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

In today’s episode, Kyle Grieve and Shawn O’Malley discuss HEICO and TransDigm, two dominant players in the aerospace components industry known for their pricing power and resiliency. They’ll compare how each company grows through acquisitions and organic expansion, how they approach debt and capital allocation, and what gives each business its durable competitive advantages. The discussion also covers the risks facing both companies, including regulatory scrutiny and reliance on continued aerospace demand, as well as potential sources of future growth. IN THIS EPISODE YOU’LL LEARN: (00:00:00) Intro (00:06:41) How TransDigm built its sole-source pricing power model (00:10:12) How HEICO competes by underpricing original equipment manufacturers (00:16:14) Why the aerospace industry has such high barriers to entry (00:19:35) Why both companies rely heavily on acquisitions to grow (00:29:33) How each company’s approach to debt differs sharply (00:33:26) Why regulators have started scrutinizing TransDigm’s acquisition strategy (00:46:20) What gives HEICO and TransDigm such durable competitive advantages (00:54:08) How ownership and incentive structures shape each management team (01:07:30) What risks could disrupt either company’s long runway of growth (01:11:33) Where future growth could come from for both businesses (01:16:44) Valuation discussion (01:19:19) Intrinsic value of HEICO (01:20:07) Whether Kyle & Shawn will add HEICO or TransDigm to the Intrinsic Value Portfolio Disclaimer: Slight discrepancies in the timestamps may occur due to podcast platform differences. BOOKS AND RESOURCES Join the exclusive ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠The Intrinsic Value Mastermind Community⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠. Track ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠The Intrinsic Value Portfolio⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠. Portfolio Review ⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠Submit Tool⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠. Listen to the TransDigm episode with Daniel and Shawn. Listen to our HEICO episode with Clay Finck. Listen to the TransDigm Foundations with Nicholas Howley. Listen to TransDigm episode with Nicholas Howley. Read The Compounders book. Check out our previous Intrinsic Value breakdowns: Copart, Comfort Systems, SpaceX, Copa Holdings. Follow Kyle on ⁠⁠⁠⁠⁠⁠⁠⁠⁠X⁠⁠⁠⁠⁠⁠⁠⁠⁠ and ⁠⁠⁠⁠⁠⁠⁠⁠⁠LinkedIn⁠⁠⁠⁠⁠⁠⁠⁠⁠. Follow Shawn on ⁠⁠⁠⁠⁠⁠X⁠⁠⁠⁠⁠⁠ and ⁠⁠⁠⁠⁠⁠LinkedIn⁠⁠⁠⁠⁠⁠. 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• 0:00Speaker 00

  You're listening to TIP.

• 0:03Speaker 01

  Welcome back to the Investors Podcast, episode 851. Today, we're pitting two of the best businesses in the entire aerospace industry against each other, HEICO and TransDigm. We'll look at these two businesses mainly from two angles in quality and value.

• 0:15Speaker 02

  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.

• 0:28Speaker 01

  Right, and I think it even got close enough 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.

• 0:44Speaker 02

  That's right, 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?

• 0:58Speaker 01

  Let's find out.

• 1:03Speaker 00

  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.

• 1:49Speaker 01

  If you caught our YouTube livestream on Serial Choirs last month, you caught a sneak peek of where this video today is headed. So, we concluded in that conversation that HEICO was a higher-quality business than TransDigm. 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.

• 2:11Speaker 02

  So, we've covered TransDigm 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 HEICO 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 TransDigm and HEICO in it.

• 2:39Speaker 01

  Yeah, and you know, to be honest, I think I've held a very, very similar bias to you there, Sean. You know, 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 you know, kind of, as you already know, airlines, for the most part, are simply just not good businesses. But when it comes to these businesses like HEICO and TransDigm, 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, you know, their parts or components, they're just cash cows. So, you know, three of HEICO's named competitors are General Electric, Pratt & Whitney,

• 3:23Speaker 01

  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 HEICO and TransDigm has very nice profit margins as well, you know, not quite as high as GE Aerospace, but still very solid, with HEICO coming in around 18% and TransDigm producing profit margins of about 21%.

• 3:49Speaker 02

  So, I think the message here is pretty clear. The margins on these businesses making airplane engines or parts is clearly very high. 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.

• 4:11Speaker 01

  Well, you know, I don't think we should beat ourselves up too badly. After all, there's only so much time in the day. And I guess, you know, if I'm being completely honest here, if I had to attempt to tell you what parts, you know, there are inside of an aircraft engine or how it works, my answer would approximately be, I haven't got a clue. So, you know, 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, you know, 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 in the future.

• 4:56Speaker 02

  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

• 5:40Speaker 02

  something as innocuous as literally just a screw.

• 5:44Speaker 01

  That's right. But perhaps the best part about businesses like TransDigm and HEICO 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 HEICO. So, in that book, they told a really, really good story about meeting the Mendelson brothers who run HEICO. 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?

• 6:27Speaker 01

  The Mendelsons 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, you know, thousands and thousands of different competitors out there.

• 6:42Speaker 02

  Getting to that point, I do think we should discuss the business models for both of these businesses. Daniel pitched TransDigm to me about a year ago, so I can maybe start us off there as we do the comparison. So, TransDigm 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 TransDigm 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. And the gist of why he founded the business was that a large percentage of an aircraft's

• 7:24Speaker 02

  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 lifecycle. So, that sounds like a pretty good business model to be in, right? And that lifecycle 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

• 8:09Speaker 02

  that already had their toe dipped into this space.

• 8:13Speaker 01

  Yeah, I mean, getting an annuity-like revenue stream 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 TransDigm really gives you that. But it's worth noting that TransDigm 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 TransDigm was built on. And I think TransDigm 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.

• 8:50Speaker 02

  I know TransDigm 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, Howley 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.

• 9:09Speaker 01

  Right, and I think that he found that to be kind of a real bottleneck, at least for the beginning part of the business, because, you know, if you want to have pricing power, which is one of TransDigm'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 TransDigm 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, you know, 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, TransDigm does offer parts that do go into brand-new aircraft, so they'll offer parts that do go into engines.

• 9:53Speaker 01

  But where TransDigm and also HEICO 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 during routine maintenance.

• 10:12Speaker 02

  And those aftermarket sales make up about 55% of TransDigm's business. So not trivial at all. And before we discuss HEICO's business model, I have to mention that TransDigm 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.

• 10:57Speaker 02

  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 TransDigm's 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. Right? Seat belts 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.

• 11:39Speaker 01

  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, TransDigm grows both organically, driven by its value drivers, and then also through M&A. But let's now take a look at HEICO. So it's not too dissimilar from TransDigm. You know, they both have organic and non-organic growth. They both made a ton of acquisitions over their lifetime. HEICO has made more than 110 acquisitions since 1996. So HEICO also makes parts for OEMs for new aircraft, but they have a very large aftermarket component as well.

• 12:24Speaker 01

  So if you add up HEICO'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 TransDigm.

• 12:35Speaker 02

  From the recurring revenue aspect generated by these aftermarket sales, the two businesses are definitely very similar. And I think, 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.

• 13:18Speaker 02

  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? And so I know HEICO 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.

• 13:52Speaker 01

  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 TransDigm. So HEICO 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 HEICO's business model is the regulation of its parts. So 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.

