Ever wondered which market has the highest margins in the industrial world? It’s the aerospace aftermarket—and there’s no company that’s capitalised on this opportunity quite as well as TransDigm.
Rob Small, the Managing Director of Berkshire Partners (and former board member of TransDigm) says, of the company:
“I think that the biggest lesson in TransDigm in many ways is [that] they’ve optimized their situation as well as I’ve seen anyone optimize a situation. And really thinking through what is going to work best in that particular situation, and they do that and continually try to figure it out and get better at it.”
TransDigm, to paraphrase Charlie Munger, took a simple idea and took it seriously. (It should be said that Munger does not like TransDigm’s model, but about which — more in a bit).
TransDigm’s approach seems to have worked — a dollar invested in 1993 would have been worth $1,750 in 2022. TransDigm also hit a remarkable IRR of 36% across this thirty-year period. On the 50X Podcast, investor and author of William Thorndike argued that the company has created “other-worldly shareholder value”. This is the story of how TransDigm did it.
TransDigm, then called TD Holdings Corporation, was originally incorporated in 1993 by private equity firm Kelso & Company. It was originally intended as an entity to house four aerospace companies that Kelso had acquired in a leveraged buyout from IMO Industries Inc. Intruigingly, Kelso shared ownership of the company with two former employees of IMO Industries, Nick Howley and Doug Peacock, who would play an instrumental role in building TransDigm. By December 1998, Odyssey Investment Partners acquired a majority stake in TransDigm for $100 million, valuing the company at $450 million. In July 2003, Warburg Pincus took over with a transaction that put TransDigm at $1,167 million. The company made its public debut on the New York Stock Exchange in March 2006, with Warburg Pincus remaining invested until their exit in 2009.
Before diving into TransDigm’s business, it’s important to understand the unique market in which the company functions. TransDigm operates in the aerospace aftermarket — a secondary market for spare parts, accessories, and non-core airplane equipment.
Airplanes are incredibly complex machines made up of many small parts. What makes the aerospace aftermarket interesting from a supplier’s perspective is the nature of the demand. Some airplane parts do not need to be replaced for decades. Other parts are replaced more often — if infrequently. But even the volumes for the parts that are replaced often tend to be low.
Why, then, is the market attractive? The answer is regulation. Even the smallest, most insignificant airplane part is subject to certification: once a part is approved for an aircraft, it cannot be swapped out for another part without a new regulatory application. Such applications may take years. This implies that for as long as an airplane model is in service — which is typically decades — demand for parts will continue to exist. And it means absolute pricing power for the aftermarket parts supplier: if an airplane is not cleared to fly, carriers face impressively large sums of lost revenue — far larger than whatever they have to pay for an overpriced part. Predictably, these dyn ...
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