Chit Chat Stocks - TransDigm (Ticker: TDG) with Lou Whiteman

Episode Date: August 3, 2023

TransDigm Group Incorporated (TDG) is a global aerospace manufacturing company that produces highly engineered components and systems for commercial and military aircraft, navigating challenges in the cyclical aerospace industry and defense spending. Listen as Brett and Ryan ask questions about the company, its business model, and valuation. Enjoy the show! ***************************** Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney  Subscribe to our Substack to receive free show notes and charts that go along with every episode: https://chitchatmoney.substack.com/ Interested to see more of Lou's work? Find their Twitter here: https://twitter.com/louwhiteman?s=20 Contact us: [e-mail] Timestamps TransDigm | (3:51) Acquisitions | (8:55) Management | (18:33) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. This is our Thursday deep dive episode where we interview analysts to discuss a single stock or industry. And today we have on the show, Lou Whiteman, and we're talking about Transdime Group. For those that don't know, Transdime has been really a remarkable compounder since coming public and Lou gets into kind of the secret sauce or the blueprint that's allowed them to do that. But a little pitch for Lou. Lou has been a Motley Fool contributor for a long time. He's been investing his own money and doing so quite thoughtfully. And I think doing so well for a while as well. And he's also the author of Fits and Starts. And he's talking at the Money Collaborative 2023, which we're going to reference that again in a little bit.

But we just had on Travis, Jason, and Matt Frankel. If you're interested in it, they're all talking at the Money Collaborative. It's on August 18th in Alexandria, Virginia. they're really, I've met, I think most of them and they're all really wonderful people. I really recommend going. You can just check it out on moneycollaborative.com or I believe it's in any of their Twitter bios as well. But this episode was a lot of fun. Transdime is one of those secret compounders that not that many people talk about. And it's not something that people are really that familiar with on the customer side of things, but it's been such a moneymaker for investors over the years and the management team really seems to care about shareholders. Lou gets into why

all that is. So without further ado, here's our interview with Lou Whiteman. Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guest is not formal advice or recommendation. Now, please enjoy this episode. All right, welcome in. Today, we are joined by first-time guest,

Lou and I, well, Lou Whiteman, but Lou and I have spoken before. He's just never been on the show contributor. He also runs the newsletter Fits and Starts. And we'll talk a little bit more about his investing philosophy, but he will also be speaking at the Money Collaborative 2023, which was the event that we talked about with Travis Hoyum, Jason Hall, and Matt Frankel last weekend. But it's going to be on August 18th. It's going to be an in-person event in Alexandria, We have Virginia, where they're going to talk all things investing, and Lou will be there to speak. But I guess let's do a little get to know you for investors that are listeners that

don't know you. When did you start investing? What's kind of your circle of competence, I guess? What kind of stocks do you follow? Great to be here, first of all. I don't know if you were ducking me or I was ducking you, but it's good to be out here. Yeah, so I got my start in the 90s. I have done various things tied to investing and writing before then.

And yeah, most of my career has been either in the financials or in the industrials with aerospace and defense kind of back into the 90s, back before the dot-com boom fell apart and what was going on in Northern Virginia there. So I tend to, as you can tell by my hairline, I'm up there in age. I tend to try and buy and hold and not work too hard at it. So I'm looking mostly for companies that don't keep me up at night and trying to have fun in the process. It's a good approach.

And today we're talking about hopefully one of those companies, Transdime Group. I guess maybe this is one that if you're in the investing community, you've probably seen the name thrown around, but it's probably not a company, or at least the brand Transdime is probably not something customers are kind of that familiar with. So why don't we talk about what they actually do business-wise and how do they generate revenue? Sure. Sure.

Okay. I think the best way to think of TransTime is almost as an industry-specific private equity firm. The actual company, its headquarters in Cleveland, they have a small headquarter office. But for the last 30 years or so, what they have done is they have been buying up aerospace and defense parts business, basically, streamlining them as needed and basically letting them run on their own. It's kind of boring stuff. I think specialized valves, pumps, motors, other products. But what

they all have in common is they are essential to their customers' operations. And the key to this as an investment is they are very good buyers. They are very good identifiers of targets. Almost the way a core competency of a private equity firm. I mentioned way back when I was kind of involved in the m&a side of things um before they were public uh the trans time late 90s dealing with a lot of m&a bankers talking to them they to a person they wouldn't shop their garbage to trans time that was kind of like you know you just don't even bother calling them if you weren't sure about an asset and that was kind of when they first got on my radar screen is this stream it's this little company that were very good at buyers at buying things so you know it's