• 14:34Speaker 01

  Nearly every single component that HEICO sells has been approved specifically by the FAA.

• 14:39Speaker 02

  So I think the simple way to think about this is that HEICO 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.

• 15:09Speaker 01

  Right, exactly. 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 the advantage as well. So the cool part about HEICO 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 HEICO'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 rangefinders 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.

• 15:54Speaker 01

  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?

• 16:15Speaker 02

  It's a tough question, because when you strip away the details, it does seem like the two businesses are remarkably alike, right? They both lean heavily into the aerospace parts aftermarket with well over half of their revenue coming from parts that have to be replaced during an aircraft's 30-plus-year lifecycle. So a lot of overlap there, and right? They both kind of grow through a mix of organic growth and acquisitions, and they both enjoy some regulatory protections and barriers to entry 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

• 16:59Speaker 02

  opposite from each other. TransDigm'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 HEICO comes in with an FAA-approved alternative, and they're basically trying to cut costs, right? 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 HEICO. When your pitch to customers is the same quality at a much lower price, they're going

• 17:42Speaker 02

  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 just, it strikes me as being much more sustainable, whereas TransDigm'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 TransDigm's pricing power being a very compelling component of the business from the shareholders' perspective, even if it's

• 18:26Speaker 02

  a bit predatory in some ways, and more likely to attract regulatory scrutiny, which makes me think it's somewhat less sustainable. But I come with my own biases, and so I'm kind of curious to see whether you see it differently.

• 18:39Speaker 01

  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, you know, these kind of largely commoditized products, something like a Walmart or a Costco. But the aerospace industry in which HEICO operates clearly does not sell commoditized products due to the high barriers to entry. So while I do think it's compelling, I'm still not sure if it's more compelling than the pricing power advantage TransDigm offers. You know, 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

• 19:23Speaker 01

  your profits due to the effects of operating leverage. Another very important part of TransDigm and HEICO'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.

• 19:36Speaker 02

  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, HEICO 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.

• 20:10Speaker 01

  Yeah, and kind of the point about the pace of acquisitions is really fascinating to me just in serial choirs in general. So the problem with most serial choirs 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 perspective returns of that acquisition. So we can actually take a look at HEICO'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 about $175 million apiece. Now, I was a little disappointed with the disclosures of their acquisition criteria, but here's what we do know. So they focus on acquiring

• 20:52Speaker 01

  approximately 80 to 100% of the target business. And they do this because it allows the existing ownership group to continue having some skin in the game. So we can tell from older earnings calls that they do have a set of three criteria when they're looking at a potential acquisition. The first one is that they're just fairly priced. Second, they are a very good business with strong various entry. And third, they want superior leadership teams that they'd be happy to work for for the next three decades. Victor Mendelson, the co-CEO of HEICO, along with his brother Eric, has said they generally look for businesses with about a 20% operating margin and then a return on investment of about 20 to 25%. So you can see there in the point that they made about management that not only is HEICO long-term, but they also want to partner with people who are also long-term.

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• 24:43Speaker 03

  All right, back to the show.

• 24:45Speaker 02

  So this all sounds pretty good, especially when you think about the runways that these businesses have. The acquisitions, when done correctly, should provide a ton of value, whether they grow or not, simply because they sell a product that will be in demand for decades with very little competition. And so, yeah, that's a very, very nice business model to have. So my question for you is, what about their failures? I mean, clearly, they can't be batting 100% on all these acquisitions.

• 25:14Speaker 01

  Yeah, so the number that I've seen quoted is that they've been successful about 98% of the time on these acquisitions, meaning there's probably two acquisitions out there that were considered unsuccessful. Now, I'm not exactly sure what that means. Maybe that means they were a complete zero, or maybe they were able to still extract some sort of value from them during their lifetime of eventually becoming worthless. But either way, it's a very, very good track record. You know, I've owned a few serial choirs, and for the most part, since they are usually forever-home type businesses, the parent company is usually quite reluctant to just let the business go to zero. That means laying off an entire staff, and that's kind of antithetical to the kind of forever-home business model that a lot of these companies are trying to run.

• 25:55Speaker 02

  Yeah, for sure. That's one of the more underrated aspects of, I like the way you call it there, the forever-home model. I think that describes it pretty well. I mean, if you're a founder deciding who to sell your life's work to, I don't think we should underestimate that. A lot of these people have built these businesses over a lifetime. Knowing that the buyer is not going to gut your team or flip the business in a few years really matters a lot because the team are people that you've maybe worked with your entire lifetime, and they've got family members, they're friends, they're people you send Christmas cards to every winter. And so having that reputation of treating the businesses that they take over well, I think can help HEICO win deals without always being the highest bidder. And that's an advantage we've seen with Berkshire Hathaway, too, and Warren

• 26:38Speaker 02

  Buffett, where he, for the most part, just wants to let companies keep doing what they've been doing and provide some sort of liquidity exit, but he doesn't want to come in and do this private equity approach of just slash costs and fire everybody and something like that. And so I think this advantage does show up inside the business, too. When you have employees at a newly acquired company, knowing that they won't be cut the moment that there's some kind of dip in results, they're more likely to stick around longer and share what they know and think long-term. And in an industry like aerospace, where so much of the value lives in engineering know-how and these really hard-won relationships with both customers and regulators, I think keeping those people is a big deal. So that

• 27:20Speaker 02

  culture ends up actually compounding right alongside the financials over time. And so just getting back to the M&A angle, I think we should linger on that more. Does TransDigm seem pretty similar in terms of their criteria to HEICO? Or do they have any important divergences in the way that they approach M&A?

• 27:40Speaker 01

  Yeah, so unfortunately, TransDigm's disclosures aren't that much better than HEICO, which means we kind of have to become Sherlock Holmes here again and do some detective work. So all the disclosures say is that they focus on these three things in the M&A process, which is aerospace products, proprietary engineered products, and significant aftermarket content. Pretty unhelpful, right? But luckily for us, they actually do have a really good investor deck back from 2024. So we can assume that TransDigm, given its history, is aiming for very, very good returns. You know, this is a business that has, after all, compounded revenue at 18%. So in their 2024 Investor Day presentation, they mentioned their objective was to produce somewhere between 15% to 20% return per year on average. Another helpful

• 28:21Speaker 01

  slide from the investor deck outlines a typical investment. So they focus on an internal rate of return of about 20% for shareholders. Howley has mentioned in interviews that he will tend to aim a little higher for an extra margin of safety as well. So it's worth noting as well here, it's really important that they do fund their acquisitions with debt. So the IRR calculation takes that into account.

• 28:42Speaker 02

  Well, since we're speaking about debt, it's important to talk about really the amount of TransDigm's debt I find to be a bit, makes me a bit uneasy compared to how much debt a business like HEICO uses, where they do so at a much lower ratio relative to their operating earnings. So just to put some numbers around that for context, HEICO's median net debt to EBITDA, or EBITDA is an operating earnings proxy, it's about one times. So their net debt is just one times multiple of their operating earnings. Whereas if you look at TransDigm's, they have about six times their operating earnings in net debt, going back over the last two decades.

