investors.

[Liberty]

http://www.transdigm.com/phoenix.zhtml?c=196053&p=irol-newsArticle&ID=2042797

 

New acquisition, $496m (with some tax assets).

[loganc]

Is there any business in this space that is close to TDG in terms of business mix exposure to aftermarket?   

[Liberty]

Is there any business in this space that is close to TDG in terms of business mix exposure to aftermarket? 

 

Close? Not that I've  found.

[Liberty]

http://www.transdigm.com/phoenix.zhtml?c=196053&p=irol-newsArticle&ID=2043926

 

Highlights for the second quarter include:

 

Net sales of $619.0 million, up 4.8% from $590.8 million;

EBITDA As Defined of $288.1 million, up 9.5% from $263.0 million;

Net income of $110.9 million, up 22.7% from $90.4 million;

Earnings per share of $1.96, up 31.5% from $1.49;

Adjusted earnings per share of $2.11, up 12.8% from $1.87; and

Upward revision to fiscal 2015 financial guidance.

 

W. Nicholas Howley, TransDigm Group's Chairman and Chief Executive Officer, stated, "This has been a busy 60 days for our team.  We closed two acquisitions for about $800 million in purchase price in the calendar month of March and announced the execution of a contract for a third deal last week for approximately another $500 million of purchase price. All three of these businesses are primarily commercial transport focused with significant proprietary and aftermarket content.  All three acquisitions fit well with our consistent strategy and should yield private equity-like returns for our shareholders."

[loganc]

Maybe this is a stupid question, but,  looking at the 2Q slide deck, why do they not provide a numerical breakout between OEM and Aftermarket with respect to Adj EBITDA?  Is there some place in the filings that I should look to find the numerical breakout?

[loganc]

Again, probably stupid question, but how do you guys think about the debt structure here?  So, they did 450MM @ 6.5% due 2025.  As of 12/31/14 there is 3.9B of term loans.  Is it not a significant risk to not term out some of the term loan?  It seems like the Malone entities are working towards fixed rate leverage (e.g. SIRI balance sheet and the recent refinancings at VM). 

[jschembs]

It's essentially a rollup compny of avionics, aviation, and tech parts manufcturers. I looked at it shortly after their ipo in 2007 and passed :(. They weren't cheap then either, and based on there moat and fcf I don't think they will get cheap.  Alan Fournier of Pennant bought them early on and still holds all the shares. Big winner for them.

 

Warburg Pincus was the sponsor.  I've tracked a number of Warburg Pincus companies that have done very well after ipo, so I watch for them now. Don't want to make the same mistake again.

 

If you are sure that these guys have a huge moat and will grow earnings or cash flow a share by > 10%, then a 20x multiple can be cheap imo.

 

It's interesting to read these posts from 2013, where 20x is considered an acceptable hurdle that most of us would consider expensive. I've certainly come to appreciate the hidden value of ~25x EPS on strong, sustainable growth, but I wonder what folks would substitute for 20x in the earlier quote in today's environment. TDG is currently around 60x TTM EPS.

 

I recognize much of the bump in P/E is the substantial increase in debt/interest expense, so the relative increase in EV/EBIT is less so. The downside of course is the significantly reduced margin for error in business execution introduced by the debt load.

[Liberty]

It's essentially a rollup compny of avionics, aviation, and tech parts manufcturers. I looked at it shortly after their ipo in 2007 and passed :(. They weren't cheap then either, and based on there moat and fcf I don't think they will get cheap.  Alan Fournier of Pennant bought them early on and still holds all the shares. Big winner for them.

 

Warburg Pincus was the sponsor.  I've tracked a number of Warburg Pincus companies that have done very well after ipo, so I watch for them now. Don't want to make the same mistake again.

 

If you are sure that these guys have a huge moat and will grow earnings or cash flow a share by > 10%, then a 20x multiple can be cheap imo.