a funny little thing. Normally, this goes against my gut because with industrials, I never want to invest in the middleman because the middleman gets squeezed both ways. In Transdime's case, you have Boeing constantly trying to bring down their costs and their costs are Transdime's margins. You also have Transdime has a lot of suppliers on its own. So it's kind of risky to be in the middle, but this is a company that they are very good at executing. They're very good at what they do, and it works for them. Within aerospace, they're pretty diversified. About 55% of revenue comes from the aftermarket, which is spare parts. The rest is from new equipment, like dealing with Boeing, Airbus, some of the defense primes directly. Defense is about 40%

of the portfolio. Commercial is about 60%. It's the aftermarket. It's the spare parts where they really make their money. 55% of revenue or something from the aftermarket, but almost 75% of EBITDA. So that's what this story is. It's the story of a company that is very good at identifying assets, getting the best out of the assets and compounding that over time using the cash to buy other things and grow from there. And I'm guessing most of those aftermarket customers are just the big airlines. Is that right? Big airlines, the Pentagon, which we can get into later, kind of some of the things there, but yes, the spare parts and we can get into kind But their secret sauce is rare and necessary, where these parts that if you're Delta Airlines and you need a part to fly from Seattle to Atlanta and to get those 300 paying customers, you're not really price sensitive in that moment.

Right. And that's why spare parts is such a wonderful business for them. You know, and this is just kind of, you know, just I guess the brief history or kind of where they've gone. They were founded in the 90s, just $10 million of private equity money to LBO a couple of businesses out of a company I don't think even exists anymore. They've done maybe five, six dozen acquisitions over 30 years. Revenue since starting, up 18% compound annual growth since their inception in 1993. EBITDA has grown at a 21% CAGR. Big thing is, and I really wish I could tell you I got in at the IPO, but they went public in March

2006. TransTime has delivered a total return of 8,552% since that March 2006 IPO. That's total return without paying a regular dividend, by the way. They've done special dividends, but they do not even, that's basically just on stock appreciation. That's what they've been able to do with just this tiny little $10 million seed to buy a couple of spare parts business from something called IMO Industries, I believe, but something, point is, you've never heard of. So it's kind of, you're buying into their expertise almost more than you're buying into, wow, I've heard of this valve or anything. Like you said, it's not a company that you're going to go onto the shelves and buy stuff for. What you're buying is this management team and what

they are able to do in identifying and maximizing the value of assets great news the federal ev rebate is back eligible customers get up to five thousand dollars with the federal evap rebate on select 2027 volt and 2026 equinox ev models visit your local chevrolet dealer today for more details now you hit some of the stock kind of performance and the ipo and stuff like that and this question is a very short one and it can turn into probably into an hour-long podcast in and of itself but from like an acquisition perspective or from a strategy perspective you know is there any important inflection points in their history that investors should know about to you know help for the context as we try to analyze what the business looks like today so until recently

they really didn't do a lot of huge deals uh there was something called easterline a few years ago and they did a decent size one earlier this year, but they've mostly been, there isn't like a wow deal on their books, which is kind of the point of what they're doing. They are identifying a lot of things that are kind of excess to another company's core portfolio. A lot of what they buy are divestitures. So it really is slow and steady. I think that if there was an inflection point for them, it was sort of when they reached a certain mass where people started noticing them. Because that's, I mean, you can see the stock sort of took off with kind of the boom in aviation, kind of just when they reached a key mass where it wasn't just a couple of parts business.

It was this whole collection of things that were an essential part of the airline's operations. Okay. We're going to talk about some of the price increases that they've seen over the years, but you mentioned that being the middleman in the industrial space generally means you're going to get squeezed. That doesn't seem to have been the case for Transdime. Why have they been able to continue raising prices? Why are they different? What's their moat? Yeah, that's a great question. That's the key to understanding this business. And first of all, I think this will knock you out of your seats, but their margin profile is just software-like. They get 45% to 50% EBITDA margins on a hardware business, on this middleman

business. And they've done that consistently throughout their histories, hence the EBITDA growth. So yeah, the key question to understand is companies, how are they able to do that? And how has that not been eroded away? And I'll give you a couple of stats that kind of get to it. And then I think we can dive in on it. 90% of their sales come from what they call so-called proprietary revenue. Now, how they break that down roughly is either products in which they hold patents, so you can't just duplicate it, or products that fall into this category, essential but rare. Essential and rare is a neat thing. And you kind of only see it after the fact if you're me. With them, I think hopefully they do a pretty good job getting ahead of time.