• 29:26Speaker 02

  That's a median figure. So I will admit though, it is very clear in TransDigm's case that many of its subsidiaries are much needed by the aerospace industry. And that might even be an understatement. And because of this, its future revenue streams are very much very reliable and forecastable, which supports them being able to carry more leverage. But again, when you compare the two, just simply HEICO is much less leveraged.

• 29:54Speaker 01

  Yeah, I mean, I think it's kind of impossible here not to give the edge in terms of debt to HEICO. When you account for TransDigm's kind of Bond villain sized debt pile. And I do want to look at debt a little more, but in terms of M&A, I did want to add a few things here for TransDigm. So TransDigm, through its chairman Nicholas Howley, is very specific about how it improves incoming acquisitions. Sometimes they will buy a business just to carve out very, very specific product lines, then solve the parts that they don't like. This allows them to leverage their three value drivers, price increases, cost reductions, and new business, which helps drive further margin expansion as well as organic growth within their acquisitions. So a great example of this framework in action that TransDigm shared was in this business called Esterline Technologies. So this was a business that they acquired back in 2019.

• 30:38Speaker 01

  They ended up selling about a quarter of the business, getting rid of these non-aerospace units or businesses that didn't fit their criteria. But over a five-year period, they actually doubled their EBITDA margins in that one business.

• 30:49Speaker 02

  Gosh, that's an incredible acquisition, especially when you consider that the size of it was done at $4 billion.

• 30:56Speaker 01

  Yeah, it was a very nice acquisitions. And you know, if you remove debt from it, I think I prefer TransDigm's M&A framework. I like their ability to really increase margins over time by leveraging their value drivers. Keep in mind, I may be a little biased here as I am an owner of Perimeter Solutions, another business that Nicholas Howley helped create using a very, very similar playbook, but just in other industries. So when I was looking closer at TransDigm, I could see Perimeter Solutions DNA just all over it. You know, the way they optimize new acquisitions based on very specific criteria and these value drivers. But they also utilize a little bit of leverage. But I still don't think it's fair to take the debt part out of the equation because obviously it exists and it's real. And there is also the chance, of course, that HEICO also has their own way of optimizing their own margins.

• 31:40Speaker 01

  And maybe they just choose not to discuss it with shareholders or competitors. So I do want to add onto the whole debt thing because it's important to understand the magnitude of debt that TransDigm is currently carrying.

• 31:51Speaker 02

  I thought the number was pretty scary and notable when Daniel pitched it way back a year ago. But given the quality of the business, I think generally it's safe to say I was pretty okay with it, which was why we did end up adding TransDigm to the portfolio for at least a brief period of time, the intrinsic value portfolio.

• 32:11Speaker 01

  Yeah, so the really eye-popping numbers from TransDigm is just their net debt position of about $31 billion. So this puts their net leverage ratio somewhere in the 5.8 times range. And just to contrast that with HEICO, which is admittedly a much smaller company than TransDigm, they only have $2.3 billion in net debt and a net leverage ratio, you know, around 1.6 times. So EBITDA to interest is just three times for TransDigm versus 11 times for HEICO.

• 32:36Speaker 02

  I think that's really all you, you probably need to know, right? When it comes to the debt situation, again, it's just clear that HEICO is in a much safer position from some perspectives. And like I mentioned earlier, given the fact that TransDigm is often the sole source from many of its components, it does give them some permission to lever up a bit on these deals if it thinks it can continue finding more of them out there with similar sort of competitive advantages.

• 33:01Speaker 01

  Yeah, no arguments there. So you actually just brought up a point there about competitive advantages. And I think that both of these businesses have several that we should now discuss.

• 33:09Speaker 02

  We should, yeah. So Daniel made a really good point to me in his pitch on TransDigm about their monopolistic positioning. And my conclusion was that there are two separate kinds of monopolies. There's the government granted monopolies and then there's natural monopolies. And so a government granted monopoly is one where the government evidently grants a company a monopoly. You know, so think about telecom businesses where they enjoy some regulatory privileges. But a natural monopoly is really the best possible kind. Because under a government monopoly, the government can giveth and it can taketh, right? So that monopoly-like status can be stripped very quickly if regulators or the government decide they no longer want to tolerate your business model.

• 33:53Speaker 02

  But under a natural monopoly, the government can't really do anything. A natural monopoly forms because you're so superior at what you do compared to your competition. So think about Google and Google search. And so at the time, Daniel even showed a clip where the House Oversight Committee tried to understand why companies like TransDigm don't have competition. And when the government can't step into a business that has a monopoly, there just really isn't as much they can do to stop a business from utilizing its pricing power. And so that is really the position that TransDigm is in.

• 34:32Speaker 01

  Yeah, and it's a really beautiful position to be in, although I know Charlie Munger would disagree. So when asked if he was familiar with TransDigm, he said, 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 and they're famous for it. I regard that as immoral. So it's a pretty interesting point. And I think the whole morality aspect is something that I think investors largely have to just decide for themselves. If you're looking for a business that has kind of a win-win aspect to it like Costco, well, okay, I can see the difference. But to me, pricing power is just a natural part of capitalism. And I respect businesses for putting themselves into those places on purpose. And you know, if you really want to nitpick, Costco also forced many of their suppliers

• 35:13Speaker 01

  to do things like absorb the tariff adjustments rather than just absorb it themselves. And the only reason they can do this was due to the bargaining power over their own suppliers.

• 35:22Speaker 02

  I would probably mostly agree. I don't think it's an investor's job certainly to be policing what a business charges. And if TransDigm's customers are willing to keep paying, that does tell you what the parts are worth to them. And where I'd probably push back a little bit is that Munger's point, I don't think is entirely about morality, right? When a big chunk of your customer base is the Department of Defense and the bill ultimately lands on taxpayers, that aggressive pricing strategy does become something of a political risk because it invites political attention. And we've seen that with FICO recently. And it's worth remembering Munger sat on Costco's board for decades. So he clearly had a strong preference for businesses where the customer wins as well.

• 36:04Speaker 02

  And it's really about returning as much value to the customer as possible, rather than extracting as much pricing power as possible. So for me, the question is less about morality and more about how durable the pricing power is and how durable the pricing power is if the customer ever gets a chance to meaningfully push back. So if we looked at TransDigm and HEICO though, through this lens of being a monopoly, I'm curious how you think which, which of the two has the stronger positioning?

• 36:36Speaker 01

  Yeah, I think I'd probably have to go with TransDigm. You know, just the fact that they are the sole provider for a large number of their parts means that just, there's no alternative that exists. HEICO is obviously incredibly well positioned due to the FAA regulations as, you know, one of the few manufacturers of certain parts. But they'll admit that the OEM is often the sole source for many of the parts that they develop. So technically they'll always have at least one competitor there from the OEMs, even if they have that advantage of selling those components at a very, very steep discount. So, you know, I think when it comes to both of these businesses, it's really like nitpicking about who you'd rather have between peak LeBron James or peak Michael Jordan. They're both ridiculously good and you can't really go wrong with either choice.

• 37:17Speaker 02

  I think TransDigm is probably the Jordan in that matchup, just ruthless, relentless, and not really especially concerned whether the other side likes it. And then I guess HEICO is more like LeBron for our basketball fans out there that are following along with the conversation because they win by making people around them better. And in this case, that's by saving customers money. And it's also built for longevity, right? LeBron is still playing to this day. It's incredibly long career. So the question for investors is whether you want that killer instinct of Jordan or the staying power of maybe LeBron. And I would probably take personally the LeBron approach for business as being more attractive to me as an investor. But come on, don't get me wrong.

