TransDigm: Operator to Capital Allocator with Nick Howley
Nick Howley is the Founder and Executive Chairman of TransDigm. In this discussion, we study TransDigm’s evolution under public ownership. Since its IPO in 2006, the company has outperformed the S&P by 15-fold and its peer group by 9-fold. We unpack its approach to special dividends and leverage, examine meaningful acquisitions alongside disruptive crises, reflect on the prior three decades, and consider TransDigm’s future beyond $50 billion of Enterprise Value.
Explore the materials we used to prepare this podcast episode, including our proprietary research, original investment memos, and more.
July 10, 2022
Internal case study on TransDigm’s value creation playbook, historical performance, approach to capital allocation, notable crises, and peer group.
Private Placement Memorandum
Memorandum prepared for TransDigm’s original acquisition of Imo Industries’ Aerospace Components Group in partnership with Kelso & Company.
Private Investor Presentation
Investor presentation prepared for Warburg Pincus following the 2003 auction process.
2003 Investment Memo
May 23, 2003
Berkshire Partners’ investment memorandum from their unsuccessful bid with Greenbriar Equity Group and Western Presidio to acquire TransDigm in 2003.
2003 Exit Valuation
May 23, 2003
Diligence on exit valuation expectations leveraging comparable companies, historical trading multiples, and relevant private transactions.
2008 Investment Memo
May 19, 2008
Berkshire Partners’ investment memorandum from their open-market acquisition of public shares in 2008 following Stockbridge’s investment in 2007.
2008 Investment Presentation
May 19, 2008
Research and data behind key investment considerations supporting Berkshire Partners’ 2008 investment memo.
Esterline Initial Assessment
Long Path Partners
Initial evaluation of TransDigm’s $4 billion acquisition of Esterline, leveraging public filings and management commentary.
Mental Model Framework for TDG
Long Path Partners
Overview of Long Path’s framework to assess a business’ value accretion, initially informed by TransDigm’s example.
Systems view of Constellation Software and TransDigm, investigating the game selection, strategies, and execution responsible for their success.
Could TransDigm be the Valeant of the Aerospace Industry?
January 20, 2017
Short report speculating on price gauging, an unstable capital structure, and other headwinds that preceded a spike in short interest.
Bull Thesis in Response to Short Report
Value Investors Club
March 21, 2017
Anonymous investment case for TransDigm in response to Citron’s short report, addressing pricing, acquisitions, and leverage.
Interview with Yen Liow, Aravt Global
Graham & Doddsville, Issue 36
Interview in which Yen Liow highlights Nick Howley and TransDigm as an excellent manager and business.
Interview with Alex Captain, Cat Rock
Graham & Doddsville, Issue 39
Interview in which Alex Captain shares his perspective on TransDigm following COVID-19’s influence on aerospace.
Capital Cities: Briefing
The Outsiders, John Gilligan
January 27, 2005
Investigation into Capital Cities’ superior performance from 1966 through 1995, detailing industry-leading operational execution and its unparalleled acquisition activity.
Capital Cities: Interviews
The Outsiders, John Gilligan
May 11, 2005
Interview highlights from key operators, including Tom Murphy and Dan Burke, and investors featuring Capital Cities’ decentralized structure and disciplined operating practices.
in this interview
- Download the full transcript
- CEO Time Allocation Post-IPO
- Attracting Long-Term Shareholders
- Evolution of Board Post-IPO
- Approach to Leverage and Protecting Downside
- Navigating the Great Financial Crisis
- Approach to Special Dividends
- Stock Repurchases as Alternative
- Kirkhill Acquisition
- Esterline Acquisition for $4 Billion
- Investing in Product, Quality, and Innovation
- Remaining M&A Runway
- Short Seller Assault in 2017
- Navigating COVID-19
- Approach to Managing through Crises
- Nick’s Transition from CEO to Chairman
- Managing Personal Liquidity
- The Howley Foundation
- Snapshot of TransDigm Today
- Lightening Round
- TransDigm’s Influence on Nick’s Life and Investment Philosophy
CEO Time Allocation Post-IPO
[00:05:51] Will: Welcome back to our interview with Nick Howley. In our first session, we covered TransDigm’s first 13 years under private ownership and today we’re thrilled to dig into the subsequent 15 years plus under public ownership. As we transition, I’m reminded how unique Nick is as a guest here on 50X, wearing two hats, so both the longtime CEO and the longest-standing investor at TransDigm. So, while the private equity backers we covered in our last session achieved extraordinary returns and Stockbridge and others have enjoyed an exceptional run under public ownership, Nick may be the only investor to have participated in that 1993 financing, who still holds shares today. With that said, let’s dive in.