 

It's interesting to read these posts from 2013, where 20x is considered an acceptable hurdle that most of us would consider expensive. I've certainly come to appreciate the hidden value of ~25x EPS on strong, sustainable growth, but I wonder what folks would substitute for 20x in the earlier quote in today's environment. TDG is currently around 60x TTM EPS.

 

I recognize much of the bump in P/E is the substantial increase in debt/interest expense, so the relative increase in EV/EBIT is less so. The downside of course is the significantly reduced margin for error in business execution introduced by the debt load.

 

GAAP EPS is not the metric to use with acquisitive companies like this. VRX doesn't have a PE of 75x either. Look at FCFx or at least the company's adjusted cash EPS. TDG has been trading between 20-25x FCF lately.

[jschembs]

It's essentially a rollup compny of avionics, aviation, and tech parts manufcturers. I looked at it shortly after their ipo in 2007 and passed :(. They weren't cheap then either, and based on there moat and fcf I don't think they will get cheap.  Alan Fournier of Pennant bought them early on and still holds all the shares. Big winner for them.

 

Warburg Pincus was the sponsor.  I've tracked a number of Warburg Pincus companies that have done very well after ipo, so I watch for them now. Don't want to make the same mistake again.

 

If you are sure that these guys have a huge moat and will grow earnings or cash flow a share by > 10%, then a 20x multiple can be cheap imo.

 

It's interesting to read these posts from 2013, where 20x is considered an acceptable hurdle that most of us would consider expensive. I've certainly come to appreciate the hidden value of ~25x EPS on strong, sustainable growth, but I wonder what folks would substitute for 20x in the earlier quote in today's environment. TDG is currently around 60x TTM EPS.

 

I recognize much of the bump in P/E is the substantial increase in debt/interest expense, so the relative increase in EV/EBIT is less so. The downside of course is the significantly reduced margin for error in business execution introduced by the debt load.

 

GAAP EPS is not the metric to use with acquisitive companies like this. VRX doesn't have a PE of 75x either. Look at FCFx or at least the company's adjusted cash EPS. TDG has been trading between 20-25x FCF lately.

 

I understand FCF is better because of intangible amortization and other GAAP peculiarities, but TDG for example is trading at roughly the same EV/FCF multiple as it was in 2011, with FCF roughly 2x 2011 levels, net debt/EBITDA roughly 25% higher, with the cycle four years further along its curve. Perhaps folks believe aircraft is no longer a cyclical industry, and the future is bright enough to support those levels.

[Liberty]

I understand FCF is better because of intangible amortization and other GAAP peculiarities, but TDG for example is trading at roughly the same EV/FCF multiple as it was in 2011, with FCF roughly 2x 2011 levels, net debt/EBITDA roughly 25% higher, with the cycle four years further along its curve. Perhaps folks believe aircraft is no longer a cyclical industry, and the future is bright enough to support those levels.

 

TDG isn't Boeing. What matters isn't how many aircrafts are sold in the short-term. What matters to TDG is RPM (revenue-passenger-mile), because they make the vast majority of their FCF on the aftermarket for their vast installed based with lifecycles measured in decades. What also matters is if they can maintain or improve their content % on new platforms, which they have been doing. RPM is a relatively non-cyclical thing which barely dipped after 9/11 and the GFC of 2008-2009, and has been growing mid-single-digit the rest of the time.

 

TDG makes relatively little to OEM sales, and even loses some money by providing parts while new platforms are in development. The aftermarket is where it's at.

[jschembs]

I understand FCF is better because of intangible amortization and other GAAP peculiarities, but TDG for example is trading at roughly the same EV/FCF multiple as it was in 2011, with FCF roughly 2x 2011 levels, net debt/EBITDA roughly 25% higher, with the cycle four years further along its curve. Perhaps folks believe aircraft is no longer a cyclical industry, and the future is bright enough to support those levels.

 

TDG isn't Boeing. What matters isn't how many aircrafts are sold in the short-term. What matters to TDG is RPM (revenue-passenger-mile), because they make the vast majority of their FCF on the aftermarket for their vast installed based with lifecycles measured in decades. What also matters is if they can maintain or improve their content % on new platforms, which they have been doing. RPM is a relatively non-cyclical thing which barely dipped after 9/11 and the GFC of 2008-2009, and has been growing mid-single-digit the rest of the time.