• 38:01Speaker 02

  I still see Jordan as being the greatest basketball player of all time. So it's not a perfect metaphor, but I do like it as a bit of a framework. And just to keep us moving along here, because I know we could definitely talk basketball for longer. If we had to choose how to label some of the competitive advantages for both companies, what would you go with, right? What are the advantages that these companies have and that make them unique?

• 38:28Speaker 01

  Yeah, I think if I had to simplify it, I think both HEICO and TransDigm offer high switching costs. So for the most part, switching is either impossible or economically unfeasible. Sure, the OEMs can make a stink about a customer maybe using these aftermarket parts that aren't their own. But if they want the customer's business again in the future, they basically have to just accept that the customer is going to use aftermarket parts from a different company because they can get them simply at a much better price while delivering essentially the exact same performance. Now, there are a few major drivers that help switching costs for both of these businesses. So if I use the hidden monopoly framework, there's a few attributes on which I think both businesses score very, very highly on.

• 39:06Speaker 02

  And just for anyone unfamiliar with this idea of a hidden monopoly framework, it's basically a framework for evaluating the relationship between a business and its customers, right? Is that pretty much the correct way to frame it?

• 39:18Speaker 01

  That's exactly it. So all businesses have different levels of customer loyalty and the framework really helps kind of nail down why customers will stick around versus switching to another business. So the first aspect that really stood out to me was in the satisfice heuristic. So if the component works and it works really well, there just really isn't that much of a reason for an airline to go and experiment with others as long as they know the component is very, very trustworthy. Another really good point that Daniel made when discussing TransDigm was that this business keeps customers coming back despite changing financial circumstances. Sure, if something like COVID happens, well, yeah, planes are going to be grounded, but they're still aging, so you may have to wait. But at some point, those aircraft components do need to be serviced and there really is no option to just cheap out on replacing these parts.

• 40:03Speaker 01

  You can't just go to Lowe's to pick up a screw that's going to be used on an airplane.

• 40:07Speaker 02

  Trust also matters a ton here. The old saying, if it ain't broke, don't fix it, I think applies, right? Because having parts that don't work is something all regulatory bodies want to avoid at all costs.

• 40:21Speaker 01

  Precisely. And I think this leads to our next part on switching costs, which is the high cost of failure. So for instance, in 2019, the FAA forced all Boeing 737s to replace about 148 parts within the next 10 days. So very, very quickly. Now, this was unrelated to the two crashes that they had, but the FAA basically concluded that the affected parts may be susceptible to premature failure or cracks resulting from improper manufacturing process. Although a complete failure of a leading edge slat track could not result in the loss of the aircraft, a risk remains that failed parts could lead to aircraft damage in flight. Now, we have no idea of knowing where these parts came from, other than that it was a sub-tier supplier for Boeing. So any business that has a reputation like this probably is going to be a lot lower

• 41:06Speaker 01

  in the pecking order in the future versus a business such as HEICO, which prides itself on never having any parts fail during their entire lifespan.

• 41:13Speaker 02

  What I like is how self-reinforcing these dynamics can be. Once a part works, customers have little reason to go shopping for something new. And even when budgets get squeezed, like during COVID, the maintenance can be delayed, but it can never be skipped ultimately. And because the cost of failure is so catastrophic, nobody wants to be the one, of course, who gambles on an unproven supplier. And so if you put all that together, being the incumbent becomes enormously valuable. It's a really significant status quo advantage. And so I think this does play out a little bit differently for each company, though. For TransDigm, all three simply lock in the status quo since customers are often buying the only approved part in existence.

• 41:56Speaker 02

  Whereas for HEICO, the high cost of failure was actually the hurdle it had to clear first. And so it had to earn trust as a credible alternative to the original equipment manufacturer, one FAA approval at a time. But once it did, those same barriers started working in its favor because anyone trying to undercut HEICO, well, now they have to run into that same wall of skepticism and review. So TransDigm benefits from these barriers by default. Well, HEICO sort of earned its way inside of them. And to me, that makes the business's position more durable. And I know we were discussing this business a little bit off air and you were really giddy about thinking about the switching cost benefits that both of these companies offer

• 42:41Speaker 02

  as aerospace component manufacturers. But I think there are some other advantages that we should probably talk about.

• 42:47Speaker 01

  Yeah, I never thought I'd hear the words giddy and aerospace components manufacturer used in the same sentence, but here we are. So got to back to your point there just before I move on here. It's really important, like you just said, that HEICO essentially worked their way into that. And one of the ways they did that was basically by partnering with Lufthansa. So and since that time, they've done that with multiple other airlines as well. So I think they've done a really, really good job of building their own loyalty kind of from scratch, which is, I think, very, very commendable. So another one of the benefits that keeps customers coming back are sunk costs. So if an OEM no longer wants a part or maybe doesn't like a supplier, it's pretty unlikely that they're going to replace every one of the supplier's components on every single line of one of its planes that are using that exact component.

• 43:31Speaker 01

  You know, there are sunk costs involved here. The planes cannot be grounded for extended periods of time just because the OEM decides to sever business with someone. A plane on the ground just isn't making the airlines any money, nor is it doing any actual defending if it's part of the military. Then you have the fact that for many OEMs, the parts do have more than one supplier. So you're basically stuck with what you got, whether you like how they price a product or not. And because these parts are highly engineered to very specific specifications, it's obviously not easy to just go out and find someone else to make them for you, even if you wanted to. And the last one I'll mention relates to the point that I made on the high cost of failure. These are personal credibility costs. Sean, you kind of already just alluded to it here, but if you make an error buying a faulty component from a new, say, cheaper supplier, and then later it's found out

• 44:16Speaker 01

  that that part doesn't function as it should, well, the chances are very good that you'll probably just lose your job. It's like a hedge fund manager who just copies the market. They know they're not going to get fired for buying some boring blue chip. But if they decide to try to be bold and buy something nobody else has invested in and it fails, well, chances are they're going to get fired because nobody else made that exact same mistake. And this keeps them from trying to do anything different. This is a benefit, though, I think, for aerospace components businesses.

• 44:41Speaker 02

  Well, it reminds me of a pretty common problem that we see around innovation. And so a company like Amazon, which we own in our intrinsic value portfolio as a holding, it would never be where it is today if they fired everyone who tried to innovate, right? Amazon started as an online bookseller and is now one of the largest retailers, streaming companies, and also cloud computing companies in the world. So how's that for innovation over time? And not really that much time either, right? They've done a lot of that in like a two decade timeframe, maybe almost three decades. And so the difference, though, is that Amazon is not going to kill anybody when they try to innovate, or at least I hope not.

• 45:21Speaker 02

  Where the same really can't be said of at least the consequences of mistaken innovations in the aerospace components industry. So that is definitely something to consider, why kind of structurally there's more of a risk averseness in that space. And so my question for you is, do you think either of these businesses have any other competitive advantages that would distinctly further strengthen their mode?