So, the company comes public and I’m curious, first 12 months after being public, in terms of your time allocation as the CEO, how different was it versus how you were spending your time as the CEO of a private equity-owned company?
[00:07:04] Nick: I would say in total, not as much different as I feared it might be. I was concerned about going public. One, I was concerned it would be a time sink, that’s all I’d do. I didn’t like the publicity. You essentially are going to start to live in a fishbowl. Whereas I said, in total, it was probably not as onerous as I expected going in. I would say the living in a fishbowl was probably at least as bad, if not worse, that’s clearly a negative. I was concerned that we would lose our culture and value focus. Those were probably my biggest concerns I had.
And I would say my goal in it was to try and stick to our strategy as clearly as we could. Try and clearly explain to the public shareholders that you should think of us like a private equity business that is operating in the public market. That’s how we intend to operate. We don’t intend to change our leverage. We don’t intend to change our methodology. We intend to stick with our strategy as close as we can.
And my other goal was to be credible. It became clear to me very quickly in this, it become clear before that, that it’s a marathon, not a sprint. You’re going to have to deal with the same people over and over and over again. So, there’s no sense starting down a bullshit path, you’re going to get caught. There’s too many smart people trying to keep track. You’re going to get caught, so be consistent, be honest. If it’s bad news, it’s bad news. We’re all big boys. We can get it. Those were the things I was after.
I would say in my time, for the first year or so, I would estimate it was a day or two or a month. Probably did the equivalent of a day of prep, earning call, and then calls to shareholders. And afterwards, I probably did another day a month either in New York, Boston, Chicago, or something visiting shareholders.
I can’t say that the operation of the business changed much. That was my goal was not to change it much.
Attracting Long-Term Shareholders
[00:09:07] Will: When you went public, Warburg still held onto a large ownership position, a majority ownership position, which gave you a little bit of a buffer, I guess. I’m curious, how long did it take you to attract the public market investors who really got that PE in the public markets story? Because Warburg is, over time, post IPO selling down its position, how long did it take you to find the group that really got it?
[00:09:32] Nick: I would guess… Warburg was probably mostly out by 2007, 2008. I don’t exactly know the answer, but in 2008, the shit hit the fan with that Great Financial Crisis. I think probably by the time we got through that, we had pretty well established the group that would stick with us. So, what’s that? Three, four years?
[00:09:51] Will: Yep.
[00:09:52] Nick: And performance by the way… Primarily performance. At the end of the day, how well you tell the story or the gift of gab or any of that over time doesn’t matter.
Evolution of Board Post-IPO
[00:10:00] Will: How about the board? Was the board any different and did it function any differently post IPO?
[00:10:05] Nick: Other than a little more careful because of all the rules around a public company, I can’t say that it functioned substantially different. The board continued to be… I think Rob Small came on right soon after the IPO. It was three Warburg guys, it was Doug Peacock, my partner, myself, and Sean Hennessy. Sean did a very good job of bringing the public company general process and discipline.
[00:10:30] Will: And Sean’s background, again, Nick was?
[00:10:32] Nick: He was a CFO of Sherwin-Williams for many years.
[00:10:36] Will: So, the total board size was seven or eight, something like that. Small by public company standards. And the majority of those directors, including Rob, once he joined, had some private equity background.
[00:10:46] Nick: Had some PE background. And by the way, that was not by happenstance. Warburg is because they were there, but I’m very happy with guys with PE background on the board. They’re focused on value creation. That’s what you want to be focused on.
[00:10:58] Will: Well, the other thing is, if you look at that group, all of them were substantial owners.
[00:11:03] Nick: That’s right.
Approach to Leverage and Protecting Downside
[00:11:04] Will: Which is unusual in public company land.
Picking up that capital allocation thread post IPO, one relates to a source of capital and the other relates to a channel for deploying it. The first is leverage. So, you guys delevered down to that four and a half times enterprise value to EBITDA level to go public. Can you talk about how you, over… really, if you look at it, over six or seven years, gained conviction about being able to run the company at a higher level of leverage once public?