 

TDG makes relatively little to OEM sales, and even loses some money by providing parts while new platforms are in development. The aftermarket is where it's at.

 

Fair enough - as you can tell, I haven't spent much time on the name, so the cyclical point seems off base. But is mid single-digit growth worth 25-30x FCF? Guess that's the "Platform Value" of future anticipated acquisitions.

[jschembs]

I understand FCF is better because of intangible amortization and other GAAP peculiarities, but TDG for example is trading at roughly the same EV/FCF multiple as it was in 2011, with FCF roughly 2x 2011 levels, net debt/EBITDA roughly 25% higher, with the cycle four years further along its curve. Perhaps folks believe aircraft is no longer a cyclical industry, and the future is bright enough to support those levels.

 

TDG isn't Boeing. What matters isn't how many aircrafts are sold in the short-term. What matters to TDG is RPM (revenue-passenger-mile), because they make the vast majority of their FCF on the aftermarket for their vast installed based with lifecycles measured in decades. What also matters is if they can maintain or improve their content % on new platforms, which they have been doing. RPM is a relatively non-cyclical thing which barely dipped after 9/11 and the GFC of 2008-2009, and has been growing mid-single-digit the rest of the time.

 

TDG makes relatively little to OEM sales, and even loses some money by providing parts while new platforms are in development. The aftermarket is where it's at.

 

Fair enough - as you can tell, I haven't spent much time on the name, so the cyclical point seems off base. But is mid single-digit growth worth 25-30x FCF? Guess that's the "Platform Value" of future anticipated acquisitions.

 

Speaking of Platform Value, I see they just acquired Pexco from Saw Mill Capital :)

[Liberty]

I understand FCF is better because of intangible amortization and other GAAP peculiarities, but TDG for example is trading at roughly the same EV/FCF multiple as it was in 2011, with FCF roughly 2x 2011 levels, net debt/EBITDA roughly 25% higher, with the cycle four years further along its curve. Perhaps folks believe aircraft is no longer a cyclical industry, and the future is bright enough to support those levels.

 

TDG isn't Boeing. What matters isn't how many aircrafts are sold in the short-term. What matters to TDG is RPM (revenue-passenger-mile), because they make the vast majority of their FCF on the aftermarket for their vast installed based with lifecycles measured in decades. What also matters is if they can maintain or improve their content % on new platforms, which they have been doing. RPM is a relatively non-cyclical thing which barely dipped after 9/11 and the GFC of 2008-2009, and has been growing mid-single-digit the rest of the time.

 

TDG makes relatively little to OEM sales, and even loses some money by providing parts while new platforms are in development. The aftermarket is where it's at.

 

Fair enough - as you can tell, I haven't spent much time on the name, so the cyclical point seems off base. But is mid single-digit growth worth 25-30x FCF? Guess that's the "Platform Value" of future anticipated acquisitions.

 

RPM are growing at mid-single digit. TDG's FCF/share can grow much faster than that, as it has.

 

They are very adept at using leverage, which I think makes sense because of the stability of their cashflows (these sole-source, proprietary, regulated aftermarket parts on platforms that fly for decades are kind of like growing annuities), have a multi-decade track record of M&A and operational excellence (they are very good at increasing margins at the companies they buy), and they aren't afraid of shrinking the equity with buybacks and special dividends when they have excess capital.

[Liberty]

Speaking of Platform Value, I see they just acquired Pexco from Saw Mill Capital :)

 

Yep, they deployed 1.3bn in the past 90 days :)

 

Update: New presentation: http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NTgxMDI3fENoaWxkSUQ9Mjg2NjM4fFR5cGU9MQ==&t=1

[muscleman]

How do guys get the FCF number for TDG? I don't think Opex cash flow minus capex makes sense here because the acquisitions will exaggerate Opex cash flow.