But it's tough to commoditize something that is essential but rare because Delta Airlines, that valve that they need to fly that flight, they may only need a dozen of them or so a year as things break or whatever, whatever the number is. You can't just fire up a knockoff plant in Mexico or China and make those profitably. So part of this is, yes, patents, but part of this is just products that are maybe when you need them, daggone it, you need it, but you don't need enough of them that you can really just mass produce it. You know, a couple of stats on that, about 75% of their sales come from products, which they are the sole supplier. So they have no competition on it.

The other thing is they are also very good at pricing on the corporate level. That is one area. I mean, it's mostly these businesses run themselves, a kind of a private equity model. But with any good private equity firm, you are the CEO's best friend and confidant, right? So there are some things that you help them with. Truth is, you know, like I said, if Delta or Alaska needs that part, they are not price sensitive. That is where sort of their modeling.

And once they have a business in-house, they know how to price these things perhaps better than the former owner. um the other thing on margins and then um i'll let you guys kind of dig down on one is and we learned this during the pandemic about 80 percent of transdynes costs are variable so that they have a lot of levers to pull as demand ebbs and flows i mean you know the pandemic and this is kind of was the ultimate k test case for this company where as you know if flying stopped right and And even on the defense side, you saw a major slowdown in both production and even maintenance just because people couldn't meet at the same room to build things and maintain things.

Sales kind of fell off a cliff. And we get into kind of what happened to their business then, but it held up. And a lot of it is that cost side with so much of their cost variable, they are able to control their costs to support their margins, even when times aren't great. no that's quite interesting because you think about in the aerospace industry something like boeing you know they're not in that they're not that variable cost uh whatever scenario at all you hit a lot of the financials that are kind of the overview and if you have any follow-ups that are important for that please uh let the listeners know but i wanted to ask as kind of you know

this business is one where yeah the margins are great but it's one where you're betting that they're going to have cash coming in. And like you mentioned, it's like a private equity firm. You get cash coming in, you reinvest. Cash coming in, reinvest in new opportunities. I want to talk about their hurdle rates, their return on invested capital expectations, their IRR expectations.

Do they talk about that explicitly? And if so, what are they? And do you think it's important that they, I don't know, to this thesis? Yeah, they do. I don't have that in front of me, unfortunately, kind of some of the things, but yes, no, they are very, And I mean, cash usage, and we can get into it later too, the dark side of private equity

or maybe is that, you know, it is a very, it is a debt intensive business. And so cash management balance sheet is a very important part of the story, whether you're a bull or a bear, you know, they set targets. They are very proud of some of those stats that I told you at the top, just as far as the CAGR return, but you will see this business kind of go with the flow. The reason I think we like to look at a 30-year average is because there are up and down years in this business. You cannot escape a cycle in a business like this. So I don't know if, as someone who is invested and watches this company, I don't necessarily look towards a metric on an annualized basis.

I need this consistently year after year. I think it is, you have to step back and look at over this trend, what they are doing or what a period is, which is kind of a long way not to answer your question. But I do think it can be tough other than to say they are deadly focused on these margins. And we can get into, like I said, even a margin, they shoot for a 50% margin. Even during COVID, they were in the 40s. I think we you're talking about the fixed cost versus the variable cost. That June quarter in 2020, so April to June, back when everything was going down, revenue fell by, I think it was about a third. And the EBITDA margin still came in at like 41% or something. The next quarter,

revenue was still down 25, 30% year over year. Margins were actually up slightly from the quarter previous. You know, the funny thing about this company, and there's been multiple short attacks, there's been multiple kind of times where it was popular to kind of say the end is near. I've been hearing for 30 years that this isn't sustainable because economics 101, competition, all that. And yet they have still done it. And they've done it in some of the worst markets. And I think, yeah, I think it speaks to kind of just the way they are organized and their ability to find assets where this is sustained. What are their big costs? You said it's kind of unique compared to maybe other aerospace companies.

What are these costs? Is it just mainly manufacturing employees? What are the things you're tracking that makes them more variable versus fixed? Well, yeah, a lot of that is that for them, a lot of their labor is variable. And I think, you know, you mentioned Boeing. I think that would be a huge. And again, a lot of these are unit to unit. So it's hard to look, but there's an advantage for that. I doubt I would like this business as much if somehow the Teamsters were able to organize TransTime as a whole, because then you have a collective bargaining issue. but a lot of these are relatively small units. And you don't have the same fixed cost issues that you have with labor on say the 777 line or something like that. Raw materials are another

big thing. And they are going to see that just like everybody has. Again, with the rare but essential model, you can hopefully adjust pricing for that. Delta needs that valve, whether or not your raw material costs are down 20% or up 50%. And I think this is definitely one of those businesses where you can raise prices to match costs faster than you have to lower prices as costs go down, because again, so much of that revenue is proprietary. Okay. We're going to talk a little bit about the debt strategy in a second, because we've alluded to that a couple of times, but I want to talk about management first. everyone I see online or anyone we talk to that owns Transdime says the executive team there is

