The aviation aftermarket has seen some big mergers recently, such as Heico’s purchase of Wencor. Aviation Week editors discuss why mergers are picking up and the outlook for more.
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Rush Transcript
Lee Ann Shay:
Welcome to this latest MRO podcast. In this episode, we'll be talking about mergers and acquisitions in the aftermarket. I'm Lee Ann Shay, Aviation Week's executive editor for MRO and business aviation, and I'm here with my colleagues James Pozzi and Michael Bruno. James is our MRO editor for the EMEA region, and Michael is our executive editor for business. James and Michael, welcome. Thank you for joining me.
James Pozzi:
Hi.
Michael Bruno:
Thank you. Great to be here.
Lee Ann Shay:
Let's get started with just the overall state of the market. During the pandemic, many of us, including me, thought there would be more consolidation in the aftermarket at this point. However, I think we're starting to maybe see an uptick. What are your thoughts on this?
James Pozzi:
The market is in a recovery phase, of course, going into 2023, certainly a lot stronger than the previous years, although we were seeing that pickup I guess from 2022 onwards. In terms of M&A, it's been some really interesting deals so far, like a good flow of them. And I recently compiled some of the ones that stood out in terms of their size and scale of the deals, and in terms of market segment too. Some of the ones that really come to my attention are in the parts space. I mean, there's a big deal I think to be completed late this year, that's Heico buying Wencor. And they're a company, of course, that have stated previously that they would look to make some acquisitions in the aftermarket.
The parts space actually is very interesting, I think. That was one that was widely tipped for consolidation, and we've seen a few more of those so far this year. Some of the most interesting ones I think are maybe the mooted Barnes and MB Aerospace acquisition, which has been touted this summer, to be completed later this year. That's a big deal, certainly. And also a lessor, elfc, obviously based in Ireland, buying a Chicago-based engine parts repair supplier, INAV. And that's really to get better access to the end of life parts market, which has obviously seen a lot of longevity, and think of the engine types like CF34-10, of course, the CFM56-5B and 7B, and the VT500.
Other things we've seen so far this year in Europe where I'm based, there's been a lot of activity there, certainly in my country, the UK. A couple of MRO specialists have been acquired. I think that's obviously for geographical purposes, but also there's been some capability additions there. The most recent one is Sabena Engineering of Belgium adding Aircamo, completing their majority investment in that last week, and that gives them a bit more scope in the UK, and having another MRO to work with specializing in areas such as camo and airframe MRO. So that's certainly a geographical move.
And another one of the really interesting ones actually, I thought, was AAR a few months ago buying a software company, of course, Trax. AAR of course has made its digital strategy well known, and its plans around that, so it'll be interesting to see an MRO acquire a software provider, take it in-house, and how do they turn that into a revenue driver? How does that improve some of their operational parts of the business? And how are they going to utilize that business? So that'd be a very interesting one too, an MRO taking a software company in-house.
Michael Bruno:
And just to follow up on what James is talking about, he's got a great recitation there of the current activity, and absolutely AAR, and even maybe even more than that the Heico-Wencor deal, it's just so amazing and I'm sure we'll talk about that more here. But if you want to step back from a 60,000 foot level and look and ask the question, why now? What's going on? I think one thing to remember is, here we are in mid-2023, and we're three years after the onset of the pandemic, and it basically took the whole world, not just in aerospace and aviation and MRO, but it kind of took the whole world until most of last year to really come to grips with the idea that we were through the pandemic, and that you could see the new trends emerging.
In aerospace and aviation, to abuse a cliché, M&A activity had been grounded for quite a long time, because everybody was waiting to see whether passengers were going to go flying again on commercial airliners. And that determines how many you either need to buy or you need to keep in play in your fleet, and if you don't have them active on your runway right now, you got to go get them out of the parking lot. And so all that was trying to be determined. People were trying to figure out how many airplanes were Airbus and Boeing really going to deliver, not just for that year, but how much could they really deliver in the mid-term with the supply chain issues that you all have talked and written a whole lot about, and really covered extremely well.
So a lot of stuff just had to be... People were waiting to see and have more confidence on how it was developing. And by the early part of this year, confidence really started to increase. And so you see people making moves, not only because strategically they've decided something like MRO is really going to be a great place to invest in the next few years, but also you had some external events such as interest rates, the cost of borrowing and the cost of money had really started to change. And whenever a change happens, that triggers people to get off the fence one way or another. Either they get off the fence of a deal they thought they were going to do and they abandon it, because they don't like the rising costs, or they say, "You know what? I really believe in this deal. I need to go forward and get it done before costs get even higher." So a lot of things came together to make 2023 really the year that we start to see a lot of action.
Lee Ann Shay:
Gentlemen, thank you so much. Those are all fantastic points. And Michael, you'd mentioned supply chain. I think almost every conversation seems to come back to supply chain and workforce shortages. At the Paris Air Show, I spoke with William Ampofo who leads Boeing's supply chain efforts across the whole enterprise, and he said that obviously the company is closely monitoring its supply chain, and they have about 300 people, from lean specialists to industrial engineers, at suppliers that they're concerned about. However, he said that there are also still some distressed suppliers that they no longer are giving government support, or the interest rates going up, that might need to be bought out. What's your take on the number of suppliers that are distressed, and is the sale of those going to start picking up?