[00:11:36] Nick: I’d say conviction and also, I think we convinced the public world.
[00:11:40] Will: Yeah, both parts of that, absolutely.
[00:11:43] Nick: I was never particularly concerned about the leverage level once we got past six or seven years. But Warburg was of the belief, and I think they were probably right, we didn’t want to be too high going out into the public market.
Maybe I can explain the process each time we lever up for some reason, either on purpose or we lever up by mistake because the market craps out on us. We typically go through what we think are some very onerous downside scenarios. We take the worst downturns we’ve ever seen in each segment and assume they all hit it once, which has never happened. Then we say, “Would that bust us?” And it never does and that usually gives me some comfort. Now, will that hurt the equity holders? It will hurt the equity holders substantially, but if the business is still what we think it is, that’s a passing phenomena. You’ll get through that.
And we go through that each time we lever up. I explain it to the equity holders. “This is why I feel comfortable. If you don’t, you don’t, but this is why we feel comfortable.” I’d say we had a couple of good trials by fire. 9/11 was a trial by fire. 2008, 2009 time period was a trial by fire. And we had the down cycles, not as bad or nearly as bad as we modeled in downside, but pretty bad. But they got ugly for a bit and the company performed fine.
Each time that happens, you get more and more conviction because spreadsheets are one thing, it actually happens is another. So, what has to happen is the fundamentals of the business have to hang in. You have to in fact, be able to get the cost down ratably like you think you can. And you have to be able to maintain your pricing power through the down cycles. And if those happen, at least in the aerospace business, generally, you’re going to be okay. Again, you’re not going to like the equity, what it looks like for a while, but you’ll survive.
[00:13:33] Will: To double click on that, Nick. So, the way you stress test the leverage capacity is you literally look at each product line and you look at the worst it’s performed year-over-year.
[00:13:48] Nick: We usually do what I would say on a more macro sense. We take the market segments—the commercial transport OEM, the defense OEM, commercial aftermarket, this aftermarket, business jet, et cetera—and say, “What’s the worst they’ve ever done.” And try and assume, they all hit it once.
[00:14:02] Will: And being able to service the debt through that?
[00:14:05] Nick: Service the debt through it, not get too tight on the covenants. And again, the big assumption is the structure in the industry holds: you can hold your pricing and you get the cost down. You can also lose it that way by just sitting on the cost too long.
By the way, everyone being owners is very helpful in that. I’ve had to deal with these and other situations where you fight forever about, “Why do I have to take the cost down? And this is important and this can’t be done.” Everybody being the owner really helps that. “Look, this is where all our investment are, guys. We got to figure out how to do this.”
[00:14:40] Will: If you took the average business unit GM and you looked at their stock-based comp as a percentage of their total comp, very roughly, what is it? What has it been?
[00:14:53] Nick: One-third cash, two-thirds equity. And that’s how we calculate it when we award the options and we assume it’s going to double in five years. In fact, it’s been much more than that.
[00:15:08] Will: Hence, the focus.
[00:15:10] Nick: Hence, the focus. And almost anyone running one of our businesses, this is far and away their biggest investment.
Navigating the Great Financial Crisis
[00:15:16] Will: Maybe we could talk a little bit about the two crises, meaning the GFC and COVID.
[00:15:21] Nick: Yep.
[00:15:22] Will: In both cases, the stock got cut in half. Actually, in the case of COVID, it was down 60% in about a month. Let’s talk a little bit about, in both of those cases, how conviction built? And let’s maybe focus on the GFC first, the financial crisis, but what struck me in looking at that was how active you guys were in this 12 to 18 months around the collapse of Lehman. You did something like five acquisitions and paid your first really significant special dividend all within that period of time. So, can you just talk a little bit about managing through that and coming out the other side on your front foot opportunistically capital allocation-wise?
[00:16:04] Nick: I would say, let me deal with it first on the operating side. When it became clear to us that this was going to happen, that this wasn’t just a minor blip in the curve, that something was going on here. The most important thing in my experience there from the operation is get out ahead of it. Don’t go into denial, get the cost down fast.
So, we made our best guestimate because who knows where the bottom’s going to be. But we made our best guestimate of what we think is going to happen for the next six to nine months and we took the cost down. We probably took 20% of the cost out in a step within about a 60-day period. And that means you can’t listen to too many stories. It’s got to happen and it’s got to happen fast, then we’ll react. So, that’s the first thing we got our house in order.