top class. I guess what makes them so special? Yeah. I mean, I agree. I think I've already said this is sort of a bet the jockey play. You are buying into their expertise more than you're buying into their ability to design an amazing valve or a revolutionary new valve. So management is really important. His current CEO is Kevin Stanton. He's been there since, I think, 2018. He had been with the company before then. He was sort of the protege of Nick Howley, the guy who founded this company. Howley remains active as a chairman. He's very involved. And I mean, I think Howley is, there are other companies that sort of have a similar model where sort of it's the family involved. I don't like that as much. I think Howley did pick out

someone that I think he has mentored and who shares his vision. The conference, I was nervous when the transition happened. I think the transition has gone really well. I think they seem to work well together when they're talking to investors. The other management thing here I love is if you look at their board, and we talked about this as sort of a private equity play. You have Bob Small from Berkshire Partners, who is a longtime managing director at a firm that knows industrials. Michael Graff from Warbird Pincus, they're on the board. Everything I've seen, this is a very active board. I mean, this is almost the board is treated as an investment committee from a private equity firm. And you have some really good private equity brains there.

Directors and officers, I think own about 7%, 8%, which isn't bad for a company to size. It's not like, you know, huge amounts, but the best thing I can say about them is their track record. And, you know, and again, I, I hate past performance is not an indicator of future success, but they have, this group has a real track record of picking out the right assets and doing with them what it needs to be done. I, you know, I mean, we are seeing the generation fall off to a new generation. That is certainly going to be one of my lists of like things to watch because it is hard to do, but I do think the culture in there, and it's a very small group at headquarters. I do think the culture there has held up over time. And it is, I think that is

the key to this story is their ability to find these assets and work them the way other people can. All right. And one of the big parts of that is the financing. So people talk about the debt strategy. They say it's very smart, but I don't really know anything about it. So let's go into the details of that, can you explain Transdime's debt strategy for making acquisitions? So yeah, so they are always focused on the next big acquisition. The other side about what they're buying is there's not huge growth in most of these businesses they're buying, right? If you buy a pump for the 737, you can grow with the 737. You're not going to grow that at 5X to 737. So their growth is through acquisitions and cash, of course, is the fuel for that. So, you know,

going back towards the beginning, this is a company with private equity DNA. The way private equity gets its returns is leverage. Debt is the lifeblood of this business. I like that you say you think you've heard that they manage it well because, you know, debt can also be their downfall. I think debt is both their use of debt is a strength, but it's also a real risk. And I'd say their strategy is calculated risk. Looking just at the numbers real quick, in the last quarter, they had $3.4 billion in cash and almost $20 billion in debt. So that's debt at about over five times trailing 12 months EBITDA. That's not crazy, but that is a lot of debt. And it is getting more expensive. They'll probably release in August. So these are a little

stale numbers, but pretty good. The weighted average on that debt was 6% interest at the end a quarter. That's up from 5.8% a quarter before. So, you know, I mean, this is, it is the wrong market to have debt. A few things that I would say as far as how they manage it, they have no major maturities until 2026. They are very good at kicking the can. They have been a long-term borrower and they manage their balance sheet as far as looking years out. About 75% of that 20 billion debt is fixed at least through 2026. And some of that is they do use- That's nice. That's pretty nice. Yes, yes. And again, I mean, we still saw the 200 basis points up quarter over quarter. So, you know, that 25 percent, imagine if they hadn't done that with the 75, right? But this is, again, this is a management team. I don't think they were caught off guard by rising rates. A lot of their strategy is swaps. It's interest rate caps. It's all of those things that can be a real pain when they're not needed, but you're glad to have now.

Now, part of this is just like COVID was a time of reckoning as far as demand goes. This is a time of reckoning where we see how they manage through their lifeblood cash becoming more expensive. And I think so far they have handled it pretty well. Is it a risk? Yes. When we talk about risk, it's definitely the amount of debt they use and the way they use debt is both vital to their business and it's always going to be a risk.