Michael Bruno:
Yeah. First of all, I just want to say we're three minutes into this podcast and supply chain has come up, and I'm disappointed only that we didn't raise it in the first ten seconds, because that's the strength of this issue right now. It is such a hot topic. Just like you, somebody else who went to Paris was telling me that he could not talk to an executive in the aerospace industry without supply chain coming up in the conversation within the first five minutes. And it didn't matter who the executive was, what level, what company, what their specialty was. Supply chain, supply chain, supply chain. It continues to be the
governor, the limiter on what is happening and how much we're going to produce, both from a first article manufacturing side, whether you're trying to produce a new airliner, or whether you're trying to repair something and get the parts in the repair shop and the FBO.
So it's all supply chain right now. And you'd think sometimes from the headlines that it must be in complete disarray, and people are going out of business left and right. That's not actually the case. From the surveying and the studying and the reporting we've been doing, and particularly the MRO team here at Aviation Week has been doing on that side, we're led to believe that there are hot corners where there's a lot of issue, and then there's other major parts where things are going relatively okay.
Now, the dichotomy there is the fact that you need everybody to go well, because you need all the parts to make an airplane fly. And so all it takes is one part not showing up, and you can't either build the aircraft or repair it. So you always focus on that 5% to 10% that's not showing up and is holding back the whole airframer. There is absolutely distress in the supply chain, particularly at the lower tiers, tier three, tier four, what we will commonly call the mom and pop shops, small owner-managed shops. There are some of them that are just running out of cash. There are also some of them that are just running out of passion. The owners have been doing it for a while, they wanted to get out before the pandemic, they didn't, they had to wait, and now they've gone through the pandemic and they've said, "You know what? I'm out of here. I really just want to sell."
So we're going through a bit of turmoil. I guess the good news so far, from the survey we've done including with Bank of America, is that there isn't so much distress in the supply chain that it's seen stopping production lines or stopping repair parts from getting delivered by themselves. Don't get me wrong, it's a major issue that the OEMs and tier ones have to deal with. The repair shops want their parts delivered. Everybody's got to get those parts in, and they spend a good chunk of their time trying to wrestle with that one supplier who's not providing. But the distress that's happening is more on an individual, anecdotal level, and less about a systematic or system-wide issue that we're having.
I will say, however, there is not a consensus around when this distress will be relieved, or at least when it'll be basically overcome. We were hearing basically last year that people thought by the end of this year. Now we hear this year, people think maybe by the end of next year. I'm already hearing people say, actually it's going to be 2025 when everybody gets resynchronized. So when does the supply chain catch up? I don't know. But it is an issue everyone's going to be wrestling with, and there will be the occasional supplier that goes out of business. But for the most part, the industry seems to be managing it, like it or not.
James Pozzi:
Michael's analysis, it's a very interesting point around what he's hearing about expectations about when that will smooth over, I guess. Last year it was very much pointing towards 2023, but now recent conferences I've attended for the MRO industry, it does seem to be veering towards 2025. And that's just expectations of industry professionals, they don't obviously have the crystal ball, but that's what they feel, when it will smooth out. And interesting point about the mom and pop shops, the lower tier of the supply chain, the three and fours. At the height of the pandemic, the expectation was that a lot of those would eventually be, I guess, acquired or swallowed up or sold, possibly as distressed sellers. I'm just interested to see really when that will happen. I think it does seem pretty inevitable, but I'd be interested to know exactly when that picks up pace and volume over the next one to two years, and be very interesting to keep an eye on.
Lee Ann Shay:
Absolutely. And another point, back to the Paris Air Show, I agree with you, Michael. So many executives said they're really looking forward to the day where they don't have to choose between which parts get allocated to production, and which ones get allocated to the aftermarket. Across the supply chain, there are different... Engines is different than interiors, is different than airframes. You could probably have a whole podcast just on engine parts. But I think that's definitely a supply chain issue that we still need to be following into '25, '26, just based on the ramp-up.
Now, what about long-term forecast? We've mentioned 2025. Michael, what are you hearing, especially from analysts for long-term forecast, for M&A, especially in the aftermarket?
Michael Bruno:
An exciting time. Buyers, sellers, strategic buyers, those are companies providing parts or repair services, or what we call financial sponsors, people like private equity investors, or even family offices. It's a really, really interesting time, I think, in MRO M&A. And there are a couple of reasons for that. Some of them are obvious, but basically in a nutshell, we have rising passenger growth again in the airliner world. And that's the metric that is sine qua non. It's above everybody else. And when you have growing passenger traffic, you're going to have more activity, and you've got to feed that activity one way or another, either, again, with new aircraft or repaired aircraft. It's going to drive every aircraft to get repaired more. So there's just more money flowing in MRO than there has been, certainly not just in the pandemic, but what I'm hearing is the forecasts for the mid-term for MRO businesses are just seen as growing double-digit revenue in the mid-term, mid-term being two, three, four, five years. So that attracts a lot of investors, whether they're people who are already familiar in the sector or not. Anytime you got growing revenue, that attracts people who've got money to invest.