We were in pretty good shape cash-wise and we stayed in pretty good shape cash-wise, and we generally maintained access to the capital markets. There was probably, I don’t know, three or four month when there wasn’t much there. I think we pulled down the revolver just to be sure we had the money. That’s what we did. We ran the business. We kept running cost control. We kept price activities going.
[00:17:12] Will: And margins throughout that period stayed in the 40s?
[00:17:17] Nick: Yes, that’s right. And that’s because of the two. Because you could get your price and because you got your cost down. If you didn’t do either one of them, you would have lost your margin.
If I remember right, the OEM rates collapsed more than the aftermarket did through that one. In the aftermarket, flight activity slowed way down, but it didn’t actually go negative, where OEM went negative. Now, you get a positive mix impact out of that, which overcomes… Even though we say there’s no such thing as fixed cost, the fact is there is a little bit of fixed cost. That mix overrode that as long as you got the cost down fast enough.
We felt stable quick enough that we were ready to buy things when they came up. And I can’t say we did anything different, other than we just had our antennas out and we were beating the bushes like we always do and things came up. And we evaluated and bought them. We felt comfortable enough with our model. We felt comfortable enough that the world wasn’t going to hell. And I think we got some decent buys, not fabulous buys, but decent buys.
[00:18:22] Will: Any of those from distressed strategic type sellers?
[00:18:25] Nick: No, I can’t really say they were. By and large, you don’t see a lot of distressed things here. We’re buying proprietary sole-source businesses with a lot of aftermarket, unless you get yourself way over-leveraged. As I like to say, it’s hard to lose money in them. Some people do, but it’s…
Approach to Special Dividends
[00:18:43] Will: All right. So, the other thing that happens in the wake of the financial crisis is you guys pay your first special dividend as a public company. And so, I’m curious, thought process around that. You had done one significant dividend distribution while private under Warburg’s ownership as you returned about half of their equity.
[00:19:00] Nick: That’s right.
[00:19:01] Will: But this is five-ish years later. What was the thought process around that?
[00:19:05] Nick: The same thought process we use all the time. Our view is that the equity is the most dear capital that we have. Cost is, depending on what you want to say, 17, 20, 22% after tax. And the debt costs us, pick your number, 3, 4, 5, 6 after tax. We ought to swap it out all day. And our goal is to get equity returns to our shareholders. We looked, as we always do, we looked at the balance sheet. We looked at the capital markets and we got borrowing capacity. We feel very comfortable using it. We can get it. We can get it at a cost substantially lower than the cost of our equity. And frankly, we aren’t giving our shareholders much to be happy about and we don’t have use for it right now. We took the money and paid it straight out.
[00:19:49] Will: And just to frame that, that first dividend was 16 or 17% of the market cap?
[00:19:54] Nick: Yep, that’s right. It was a meaningful number.
[00:19:57] Will: What’s interesting to me, Nick, is I had the wrong idea in my head around you guys in special dividends. I thought that this was something that you had done regularly under PE ownership, you picked it up again once public and began to do it, but really you had done it once privately. The whole idea is something, which by the way, is very unusual in the public markets, this idea of large special dividends, really something you evolved once public.
So, I’m curious, you pay that first one and then, you begin to get on a regular pattern of special dividends. And the two that I’m interested in are you paid one in 2013 and one in 2014, and they’re both similarly 15-ish, mid-teens percent of the market cap. But collectively, by doing that, you take a step function change in your leverage level.
[00:20:50] Nick: Yes.
[00:20:50] Will: Starting with those two beginning in 2013, your leverage goes back up to between six and seven times enterprise value to EBITDA. So, can you talk a little bit about, was that the result of increased conviction, having seen how the business came through the financial crisis, or just…
[00:21:05] Nick: Yeah, a combination. We were pretty comfortable before, but we were getting quite comfortable with our ability to carry the leverage and the market was getting quite comfortable with our ability to carry the leverage. I would consistently say to investors that you’re not going to invest in a company that services a market that grows 5% real a year and get 25% return if you don’t leverage it somehow. That doesn’t work. I think people got comfortable with it.
Again, my logic always was that the equity was very expensive. It’s not my money, it’s the shareholder’s money, and I ought to use as little bit of the equity as I can to run the business. When I don’t have a clear and present use, I ought to get it back out to them. By that, I mean, either in excess cash or excess borrowing capacity. I got increasingly comfortable with it.