When I pay 1 bn to acquire a company, I have 1 bn cash outflow in investing cash flow section, and I will get more opex cash flow from the acquired's account receivable.

 

Does EBITDA minus interest tax and capex make more sense for the approximation of FCF? I wonder if a portion of the investing cash outflow for acquisitions should also be deducted from the above. Thoughts?

[portfolio14]

Thinking about the downside here.

 

Most of TDG value is in the distant future, in the order decades, relying on annuity-like contracts.

 

My question is: how will these contracts play out if an airline goes bankrupt? How do you handicap this?

 

I'm not very familiar with bankruptcy laws. In a chapter 11 situation, (1) am i right that the contracts signed pre-petition can be voided? (2) Once post-petition, can the judge force a supplier (i.e. TDG) to provide ongoing services without getting paid? (3) If an aircraft is sold, I think TDG has to renegotiate a new contract with the buyer. Correct?

 

Another complication is, US bankruptcy laws don't apply to international airlines, right?

 

 

[Liberty]

Thinking about the downside here.

 

Most of TDG value is in the distant future, in the order decades, relying on annuity-like contracts.

 

My question is: how will these contracts play out if an airline goes bankrupt? How do you handicap this?

 

I'm not very familiar with bankruptcy laws. In a chapter 11 situation, (1) am i right that the contracts signed pre-petition can be voided? (2) Once post-petition, can the judge force a supplier (i.e. TDG) to provide ongoing services without getting paid? (3) If an aircraft is sold, I think TDG has to renegotiate a new contract with the buyer. Correct?

 

Another complication is, US bankruptcy laws don't apply to international airlines, right?

 

All airlines would have to ground their planes at the same time to have an effect, just 1 wouldn't be material (and they also have a decent chunk coming from defense), and as far as I know, except maybe on pilot strikes, planes keep flying. High fixed cost companies don't want to ground their assets.

 

But also remember that the cost of TDG's parts are very small compared to the overall maintenance and operational costs of flying airplanes. We're talking about small parts that are replaced every so often. Almost immaterial compared to fuel costs, the cost of pilots, the cost of engines, etc. That's part of why they have pricing power, most of their parts are below the radar financially but are crucial if you want to fly.

[loganc]

Liberty,

 

What are the material risk factors here?  What would change your mind about this company?

 

I certainly see potential risks in terms of the acquisitions (e.g. acquisition of inferior businesses relative the current "base" businesses), interest rates, and "key man" risk with Howley.

 

Thanks.

 

Edit:

 

I want to make sure that it is clear that I believe TDG to be a very high quality business.  I am just trying to get a better sense of the true risk factors to the *business* because it is really hard to see them.  In a perverse sense, the fact that I can't figure out something that kills this business scares me because I feel like I am missing something.

 

 

[Guest Schwab711]

Liberty,

 

What are the material risk factors here?  What would change your mind about this company?

 

I certainly see potential risks in terms of the acquisitions (e.g. acquisition of inferior businesses relative the current "base" businesses), interest rates, and "key man" risk with Howley.

 

Thanks.

 

 

 

The risk is that Boeing and Airbus use a different primary supplier for their new planes (or use TDG as primary less often). I think the reverse as is actually occurring at the moment.

 

Also, King of the Hill quote somewhat describes the pricing power (initial cost is a sweetheart deal so Boeing passes TDG's profits on to future plane owners since Boeing/Airbus makes better value planes than anyone else.

 

LIEUTENANT: I wish this bill were a mistake, Mr. Hill, but that is how much it costs the Army to give someone a haircut. We spend $80,000 for each military-grade barber chair. The French make a barber chair that costs $110,000. It's a damn good chair, but I'm not gonna spend $110,000 for a barber chair.

HANK: Wasting all that money is like buying a haircut for Saddam Hussein. And I hate Saddam Hussein! I like his haircut, but that's it.

LIEUTENANT: Look, I know the chair's too much at $80,000, but then they give us a B-2 bomber for 1.3 billion. That's where we make it up. (beat) Well, you try getting a B-2 bomber for 1.3 billion. You can't do it.