but they do generate a lot of cash. Their model is fueled on what to do with that cash. Generally speaking, for the years, A, invest in acquisitions, B, manage the debt, and then C, way down the line, is return cash to shareholders. It's definitely in that order. As I said, they don't pay a regular dividend. They will pay one-time dividends if it's a market where, look, everything's too expensive. We're happy with our debt profile. Here's cash back. I think they paid something like 1850 per share to shareholders in 2022. It was over $60 a share back in 2019 when things were going real well. I do think that from here, I can't see them shying away from a good deal because of their debt. And they have been saying that the pipeline is

beginning to fill again. So I'm kind of hoping we will see. I think the debt is manageable to do deals. They have a few billion probably in firepower if they want to. But given where interest rates are, given the debt they had, I am not counting on a big one-time dividend in 2023, maybe even 2024. I think it probably behooves them to, if they can't find a deal, to pay down that debt. But again, I think balance sheet management is a lot more important to understanding in this business than it is we've reinvented the manufacturing line or we've come up with a new way to make a pump. What this is, is financial engineering. And I know it gets a bad rap, but they're really good at it. And they've been good at it for a long time and it can work.

I guess as someone who's not that familiar with the space, a question that's coming to mind for me is that it feels like they've done a lot of acquisitions. It feels like they've raised prices, maybe not to the max. Maybe there's room for them to continue doing that. But is there enough acquisition targets for them to just keep going after new parts or are they anywhere near maturity? They are more mature than they were. And I definitely, I can't imagine that 8,000% return over the next 20 years. But part of that is a product of being small and growing big. But look, I mean, we talked about there isn't one signature deal. Part of that is that they are carving things out. And yes, there are, I'm probably not exaggerating, millions of potential

targets out there. Most of them are not going to come nearly to what they would want out of it because they do want that. They want to keep that margin profile. They do not want to buy a commoditized business. They are trying to keep that 90% proprietary or, you know, so that does limit targets, but no, there are a lot of, and look, there's a lot of good reasons for this too. There are aerospace and defense has a long history of good businesses that just don't fit where we're trying to go. They have done very well on that over the years. I think, especially with sort of kind of, it's fun. We can get into this later with the risk though, but Boeing is very much trying to squeeze its middlemen right there. That in a way is a risk

for them, but that is in a way an opportunity for them because we have seen like the Easter line deal was mostly a important supplier to these companies that wasn't the best run. I hope management doesn't watch you guys, but it wasn't a very well-run company. And the opportunity there was as Boeing started turning up the heat and like, we want better. And the solution was hit the eject button. So I do think there are a lot of opportunities out there. It's always an issue of price. And it almost would worry me more if we saw a flurry of deals at the same time, because then you have to question if they're price disciplined the way we'd want them to be. But a very long answer to a short question is no, I do not worry about them running out of

targets anytime soon. Okay. And the general projection, I believe, from companies like Boeing is that air travel demand is going to continue growing steadily. I think the projection is double over the next 20 to 30 years, but who really knows? I guess, how does this trend benefit Transdyn long-term? Sure. And I will say, I'm a big believer of that forecast. And I think it's a global story, but the emerging middle class globally, the demand for Lyft out of just the world, coupled with the fact that, look, we're sitting here on Zoom, the world is constantly moving closer together. I'm really bullish on air travel. I'm a lot more bullish on air travel than I am any individual airline, which is why it's so nice. We have companies like Transdime out there,

but we talked about the revenue breakdown. They do have a role on a lot of new planes, so they do benefit from strong demand out of Boeing and Airbus. But new planes are also more commoditized. One of the reasons you make so much on the aftermarket is, is if you're talking about a 30-year-old design, they just need more parts, right? So you kind of want the older planes in service for a longer time. One of the nice things about those demand forecasts, if it's true, is is that, you know, very simply, Boeing and Airbus can't meet that demand with new planes. If there is strong demand, you are less likely to see retirements. You are likely to see fleets used longer for throughout the globe. And that is a huge benefit. If you have, if 90% of your

portfolio is parts that they can only get from you, whether or not Delta or Alaska Air is flying a 15-year-old 737. Someone will, if there's all this demand. And so to keep those planes in service. And so, yeah, I mean, more aftermarket sales, more spare parts, this is their bread and butter. And, you know, kind of with that too, because we haven't really talked about the defense side and I think we can kind of the ups and down that, but I was going to be my follow-up. So yeah. Okay. Good. Well, let me go. And then, you know, I I'll, I'll ramble and then you can, We'll get to your question. But look, I told you, it's almost been, I hate to say it, almost 30 years watching this industry. And I will say this is the first time I have seen the stars aligning for both the commercial and defense at the same time. If we do just without getting too much of a history, the 90s, we had the so-called peace

dividend. And I'm not here to boo on peace, but the Cold War had ended. The government was going to spend on things other than defense. It was not a great period for the defense side. We saw contraction. We saw consolidation. Even after 9-11, and again, I hate to be the guy cheering for war, but I'm not here. But even after 9-11 and all of the adventures in the Middle East, it was not a period of