[00:21:54] Will: Sitting here today, you’ve paid out about $10 billion in special dividends, roughly 400 times the initial primary equity.
[00:22:03] Nick: Yep.
Stock Repurchases as Alternative
[00:22:04] Will: Extraordinary. And part of that, how did you think about stock repurchases as an alternative?
[00:22:10] Nick: We’ve done a little bit of stock repurchases, but not a lot and we’ve waffled around on that and I don’t know what we’ll do in the future. Typically, the issue has been that when we did them, we wanted them to be substantial. I like the “no risk, it’s done.” The advice we would get is you’re going to have a hard time taking 10, 15, 18% of the stock out of the market quickly. You’re going to have to stagger it over time. And as you do that then you don’t know what’s going to happen to the price.
And we ultimately decided we liked the certainty. We like getting it done now, we know what we had. The story was done, it was behind us, and we moved on. When they’re a smaller percent of the market cap, we may think of that differently, but that was the guiding principle. We liked the certainty and we thought it would take too long to execute.
[00:23:00] Will: Yep, yep. So sticking with capital allocation, but transitioning to your acquisition machine… Under public ownership, inorganic growth became quite consistent and I expect the M&A function matured a bit. It’d be great to look at a more recent acquisition in a little detail, and maybe an example there is Kirkhill, which was a seemingly small deal, but led to some larger things over time. Do you mind talking through that one a bit?
[00:23:27] Nick: Kirkhill was essentially at Esterline discard. They very rarely sold, but they decided this was unfixable and they ran a very fast process. If you wanted it, you couldn’t do any diligence, just how to buy it or not. And the price was about 50 million bucks. We looked at the business. They described it as a non-proprietary, competitive business. We looked at it and we did a couple of things.
One, we appraised the property. The property, we were pretty sure, in Southern California was worth about 40 million bucks. So, then we said, “How much risk do we have if we buy this for 50?”
The other thing we were pretty sure of is they described it as a no-way aftermarket business with seals. And the only function seals perform is aftermarket replacement to keep the closure tight, so we didn’t see how that could be. And they believed it to be quite competitive, but we were pretty sure there was only one or two other suppliers in the world. But we weren’t exactly sure, so we went ahead and bought it.
We got in very quickly and the answer was obvious that this could be a winner. So, the price went up, the cost went down significantly, we invested… They had cut all the investment out, probably five years ago when they gave up on it. We probably put 10 or 12 million dollars of capital in it fairly quickly, which we don’t have to do, but this was a clear, obvious payback and a situation that had to be done.
Bob Henderson, who was a Vice-Chairman at that time and also, because we were thinking about this larger Esterline business, he went immediately in to run it for six months, along with his day job. And to quickly evaluate the management, which took about 40 days to evaluate. And then Bob got cost cutting moving along quickly. He got capital expenditure program moving pretty quickly, the obvious one. He started to renegotiate the big contracts in the aftermarket pricing and he took two TransDigm guys and put them in there, one to be President after about that six months and another to be Head of Sales and Marketing.
We divided it into product lines, relatively small product lines that we could give P&Ls for, track them. We had product line managers. We put in a mostly new senior staff. Started to track the heck out of quality, delivery, any customer issues, service them like crazy, but you got to pay for that.
And it’s just blocking and tackling. And, by the way, figuring out that what you have is really probably 70% realistically proprietary.
[00:26:40] Will: And if you were going to rank the three Ps, Nick, in terms of their contribution to that margin improvement, super roughly what?
[00:26:47] Nick: In that one, I would say price and productivity were almost equal because there was so much productivity. And I’d say the new business was slower coming along, which it almost always is. It was slower coming along but contributory.
Esterline Acquisition for $4 Billion
[00:27:00] Will: This one was the entrée, the amuse-bouche to Esterline. Is that a fair way to think about it?
[00:27:07] Nick: Yes. I would say that also had the classic situation, which we see, that someone mixes up development and engineering spending with new business. The fact that I’m just going to spend where they’re going to come, so there was a big adjustment there. Not are we after new business, but we’re going to work on things that one, that we can win and second, if we win, they’re not a booby prize. You can make money on them.