 

http://geocitiessites.com/arlen_texas/badhair.htm (somehow I couldn't get a video and geocities was my best option!)

[loganc]

The risk is that Boeing and Airbus use a different primary supplier for their new planes (or use TDG as primary less often). I think the reverse as is actually occurring at the moment.

 

Nice quote - I am a big Mike Judge fan. 

 

So, how do you know that the reverse is happening at the moment?

 

Edit: Also, how do you think about interest rate risk here, given the capital structure?

 

[giofranchi]

What are the material risk factors here?

 

I think the greatest uncertainty with this kind of businesses, which make lots of acquisition with lots of debt, is that sooner or later the man at the wheel commits a major mistake…

 

Such a risk is not "old fashioned" at all, like Ackman has recently called Munger, but imo it never goes "out of style" and therefore is very real indeed!

 

On the other hand, the men at the helm of these so-called "platform companies" tend to be very disciplined and to never stray outside their circle of competence. And this clearly diminish the risk of any major mistake. ;)

 

Cheers,

 

Gio

 

[Guest Schwab711]

The risk is that Boeing and Airbus use a different primary supplier for their new planes (or use TDG as primary less often). I think the reverse as is actually occurring at the moment.

 

Nice quote - I am a big Mike Judge fan. 

 

So, how do you know that the reverse is happening at the moment?

 

Edit: Also, how do you think about interest rate risk here, given the capital structure?

 

In general, corporate clients or after-market parts distributors prefer to work with as few suppliers as possible. If you can just pay GE and TDG instead of 40 different suppliers than you might pay a slight premium for the convenience. There has been significant consolidation in aircraft part suppliers since 2008/2009 with just a few large companies remaining. TDG has the largest % of specialty/unique/sole-source required parts (however you want to classify their advantage, they prefer sole-source) of the industry players. Mgmt has stated or hinted at this being the case whenever discussing their strategy of bolt-on acquisitions. Their goal seems to be to supply as many parts as possible for each type of aircraft. They also seem to be seeking out specific types of aircraft like some of the most common Boeing planes.

 

With recent acquisitions the debt coverage levels are relatively high but they have very predictable short-term revenue/profits that makes it easy to whether these periods of high leverage as long as they don't compound the problem. If we see mgmt pay off debt over the next 12-18 months then we should have a better idea of their risk tolerance and what they think the ideal long term leverage ratio should be (I think they've guided on this before so I have to check my notes).

 

I think changes to current US regulations (deregulation or less oversight) or operational mistakes are the largest risks. Technically they could find a fatal design flaw with the B737, B777, A320, or A330/A340 and ground all models (very unlikely) or leave TDG out of the design process of future models. Again, this is unlikely considering that TDG is a lead supplier for the B787 Dreamliner. One might also think they could run out of acquisition candidates, but the most important assets they have are customer relations or preferences and past acquisitions were meant to fortify their position as the preferred main supplier for the highest-volume new aircraft models. They could even realistically maintain/gain market share without a single additional order (though it can lower risk and hasten the process if done prudently). I don't see these as too likely but who knows.

[Liberty]

Liberty,

 

What are the material risk factors here?  What would change your mind about this company?

 

I certainly see potential risks in terms of the acquisitions (e.g. acquisition of inferior businesses relative the current "base" businesses), interest rates, and "key man" risk with Howley.

 

Thanks.

 

Edit:

 

I want to make sure that it is clear that I believe TDG to be a very high quality business.  I am just trying to get a better sense of the true risk factors to the *business* because it is really hard to see them.  In a perverse sense, the fact that I can't figure out something that kills this business scares me because I feel like I am missing something.

 

I think you have most of the big ones. Howley's great, but he also seems to have built a really good team and culture, so I'm don't think things would necessarily go down the drain if he was gone. The existing businesses would almost certainly keep chugging along, the question would be on the M&A front and how clever they are at optimizing the capital structure. To me that falls more into the "less upside" than the "big downside" bucket.