• 45:47Speaker 01

  Yeah, I do. And I know this segment's going along because these businesses really do have a lot of competitive advantages. But I think another one is simply just the pricing power. We've kind of discussed this a lot today, but I would say obviously TransDigm has the advantage there. You know, when you're the only supplier of one key part, well, then you can increase your prices and there just isn't anything really that your customers can do about it other than maybe complain to regulators. But I would say I'd obviously prefer if they didn't try too hard to piss the regulators off, though. Then, you know, if you're looking at HEICO, whether you want to call it process power or a low-cost provider, they are just manufacturing these parts at lower prices than the OEMs. And I think this is super powerful. Since they had this long history with no major accidents, their customers know and

• 46:31Speaker 01

  trust parts that come from a HEICO subsidiary. And getting it at a steep discount is nice, especially since these OEM parts are very, very pricey.

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• 49:41Speaker 01

  All right, back to the show.

• 49:43Speaker 02

  It's a pretty tight line between both of these businesses when it comes to competitive advantages. They're both very formidable and stealing business away from either of them is clearly going to be very difficult, if not impossible. And so if I had to give an edge, maybe my biases are showing you, but I would probably go with HEICO. And that's because I tend to like businesses that, again, just can price their product better than competitors while not really having a ton of competition. Whereas TransDime's pricing power is incredible, but we've talked about it. It depends on customers really having no other option. And that eventually, in my sort of speculative opinion, tends to draw attention from the people who are writing the checks, namely the Pentagon.

• 50:27Speaker 02

  And so HEICO's advantage works the other way. Every time it wins a sale, the customer saves 30 to 50% versus the OEM. So airlines actually want HEICO to succeed and keep adding new parts. And Lufthansa even owns a stake in part of HEICO's aftermarket parts business to show sort of their alignment there. And that just makes me more confident HEICO's moat can keep widening over time without inviting regulators to really intervene. So while TransDigm might squeeze more profit out of each part, I think HEICO's advantage is more durable of the two. And for someone like me who's trying to make just a few good investment decisions that compound for as long as possible before I have to make another decision.

• 51:12Speaker 02

  I really like the metaphor of just sitting on your hands investing. There's something pretty attractive about that.

• 51:19Speaker 01

  Right. And when we first did our live stream on Sierra Quires, I also picked HEICO as well. But now, you know, I'm just not so sure. So even though the government did make a stink about TransDigm and their margins, it hasn't really made that much of a difference on its pricing power. So if you look at their gross profit margins from the time they paid the Pentagon back about $19 million in excess profits, their gross profit margins have risen by about 6%. So, you know, I'm not sure that this core case really did make that much of a difference to actually lessen TransDigm's ability to increase its prices. So while I still agree with you that I think I like the fact that HEICO seems to have mainly stayed out of the crosshairs of regulators, I still think it speaks to TransDigm's strength that they can pay a fine and then just go on their way, continuing to raise prices for their customers.

• 52:02Speaker 01

  But overall, you know, I think I completely agree with you, Sean. You know, I prefer as little meddling as possible with regulators. So I think I would give HEICO the edge here and competitive advantages. But I do think it's a very small edge. It's almost like asking me if I prefer, you know, an orange sunset or a pink sunset. They're both very, very good. It's just up to personal preference.

• 52:22Speaker 02

  All right. Well, fair enough. Now that we've discussed TransDigm's transgression there, mind the pun, I think we should jump in some more depth into management with both of these businesses compounding at very good rates for multiple decades. It is a given that they're very well managed. And so the last time that we talked about TransDigm, we briefly discussed the CEO change with Michael Lysman taking over as CEO. But it happened just before the episode was released. So it really didn't offer us a lot of time to really evaluate Lysman's track record.

• 52:56Speaker 01

  Right. And, you know, even a year later, it's still probably not long enough, but we at least have a little bit more data to draw from to at least make sure he's leading the company well. So since we come in as CEO, revenues have compounded at about 13%, while EPS has grown at a CAGR of 21%. So, you know, so far, that's pretty good. But the market thinks otherwise because the business's stock price has actually declined by about 16% over that same time period. But I think he's done a pretty good job. So over the last 12 months, TransDigm has spent about $3.3 billion on new business acquisitions, the second largest amount since 2019. We'll have to see how these investments eventually play out. But, you know, given that he's buying them by following the TransDigm system, chances are pretty good that they are going to be value accretive.

• 53:39Speaker 02

  It's a pretty good start, if you ask me. I do know they had a deal blocked while he was in charge as well. And we'll cover that a little more shortly, I think. But we do need to discuss some of TransDigm's other points of alignment and incentives. During the initial pitch on TransDigm, I found the incentives to be just very well aligned with creating shareholder value. But it's definitely more of a private equity approach than a lot of the other businesses we cover on this show. And we'll kind of talk about what that means. But looking at the way they have their incentive structure set up, base salaries are pretty reasonable. They make up less than 10% of total compensation, which also includes an annual cash incentive tied to EBITDA margins.

• 54:20Speaker 02

  And then the bulk of the bonuses are generated from long-term equity awards, and those are tied to growth and intrinsic value. And so full vesting of those awards requires a 17.5% CAGR. And so I think that's pretty aggressive, but they've done a great job at earning those bonuses and earning that stock-based compensation in a way that is not dilutive to shareholders.

• 54:48Speaker 01

  Yeah, it hasn't been dilutive to shareholders, at least not what you'd think that it would be. So I think it's actually worth looking at what exactly they mean by this growth in intrinsic value. So they use something called the annual operating performance, or AOP, to measure the growth in intrinsic value. So they take the pro forma EBITDA, they multiply that by a market multiple, and then they subtract net debt and they divide all that by the diluted shares outstanding. It's a very interesting metric. I think it's one that I've never actually seen before. So I do actually think that it's a pretty good proxy for intrinsic value growth. And surprisingly, given how much share-based compensation they've given out, the share count has only actually CAGR'd at about 1%, which is a pretty low growth rate when you consider how well this company has done and how the comp is structured.

• 55:28Speaker 01

  So insiders, as of the latest proxy statement, own about 3.2% of the shares, including their options. So it's obviously not the highest amount, considering the founder Nicholas Howley is still involved as a chairman of the business. But there's one quote here that I wanted to share that I think kind of sheds a little bit of light on this matter. So he basically said that when it comes to TransDigm, he's actually in it for the money. So you have to make up your own mind about whether money is a good enough motivator. In Howley's business history with TransDigm and Perimeter Solutions, I think it's been a very, very good motivator so far.

• 55:58Speaker 02

  Yeah, money is usually a good motivator. It's worth noting, though, that Howley is now 73 years old and worth over $1 billion. But that quote you mentioned was only from just a couple of years ago. So I think Howley still has ambitions to keep compounding wealth for himself and his family. But how about we take a closer look at HEICO's management team?

• 56:21Speaker 01

  Yeah, I think you're right. And the fact that Nicholas Howley has set up a very equity-based system at Perimeter Solutions suggests he's still looking for even more compounding. So I still think that he's hungry, but let's get to HEICO's management here. Very similarly, I think HEICO's management is very well aligned. I think they have a really, really good incentive system that's pretty hard to beat, in my view. So first, let's get to management here. HEICO was and still is primarily a family-run business. So Lorance, or Larry Mendelson, passed away last year, but he was still the company's executive chairman until he passed away at the age of about 87. His legacy, however, lives on in his two sons, Eric and Victor Mendelson. So the brothers have been part of HEICO since 1990, and both have worked in a number of different roles as they moved up the corporate ladder,

• 57:03Speaker 01

  where they are now co-CEOs and the heads of the Flight Support Group and the Electronics Technologies Group.