massive investment in equipment and platforms. It was a very different kind of a battle. And the defense contractors had to adjust. I mean, there are still, the F-35 came. So, you know, there's still some things, but it wasn't that Cold War boom. That's changing in a big way post-Russia invasion of Ukraine. I mean, we just had Lockheed Martin's earnings today. And Lockheed Martin was saying that we're not going to grow until 2024 at the earliest. Today, they said, you know what? Nevermind. We're growing now. And that is the direct result of how the world is changing, kind of getting back into the Cold War mindset, the platform mindset. That works for them. We already talked about the commercial side. A friend of mine, a colleague who

was at the Paris Air Show this year. And that is, if you don't know, Paris is where all the deals get done. Most of those deals were already done, but they all get announced at this hot tarmac in June every other year in Paris. His big takeaway from that event, it's not really insight, but he was, and this is a guy who's been doing this a lot longer than I have, but he said, the order books are overwhelmed. Even if we have a slowdown, even if this is the travel on the commercial side was just this post COVID, I got to get away. There is so much demand right now. And the order books are so full, the factories are going to be overworked through 2024 into 2025. That feels like a super cycle on the commercial side.

Couple that with defense and kind of the state of the world. This is the first time I've ever seen kind of the A and D kind of clicking at the same time. And, you know, TransDigm might not be maybe the best play for that. I mean, I'd have to think about that, but TransDigm will benefit from both sides of that. And a lot of that is sort of just the equipment to keep all of this growth running. So I don't know, Brett, if that got to it, but go ahead.

No, my follow-up that I wrote down literally was defense spending growth due to China and Russia. So you definitely answered that. But it's a nice segue into this next question, which is about the regulatory heat that they've gotten. I think that's a risk people talk about, but also something that hasn't hurt their returns yet. So they have had that.

What do you think about that? Is it a big risk? why or why not? So it has been a huge headline for them. In fact, I think it was June 2019, Congress requested the Pentagon Inspector General to open an inquiry on their pricing. Now, some of this came out of, there was a short report maybe a year before that kind of identified this. And I love the short that got into it, so I don't really want to criticize them. I don't think this was their best call, but the basic thesis was, how are these margins possible? kind of, and then it went from there. But yes, TransDime ended up, management was grilled before

Congress. It made all the headlines. It wasn't pretty. They were sort of the same thing. I mean, it became the $30,000 lug nut or whatever. I know at the time, just to kind of give you kind of what was going on there, TransDime estimated about 8% of their revenue came directly from the US government, either through direct sales or through distributors. So it wasn't a big part of the story then. The margin profile defense business has never been what was expected in the commercial aftermarket. But again, part of what you're paying for, whether or not it's on the defense or the commercial side, part of it is it's hard to commoditize these products for not using much. Also, imagine you are in the procurement office of United Airlines. And Brett,

if you went to your boss and said, good news, I found a way to get this part for half the price, it's sitting in a warehouse in China. Is that going to get you a raise? You know, for an airline, the quality, knowing what it is, the reliability is sort of part of what you're paying for. That to some extent is true of the Pentagon too. The Pentagon actually kind of came out in defense of the company when this was coming on. End of 2021, that investigation was closed. It identified what I think it called $20 million in excess profits, spread over 150 contracts in a two-year period. Transdyn did do a voluntary refund of about $16 million in profits. So that was the hit.

There were no allegations of wrongdoing. If you worry about it from here, I mean, I do think you still see those headlines come up because it was. I mean, there were pictures of Nick Howery up in front of Congress. So you never want to see that. there was talk at the time, a lot of what was going on here is that the procurement rules for the Pentagon for smaller things. And these valve, I mean, I think it's a $2 million threshold where it's really scrutinized. And so again, if you need a valve for an F-35, it's probably not a $2 million part, no matter what you think of government spending. So there was talk that

find new ways to scrutinize even smaller things. If that comes along, I think it's manageable, but that could sort of ding them along with everyone else. But again, on the defense side, there's a lot of sole sourced patented stuff where even if it really is 8% of revenue, even if they have to ratchet that down, I don't think it kills the story. It was bad PR, but it doesn't really kind of keep me up at night, if that makes sense. That makes sense. Let's talk valuation. I think we've covered the business pretty well. what do the i guess what are the numbers look like today could you kind of give maybe enterprise value just to give some context on the size and then what are the how do you value