So another thing that is part and parcel to that is the fact that we're having such a difficulty in this industry producing and delivering new aircraft, that that means even more of the burden of flying all of these passengers is going to fall on the older aircraft. And of course, older aircraft need to be repaired more. So people who start digging into this say, "Wait a minute, MRO's even more exciting than I thought just from the headlines of more people are flying."
And then finally, you've got these external factors, and you've got rising interest rates. You've got inflation that had spikes, but now seems to be at least retracting to some degree. We can all argue whether inflation is going to go back to the United States Central Bank's 2% target, the 2% annual growth target, how quickly it'll get there, will it ever get there again, should they continue to try to pursue that? That's a whole other issue for people who are financially oriented. But people who make deals, they just see that inflation is coming down from the spike. So what you know at least from there is that, as a business person, you can plan. You can plan on what inflation and cost prices are going to be for either raw materials or labor. You could do better planning now that just helps you line up deals better.
So you wrap all these things together, and what I hear is over the next two to five years, particularly through the MRO activity peak we all see coming at least mid-decade, is that M&A in MRO is going to be one of the hot areas. There's more interest there than there was before. And James mentioned the biggie lately, Heico and Wencor. So Heico is well known to your audience. They usually do a lot smaller deals than a $2 billion deal for another big player like Wencor. But the fact that they are going to kick out $2 billion in a high cost of capital or higher cost of capital environment shows their absolute confidence in the growth of this market, and the ROI on that investment and that deal in particular.
Lee Ann Shay:
So you mentioned the bigger getting bigger, like Heico buying Wencor. Bundling services and growing business is nothing new, right? But are we starting to also see a shift to more insourcing instead of outsourcing?
Michael Bruno:
Yeah. I will just jump in real quick and say, I am hearing a whole lot more anecdotal evidence of it. I'm hearing more expectation from executives and from consultants that I talk to. Essentially the pendulum had swung too far in the 2010s, and if you go back all the way to Boeing with the 787 program, where there was an attempt to revolutionize the outsourcing of a big chunk of that aircraft, even more than had been done before. And I think it's worth repeating for every audience in aviation, the standard right now and has been for a couple of generations is that about two thirds of any given aircraft program is outsourced, whether you measure an activity of manufacturing, or whether you measure by financial worth, the financial value of the program. But it's about two thirds. The OEMs put the final parts together, and they of course sell it to the final customer, but two thirds of that program is built by somebody else, and it all gets trucked or trained or flown in to the final assembly line.
So we've heard that there's just been a lot of issues with that, whether it's because your outsourced companies had difficulty building the individual parts, such as in the 787, or whether here we are with a bit of de-globalization happening around the world, and you just cannot rely on just-in-time parts getting delivered from halfway across the world like you used to any more, for whole kinds of reasons we don't want to go into on this podcast, because that would be a whole hour and another day.
But the fact is, you do hear more talk about insourcing, and we've heard it from folks no lesser than Dave Calhoun, the CEO of Boeing, who talks about the next new aircraft that they build, and Boeing will build a new aircraft someday, and the next one they do, they're basically planning on bringing a little bit more of that in-house. But you also hear from suppliers like Spirit AeroSystems coming out of the pandemic saying, "We've got some capacity within our own buildings, capacity and skilled workers who know how to make parts. And they do..." Right now, spirit AeroSystems is building a lot of parts that some suppliers can't provide. Spirit AeroSystems didn't want to do it originally, but they're finding that, we can rely on our own people building these parts, and long-term, maybe we should think more about trying to do some of that ourselves, just to eliminate risk and maybe even eliminate a little cost.
So James, I don't know if you've heard anything similar, but I'm certainly hearing a lot more of it from my side.
James Pozzi:
Yeah. It'll be very interesting to see what some of the intentions are going forward, particularly the OEMs, I'd say. Obviously before COVID, we just heard a lot about OEMs looking to acquire companies and take a bigger share of the aftermarket, having that much more control and visibility over things. But that's probably changed since then. Obviously, they are beset by some supply chain issues, production troubles, and technical issues with certain programs, airframe and engines over the last few years, particularly new generation types. So their intentions going forward will be... I can't really second guess what they're going to do, but that will be interesting in terms of strategy in approaching the aftermarket, and how that plays alongside getting a grip of their supply chains and getting those into, I guess, a better shape than they have been, certainly over the last couple of years too.
Lee Ann Shay:
James and Michael, thank you for bringing up so many great points. I think we could talk about this for at least another half an hour, but instead, I think we should just wrap this podcast up and say, let's have another one maybe in a quarter or so, because I think there's going to be a lot of news.
Listeners, please don't miss the next podcast by subscribing to the MRO podcast wherever you listen to them. And one last request. If you're listening in Apple Podcasts and would like to support us, please leave us a star rating or write a review. Thank you, and thank you to our wonderful Aviation Week podcast editors. Greatly appreciate everything that you do as well. Thank you and have a wonderful day.
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