• 57:09Speaker 02

  And so what we know is that family run businesses do tend to offer higher returns than non-family run firms. And it's something I've seen a lot of studies on. And there's a lot of data backing up that point. And I think there are multiple reasons for this. And basically, they have more skin in the game, for one, and that helps them make longer term investment decisions. And that also probably makes them more hesitant to take on speculative debt and just generally increases their risk aversion that leads to them to be able to have their businesses compound with less interruption. And so you can see this directly in the HEICO and in TransDigm comparison. HEICO insiders own nearly 19%

• 57:52Speaker 02

  of the company's stock, and that provides a lot of alignment with shareholders, all the other shareholders, since insiders are also the largest shareholders of the company. And the Mendelson family alone owns the lion's share of that stake. And so I just love really seeing that kind of insider ownership dynamic.

• 58:10Speaker 01

  Yeah, me too. And that's really just the start of what's to love, in my view, of HEICO's incentive program. So HEICO considers all employees to be team members. And as such, they've tried to create as much alignment inside the company as possible, right from the beginning. I think they knew how important their team members are to the success of the entire business, and therefore, they've helped fund the team members 401ks to improve alignment even more outside of just the executive and directors. But where I think HEICO really, really shines is in the incentive structure. So even though we like to dunk on EBITDA, it is part of the three metrics that they do use to judge a performance. So you may think, well, that's unfortunate. But they also focus on things like net income to HEICO, as well as cash flow from operations. So for 2025, the target bonus require about

• 58:53Speaker 01

  10% growth in each of these three financial metrics to unlock the bonus. Now, it's really nice to see a business focus on these metrics over just vanity metrics that you see very often in something like revenue growth. And I think it creates really good alignment, because if these three metrics are increasing by at least 10%, chances are very, very good that the share price will be up, especially if you compound that number over multiple years, which they've done exceptionally well over their operating history.

• 59:18Speaker 02

  I think it is very well aligned. And what I like most is that all three metrics have to grow together. EBITDA on its own is a number that can be dressed up and manipulated, and that's why it deserves some criticism. But it's a lot harder to fake growth in net income and operating cash flow at the same time. So management can't hit its bonus just by piling on debt to buy growth. And all three metrics have compounded at roughly 15% to 18% a year for almost two decades, which really is incredible. And so a 10% hurdle rate is a realistic bar, but one that gets harder to clear as the company grows. That's just the reality of the law of large numbers. And so I also like that the alignment doesn't

• 1:00:03Speaker 02

  stop at the executive suite either. Helping fund team members 401ks gives the people building and repairing these parts every day a real reason to think like owners. And you pair that with the Mendelson family owning such a big chunk of the company, and you have a setup where management mostly gets paid when shareholders do too. But we should mention that HEICO does approach capital allocation a bit differently from TransDigm, especially on the dividend front.

• 1:00:31Speaker 01

  They do. But I actually had a pretty big surprise when assessing this. So if you look at HEICO's disclosures, they state right there that they do pay a semi-annual cash dividend. And they've been doing this for a long time, since actually before the Mendelsons even took over the company. But the dividend is very, very small, at only 0.1%. So me being an admirer of serial quires, I do prefer having this number as close to zero as possible. And that's simply because the inherent business model of serial quires is really to just allocate capital into new acquisitions, and rather that capital be put to work, rather than just paying a dividend. But when you read TransDigm disclosures, they tell you that they do not pay a regular dividend, but they have made some very hefty special dividend payments over the years. So in 2025, they paid a special dividend

• 1:01:15Speaker 01

  of $90 per share, and a year earlier, they paid $75 per share in dividends. So while they are a business that doesn't pay dividends, they also have cumulatively paid out $12.9 billion in special dividends over the last five years versus only $136 million in dividends by HEICO over the same time period.

• 1:01:32Speaker 02

  Well, it really goes without saying, but I'm going to say it anyways. Both of these companies have top-notch management teams. And I had to give the edge to one, probably, again, would give it to HEICO. I think having bonuses that cause minimal dilution and are also well-aligned with creating shareholder value is very much music to my ears as a value investor. And I think HEICO's plan to get those three metrics to rise and lockstep should ensure the business continues to compound at a mid-teens rate for many years to come. And the other piece of this for me is how each team thinks about time. So at HEICO, as we've mentioned, insiders own close to 19% of the company. And the Mendelson family has been running the business for more than three decades. So they're effectively

• 1:02:17Speaker 02

  managing their own wealth for the next generation. It's a pretty powerful motivating factor. And TransDigm setup is just sharper and sort of more private equity-like. Its intrinsic value metric is pretty clever, but it's still built on EBITDA and a multiple attached to it. And so it rewards a playbook that leans heavily on debt and big special dividends with $12.9 billion paid out in special dividends over the last five years. And so that approach has clearly worked incredibly well, but it's more of what I would call a high-wire act. And insiders own a much smaller slice of the company if something goes wrong. And so with all that said, TransDigm's results speak for themselves. They don't need my

• 1:03:01Speaker 02

  approval or validation, but that's just kind of how I think about it. I'm curious whether there's anywhere you'd push back on that.

• 1:03:07Speaker 01

  No, I think I pretty much agree with you, but just for the sake of being difficult, I will play devil's advocate here and take a look at things from TransDigm's perspective. So the TransDigm incentive structure is interesting, and it's really rare to see a business have a goal of increasing its intrinsic value like this, especially by 17.5% per year. I mean, that's just a lofty goal for any business, let alone one that's worth several billion dollars. Normally, if I'm perusing a business's proxy and I see this, I'll just nod my head, think it's impressive, then assume they just aren't accomplishing that much, because that hurdle rate is just so tough. But over the past 10 years, the share price has compounded at just under 18%. Now, keep in mind, this doesn't include the special dividends I mentioned earlier, which obviously bump up the IRR even more. So I think with TransDigm, you

• 1:03:50Speaker 01

  do have a history of success in the business. Then you do have the incentive program that I think does a pretty good job of trying to increase the one thing that we consistently harp on on the show, which is intrinsic value. And I think the other incentives on EBITDA and EBITDA margins is also to just kind of help focus the company on generating cash. Now, you have to keep in mind free cash flow as a percent of EBITDA is in the kind of 40% range, but it's still a decent proxy for the growth of free cash flow. Now, just to wrap things up here, I think, similar to you, I'll give the edge here once again to HEICO. But the edge here is a lot smaller than I initially thought, maybe about the size of a piece of paper.

• 1:04:25Speaker 02

  Well, seeing as we did add TransDigm to the intrinsic value portfolio for a period of time, I'm pretty good with that conclusion. And you mentioned something on TransDigm regarding a deal they recently made that didn't go through. And this is one of those risks that I think is inherent with businesses that get to the pinnacle of success while having monopolistic tendencies, because regulators then become more likely to try and block their imminent efforts.