the business yeah you know what i do not know their enterprise value off the top of my head so i'll be look real quick the market caps are in those around 50 billion so 70 billion or so um i i do like looking um when i value these industrials i tend to do um enterprise value to EBITDA because debt is such a part of the story. Last I looked, I looked this morning knowing this happening, about 24 times EBITDA. That's pretty close to their historical average. That doesn't look like a screaming bargain to me. It's down from where they were a while back. And of course, it's up from COVID where the stock did take a hit. They're guiding for 20% sales growth this year, which is in line with the past. So there is still, I mean, again, this is a

substantial $6 billion company is still seeing 20% sales growth, kind of what they've done historically still there. Almost more importantly, we talked, you know, they kind of hit the same supply chain issues, everyone else. They're going for earnings per share up 38% at the midpoint for the year, 2375 versus 1714 last year. So there's room for appreciation, even if the multiple is about right. And again, I don't want to deep dive into another company here, but I am going to sort of take a shot at a company to kind of talk valuation. They trade today on that metric, enterprise valuable to EBITDA, I believe, quick math, about a 35% discount to Heiko. And if you guys know Heiko, it's this company that, you know, this is sort of the same idea

where they want to find special parts business and run them. So it's kind of their closest comparable. There's a lot of differences, but they trade right now. Historically, Heiko's been public a lot longer than Transdime. But if you look at their two lines together on the enterprise value to EBITDA, historically, they've kind of gone along together since Transdime's public offering. This gap is substantial. There's reasons for that.

Heiko, one distinct difference between the two of them is Heiko is involved in non-error space stuff. So they did not take the same hit during COVID. That made sense two years ago, probably, as a valuation thing. I don't think it makes sense now. Heiko is a very good business, maybe second best, if you made me say it. But to me, it is not a superior business. So for me, yeah, valuation, it's not a screaming buy, you know, cheap right now. But given their guidance for growth, given what we've talked about, maybe the dual super cycles we have for the next few years, and just the multiple appreciation back to kind of tracking this other company, assuming they get there, I think there's a lot to like right now, even if it isn't necessarily as cheap as it was at the height of the pandemic.

Okay, we have two follow-ups before we get to our pre-mortem. These are from Twitter. These are from the account Pythia Capital, an honest account, but follows Transdime very closely. Very good fundamental investor. First one, what are the three or five most misunderstood things about Transdime by investors, regulators, et cetera, basically anyone out there? You could choose two, three, four, whatever you want. So it's funny. This is such a boring company, and I mean that with all respect, but it's such a, you know, three to five is hard.

The biggest thing, and I think no matter how many times people who are invested in and they say themselves that I don't, you know, rare and required the value of that. Just the idea that a part that only you can make that is not price sensitive to your customer at the end of the day, whatever you're going to charge Delta for that part to have that plane in service and running its schedule, it's probably worth. And maybe that sounds cynical, but I mean, it's good business. And I think if there's a biggest thing that's misunderstood, as far as, as long as I remember this company being public, it has been, these margins aren't sustainable. And it went public in 2006 and the margins are still sustainable. So I think that that is just that simple. It's hard to get right, but getting it right, I think that is the biggest thing.

If there's a couple more, maybe, you know, we talked that debt can be a powerful weapon. Yes, it's dangerous. But the idea of the private equity model, I think, is underappreciated in public markets. I never advise run to a huge debt story. But if balance sheet, running a good balance sheet is a core competency at some companies. And if you can find a company that does it well, you should, at the very least, not be scared of debt. And I guess maybe the third, Ryan, I love what you said before.

This is not a company that you'll see things on the shelf. It's almost the inverse of Peter Lynch's, by what you know. There are some good companies out there that are just hiding in plain sight because they aren't on the shelf at the convenience store. And I do think, I don't know if that's misunderstood about Transtown, but that is something that just jumps into mind when you ask that. And here's a fun one. That was the second one.

I'm not sure you have an answer here. And it's going to be a lot of speculation because here's the question. they have talked about not needing to move into new areas, which I assume is beyond aerospace and defense. But if they were, what do you think are some potential new markets where they can apply the Transdime approach to value creation? So yeah, this is the Heiko question. We were just talking about Heiko that this is because Heiko in my mind, and again, I don't want to trash them. It's a very good business, but it is an inferior business to Transdime with a better multiple. So what is Transdyn doing wrong? And Heiko has broadened its push into other sectors.