• 1:04:52Speaker 01

  Right. I mean, it's really not something you want to see, given that acquisitions are obviously integral to TransDigm's business model. So basically, what happened was in June of this year, TransDigm announced plans to acquire Stellantis Systems for $960 million, not to be confused with Stellantis. So Stellantis Systems is your prototypical TransDigm acquisition target. They sell a number of industrial products, as well as repair and supply components used in radar systems for the US Navy's Aegis combat systems, as well as the US Air Force's F-16 fighter jets, among other things. Now, the deal was essentially just completely blocked by the Justice Department. And they blocked it simply because they felt it would give TransDigm too much monopoly power on these devices, and they wanted to preserve

• 1:05:33Speaker 01

  some level of competition for some of the specific components. And since that announcement, TransDigm's share price has actually fallen by 11%. So clearly, the market is aware of what's going on there.

• 1:05:44Speaker 02

  This is where TransDigm scares me a little bit. They already had issues with regulators previously, when it was determined some of the components had 1,000% or higher markups, which the US government did not appreciate. And the Stellantis decision worries me, because TransDigm's whole model depends on buying sole-source businesses. And so the better a target fits their criteria, the more likely regulators are to see the deal as reducing competition, especially on defense programs. And if that becomes the norm, TransDigm's pool of viable businesses could shrink, or it may have to settle for deals that don't fit its playbook as well.

• 1:06:24Speaker 01

  Yes, absolutely. I think you're completely right on there. And it is pretty scary, I will admit. You never want to see regulators blocking a deal that perfectly fits your business model, because chances are, obviously, they might do the exact same thing in the future as well. So I will say, when you look at HEICO's past, I personally couldn't find any deals that were blocked by regulators. So I would say this is definitely a larger risk for TransDigm than it is for HEICO. And I think the fact that HEICO doesn't have aggressive pricing, it prices its components below the OEMs actively, helps for some sort of competition, which definitely helps keep HEICO outside of the regulators' crosshairs. Now, another risk that I think that listeners can probably already guess that we'd harp

• 1:07:06Speaker 01

  on is debt. So if there was a slowdown event, such as something like COVID, which happened again, where commercial planes were grounded, or their utilization rates go down, that would clearly affect both of these businesses, absolutely, for sure. But since they also do have military customers, that definitely helps provide some sort of floor. But if we look at TransDigm, they're clearly much more exposed to the negative effects of debt than HEICO, as TransDigm carries that very, very large net debt to EBITDA ratio that we've discussed. Now, it's worth noting that their leverage helps them improve their IRR on deals. So they have two risks that kind of stem from this debt risk. The first is that if they can't repay the debt, it could obviously cause all sorts of problems with their assets and cash flows. And second, if the leverage ratio drops, well, then

• 1:07:48Speaker 01

  they won't be able to borrow as much for their deals, meaning the IRR would technically drop, because they'd have to put proportionally more of their own money into the deals than if they can't use the same leverage ratio.

• 1:07:58Speaker 02

  Part of the reason TransDigm can achieve 30% plus IRRs on its deals is that it can use debt as part of the deal structure. And another thing that really surprised me was how much resilience these businesses showed during COVID, which admittedly was a really hard time for any aircraft-related companies. So both businesses took quite a hit to their stock prices during the lockdown. But given the long-term nature of these businesses, if you were willing to buy somewhere around those lows of COVID, you would be looking at a very, very nice return by just holding on your shares and really doing nothing.

• 1:08:36Speaker 01

  Yeah, and I was also impressed with their resiliency as well. But I think, given the fact that the world, you know, we just, we need airplanes. That's just the fact. And that's whether that's for a commercial or military application. I just really don't see that ever going anywhere. So, you know, unless you can forecast some kind of event that would ground planes for a very long and extended period of time, I think it's a pretty low risk that these businesses wouldn't be able to sell and service components for a very long period of time, especially given the fact that they also service military aircraft, which are even during COVID, they're still going to be maintained. So I will say there's definitely some sort of tail risk here, but it's pretty hard to weigh it that heavily because if demand experiences a temporary shock, it's likely to rebound later.

• 1:09:17Speaker 01

  So both TransDigm and HEICO had reductions in revenue for 2020 and 2021, but in both cases, they have rebounded incredibly well. And if you take a long-term view, it was really just a minor blip in a steady rise upwards. So if I'm looking at both these businesses and assessing risk, I think, once again, I'd probably give the edge to HEICO as the leverage issue just doesn't seem to be much of a concern for them. And then also having the risk of having deals blocked is also much lower, I think, when it comes to HEICO. But I will say, I think both these businesses carry pretty low risk. I'm really just nitpicking here.

• 1:09:48Speaker 02

  Yeah, I agree. I think I'm finding myself to favor HEICO's business model and seeing it's coming with less risk. But the one caveat I'd add is that with HEICO, the bigger risk is the price you pay in the stock market, since the market already knows how good it is. And we'll get to more of that shortly. And with TransDigm, it's almost the reverse. The stock is cheaper, but more of the risk sits inside of the business itself. And that makes sense. And so the growth of both businesses has just been insanely impressive. And it really comes down to two things. Organic growth or the ability to continue growing revenues of their subsidiaries that they already own. And then inorganic growth or the revenue associated with consolidating their income statements with newly acquired businesses.

• 1:10:33Speaker 02

  So with both of these businesses growing so much over multiple decades, the looming question really is, can they continue doing so? And if so, for how much longer? And then what is the composition of organic and inorganic growth?

• 1:10:47Speaker 01

  Right. So picture this for a second. A 30-year-old aircraft is sitting on a tarmac at your nearest international airport. The plane is still flying and generating revenue for the owner, but every bolt, valve, seatbelt, and sensor on that plane will eventually wear out and need to be replaced multiple times before that aircraft is retired. That plane isn't being redesigned. They're just running it for as long as they possibly can to get as much out of it as possible. And that, I think, is really the growth story in a nutshell. More planes like this sitting around longer, constantly in need of more components over time. So when I'm assessing a CRO acquire, I always have to ask this question. If a business is a true monopoly and already owns a large percentage of its target market, well, then growth becomes that much harder to come by. Yes, you can use your monopoly power to increase your prices, but as we've already

• 1:11:32Speaker 01

  seen, you can only really take that so far before you start raising red flags with regulators. So Daniel, I think, did a really good job of explaining the inorganic growth runway for TransDigm. Now, the gist of that was that annual global airline maintenance expenses are somewhere in the $135 billion range. Since TransDigm is active in about half of that market, it leaves them a market valued at around $60 billion. Now, aftermarket revenue for TransDigm is currently around $5 billion, but this includes military components. So this $5 billion number shrinks, meaning they have kind of mid-single-digit market share for the entire airline industry. So this means that they have quite a bit of space, I think, to grow there. Then we have organic growth. We can't forget that TransDigm is really good at optimizing their acquisitions to

• 1:12:15Speaker 01

  grow organically once they are part of TransDigm. TransDigm has an average organic growth rate of about 6%. And keep in mind, this includes the two negative outlier years immediately after COVID, which artificially suppresses that number.

• 1:12:29Speaker 02

  Yeah, COVID really threw a wrench into assessing businesses because you have to try and figure out whether to include metrics from that time or not. And will another COVID-type event happen again in our lifetime? So maybe, maybe not. But when and how big the impact will be is pretty much impossible to underwrite. And given that HEICO is in a similar industry to TransDigm, would you say the TAM number that Daniel used also applies to HEICO?

• 1:12:55Speaker 01

  I think that's a pretty fair assumption. And HEICO's revenue is about half that of TransDigm, meaning their market share is even lower. So I think HEICO still has a very long runway to go on the M&A side of things. Then on the organic side, HEICO also adds parts to its list of its already 20,000 components. So they've stated that they intend to add somewhere around 300 to 550 new parts annually. Some of this growth will come from M&A, but much of it also comes from just reengineering existing parts in-house. But it's kind of hard to get organic growth numbers for HEICO. The other issue is that post-COVID rebound numbers have definitely inflated the organic growth, and they're unlikely to remain elevated in kind of the low double digits that they seem to be, if I had to guess, forever. So Barclays set a number that Clay pointed out at around 7% to 10% organic growth for

• 1:13:40Speaker 01

  HEICO, and that seems directionally correct to me. Now, there's one thing that I have to mention here, which is that the actual TAM for both of these businesses is likely actually a lot larger than I painted. And that's because they both serve military applications, spacecraft, as well as other industries.

• 1:13:54Speaker 02

  It's a good point, and that could be where more future growth comes from once they feel that they have less M&A opportunities specifically in the commercial airlines industry. And overall, I think it's a pretty even split here when we compare these two companies. I'm not sure I can really give an edge to either with the TAMs being pretty similar overall. Maybe HEICO gets a slight edge just because they have less revenue. So they have smaller acquisitions that they can do that moves the needle for them still. And there may be more of these small companies that they can find to acquire than TransDigm would bother looking at. But that is really just purely speculation.

• 1:14:34Speaker 01

  No, I mean, that's a really good point, though. Small CRO quires do have that advantage until they scale up. But, you know, given the average acquisition size for HEICO is already $175 million over the last year, I think they aren't really doing small acquisitions by any means. So I'm not sure it's a huge edge, but I think I agree. It's really hard to give one company an edge when it seems like they both fulfill their own kind of small niche and can grow that own niche over time.

• 1:14:58Speaker 02

  Well, I think it's that time of the episode where we speak about intrinsic value. And so Daniel gave us his intrinsic value estimate for TransDigm about a year ago. And my question for you is, yeah, do we need to change his numbers much? And how have things changed over that time? So let's get into the comparisons.

• 1:15:15Speaker 01

  Yeah, let's do it. And no, actually, I don't think I have any disagreements with Daniel's modeling. The only difference is that the company has basically continued to grow and the share price has pretty much stayed the same as when he covered it, meaning it's probably even more attractive now than when it was first added to the intrinsic value portfolio. Just looking at these two companies, it's pretty hard not to admire them both. I think HEICO has gained an edge, big or small, in many different categories. So I'd probably give them the edge in terms of business quality. But as we both stated today, we have nitpicked a lot. And a lot of the edges that we granted to HEICO, in my opinion, were razor-thin. So in my view, these are both exceptional companies. I personally would have no issue owning either or both of them in the intrinsic value as well as my personal account. But the problem with these businesses is that the market also knows they are ridiculously

• 1:16:00Speaker 01

  high-quality. So as of today, HEICO trades at an EBIT to EBITDA about 30x, and TransDigm trades at about 18x EBIT to EBITDA.

• 1:16:08Speaker 02

  We know TransDigm's intrinsic value, again, from when Daniel modeled it out and estimated it to be about $1,100, which is actually about exactly where the stock is trading today. So props to Daniel. And that means the returns are going to be pretty much in line with the discount rate we use to discount the cash flows, which is, you know, maybe mid to low teens. But what kind of intrinsic value did you come up with for HEICO?

• 1:16:35Speaker 01

  Yeah, so with HEICO, in my base case, I assume revenue continues to grow at about 14%. This allows the business to grow organically as well as through M&A. Now, with how bumpy M&A can be on a yearly basis, it's great that they still have this very nice organic growth number that they can rely on when the M&A pipeline kind of slows down. From there, I apply an EBITDA margin of about 30%. This allows for continued operating leverage. This business has really consistently grown its EBITDA margin. It's been quite impressive. And with cost discipline, I don't really see that stopping anytime soon. So I allowed it to continue expanding a little bit. And then after that, I just apply a 28x EBIT to EBITDA multiple. Yes, this may seem rich, but the median multiple over the past decade is 35x. So I did want to give it a multiple that seems somewhat realistic.

• 1:17:19Speaker 01

  If growth rates and margins are stable, I don't see much of a reason to discount this too heavily. And with that, I get a price of about $550.

• 1:17:27Speaker 02

  How about you walk us through how you think about the intrinsic value of HEICO when you also account for the bull and the bear cases?

• 1:17:33Speaker 01

  Yeah, I think the downside and upside to this business aren't that massive in either direction, which is partly the beauty of this business and why it has kind of this premium multiple. It has really shown resiliency, which helps cap the downside. And the upside is also not massive as they can't all of a sudden really go out and make three or four times as many acquisitions as usual, which would drive a ton of organic growth. So if I apply my bear and bull thesis and a 20% margin of safety, I get an intrinsic value of about $354, but this only yields about an 8% return, which is below the 12% hurdle rate for the intrinsic value portfolio. I will say that I'm very, very impressed with both of these companies. I think HEICO gets the edge in quality, which is why it has that premium multiple. But I'm not sure it deserves quite that high of a premium over TransDigm.

• 1:18:16Speaker 01

  TransDigm is also an incredible business, and the fact that it's multiple is just 2/3 of HEICO is very interesting to me. I still think TransDigm probably offers a higher upside in terms of returns because of this. But to be honest, I'd probably still rather own HEICO just because I do like the business model, and it does still have some of those small edges that I think are very valuable. So my view here is probably that we just watch HEICO closely. If the price drops another 10%, 20%, I could see myself getting really interested in adding shares.

• 1:18:44Speaker 02

  I'm right there with you. And if I could only own one of these for the next 20 years, I would probably take HEICO because the more you zoom out, the less the multiple you pay today can matter. And so it has the business model I like more. It has the stronger balance sheet and is a family that's just about as aligned as you could wish for as a shareholder. But roughly 50x earnings, I just can't justify buying it at today's valuation. I'm too greedy. I'm hoping that we can get a more reasonable price on it. So HEICO is definitely going on my watch list right now. And if the market ever gives us a better price, I'll be ready to take a much closer look at it. And with TransDigm, I think I'm happy to stay on the sidelines with that one.

• 1:19:28Speaker 01

  Well, that's all we have for you today. And as usual, I'll leave you with a quote here by TransDigm founder Nicholas Halli. "We have to stay focused on both sides of the details of value creation as well as careful management of our balance sheet." You can see, I think, today that TransDigm over its history has walked this fine line very well. Because of the monopolistic and highly forecastable nature of its revenue streams, it has been able to continue to grow at a high rate while maintaining a pretty high degree of leverage. While this alone might chase some investors away, I think the strength of their competitive advantages, in my view, makes it somewhat more palatable. That's all we have for you today, and we'll see you next time.

• 1:20:01Speaker 00

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• 1:20:44Speaker 00

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