And in a way, it makes sense. We have this expertise. The perfect example is that they have a defense electronics business. They now make the circuit boards and a lot of healthcare equipment. You can see the apples to oranges, the apples to apples there. And it really did help during the pandemic, certainly because it was healthcare equipment, but just in general. So I think if Transdyn was to broaden its reach, it's probably maybe they go that way and figure out how to some of these businesses that they have, how they can expand the markets in those business versus just saying, let's start buying up the healthcare supply chain or the automotive supply chain or something like that. because I do think their industry knowledge is more of a core competency than maybe we give a credit for. There's downside to that approach too, because again, part of their core competency is understanding the industries that they do business in. I just wrote something over on my newsletter

about just kind of people don't appreciate on the defense side of things. The defense industry's greatest skill is its ability to deal with that SOB of a customer, the federal government, with all of its procurement, all of its Byzantine rules and all of that, that is the single core competency of the Defense Department. Kind of in a similar way, I do think there is value of just being very, very focused, very good. I don't think they need to move into new areas. I think if they did, I guess, since I said I trust management, I'd probably have to go along. But I think it'd be more of a, uh-oh, Ryan, to your question earlier, they can't find targets anymore than it is they see opportunity because they will talk about just the skies to limits as far as if

pricing was right, there's opportunities in this. So do what you do well. But if they were to do that, I think that the easiest thing would be how can we exploit what we own or apply what we own to new markets. Okay. Last question. And we try to ask this for all our guests pre-mortem. How How could an investment in Transdime go poorly from here? What are you kind of watching to see if your thesis is busted or something? Well, I think, I mean, the first thing, and we've already talked about it, is debt, debt, debt, debt. That is the primary risk here.

You know, Transdime's plan, their growth is built around their use of debt. I think they can handle it. I think, you know, balance sheet management is a core competency, but debt has a way of kind of things don't go as planned, right? If end markets weaken dramatically, if things go wrong, debt is what everybody is going to be watching. I don't see a scenario where that's fatal, but there are plenty of scenarios where it just puts growth on hold and maybe affects the valuation of the stock if things don't go well. So I think as far as just if the stock was the flat line or have trouble from here, it would probably some combination of what we saw in the pandemic, just end markets really, really weak and not a normal business cycle weekend, coupled with their debt wasn't ready for it. And again, we sort of got to battle test that during the pandemic.

I don't want to be too, you know, blase about it, but we did see just that happen on the market side. Fortunately, interest rates were zero, but, you know, and now we are seeing how they manage through higher interest rates. So it doesn't keep me up at night, but if something was to happen, I think that's what it'd be. Other risks, you know, look, the aftermarket, I told you I love the aftermarket. It is where you can get margins, but they tend to have short lead times.

They tend to go through periods of destocking with these distributors. And Boeing is a major distributor now, so they can kind of manage that better. TransDyn was at a much bigger advantage when your distributors are a million ma and pa shops than they are if Boeing is now the biggest parts distributor. So that is an issue. I think that's more going to be a cycle thing where you may see a quarterly hit than the thesis is busted. But that is something to watch. And something that anyone who knows anything about Boeing has heard is what they call their Partners for Success program, which that was an idea of this is Boeing's way to solve all the problems that companies like Transdawn create. Get competitive bids for everything it sources, to get competition in the marketplace, to drive down margins.

They've been talking this up for, gosh, it feels like a decade. It probably hasn't been that. As you may be aware, they've had a lot of distractions through that time. It hasn't necessarily worked out the way they hoped. We do have patents. We do have long-term relationships. And again, there is a trusted partner here thing where you don't necessarily want to go to Ryan and Brett's airplane parts, right?

Watch them bend it by hand and hand it to you. So I think that that looked a lot better on a PowerPoint for Boeing than it did kind of and it plays out. But there is, back to where we started, this is still a middleman business, and you do still have all of those things that you have to watch. Well, that is going to do it. I think that's all the questions we have. I guess, Lou, we'll definitely have to have you on again at some point. But for listeners that want to keep up with you, see more of your work, what are the best places to do that?

Probably as long as it exists, Twitter, which hopefully it'll still exist for another few weeks, right? at Lou Whiteman. The newsletter is Pits and Starts at Beehive, but it's on Twitter. I think that's it. And of course, The Motley Fool and in person in late August, if you can, because hopefully that'll be a lot of fun. It's a bunch of hopefully smart people and myself meeting and talking about investing and drinking cider, what's not to like. And it's Alexandria, Virginia. So anyone within that area, super easy for you to go to. yeah and even if it's not you can come in from the west coast guys we'll have to check those uh plane those plane prices but yeah it might be trans times fault

if they're too expensive that's right we're gonna play trans time that's right um all right well that is gonna do it we want to remind listeners that brett and i are not financial advisors anything we say or discuss here on chit chat money is not formal advice or recommendation We are, however, general partners at Arch Capital, so clients may have positions in the securities discussed in this podcast. Thank you all for listening. Thank you, Lou, for coming on the show, and we'll see you all next time.