So, we were in that and we took a run at trying to buy Esterline, probably five years before that and really couldn’t get them interested. They had a new CEO, if I recall or soon going to have a new CEO, who thought they could get it sorted out. We then decided to reengage with them again. And we looked at it. We looked at what we knew about the mix of products. It was 28 operating units and this is a business that had been stuck at 13 to 15% EBITDA forever.
That didn’t seem like it could be true to us based on the mix of products. We also found out from owning Kirkhill that they were just layering on these corporate overhead programs and costs. They put in a multiple group structure that… By the way, we’re okay with those group structures as long as there’s nobody in them. Each one had its own office with its whole staff in it. So, we decided to pursue it.
The previous time they just blew us off, but this time they were getting more outside pressure because nothing was happening. So, we got some engagement there, but we were hoping we could get it closed without such a competitive process. And that was probably naive in a public company. So, it ended up in a back and forth competitive process between ourselves and a couple of other people. We ultimately topped it. If you would’ve started off I would’ve said, “I don’t think we pay 122.” But we got more and more lathered up as we went along.
[00:29:14] Will: And Esterline, of course, was the largest acquisition in the company’s history?
[00:29:18] Nick: About four billion, public company, 28 operating units. We ran a somewhat similar drill. It was a big enough thing that we had us start biting away at it. We couldn’t throw everything out right on day one. What we could do is replace the management immediately. Essentially, we didn’t change anything at first. We took the CEO and the CFO out right away, which they knew it, we talked to them during the process.
Bob Henderson went in to be the CEO of it. And all that was changed the next day is it wasn’t public anymore. And we put somebody else in as effectively the CFO. We took two TransDigm EVPs and we assigned them to the project along with Bob. These were experienced hands and we set up a special option plan just tied to the Esterline performance against the model, which was, if it worked, was very lucrative.
[00:30:08] Will: Sorry, Nick, against the acquisition model? Against your base case?
[00:30:11] Nick: Think of it like a tracking stock or synthetic stock against the acquisition model. So, essentially if you generated this intrinsic value, which tracked the model, you got a significantly extra pop of equity. It worked very well for them.
So, that gave us the ability to go in and start to take 28 operating units and break it into chunks of seven or eight or nine that somebody could start to evaluate quickly. We had the diligence, but public diligence isn’t great. It’s okay, but it’s not great. And then we started chewing away at it. We started with the biggest units first, excuse me. We first started trying to assess quickly where we write were the ones we didn’t want.
[00:30:51] Will: Which was a significant percentage of the total.
[00:30:53] Nick: About five of them of a decent chunk of money.
[00:30:56] Will: What percentage of the total, super roughly?
[00:30:59] Nick: I would guess a quarter maybe. Not a quarter of the EBITDA, though. More of the revenue than EBITDA. And we decided to go forward and sell them. Actually, it might have been a little more if we got them all sold. One of them we couldn’t get sold because we didn’t like the price and we decided it wasn’t so bad, we didn’t give it away. The other ones, we had a certain amount of polishing to do to sell them, so it took probably a year to get them sold, which again, was different for us. The other businesses, we went through the normal drill.
The first thing got to pretty quickly is there were probably the equivalent of 300 to 400 people in the corporate structure and we just started to do that away. There were 150 in the corporate office and we just started the shut down process almost immediately and got it shut down within about six months. And then the group structures probably took a little longer, but they didn’t take a year. They maybe took four, six months and essentially those at least were somewhat functional. So, essentially that was just a push-down exercise. You push down into an operating unit. Now, I got two first basemen. One first baseman stays and one doesn’t. We just push them down. I would say, not that many got pushed down and made it. Bob and EVPs wouldn’t endorse them. The operating units viewed them as corporate sludge. And some of that may or may not have been fair, but it didn’t matter. We were moving on.
Then we did the same thing at each operating unit. Set up the product line structure, go through the pricing discipline, resize the cost base, which I would say averaged 15, 20% of personnel cost. Typically, at least half of the cost and the rest of it, the material stuff, takes a longer to nip away at. Set up a very structured analysis of the development expenses and try and cut out the programs that we don’t think you could ever make money and we’re either chasing a technical windmill or the contracting basis is no good. And get it moving.
And then, COVID hit and it’s held the margin pretty well. It has held the margin and is grinding back up again.
Investing in Product, Quality, and Innovation
[00:33:16] Will: You just alluded to the product piece of this. How do you guys think about investing in product and quality and innovation as part of the program going forward?
[00:33:27] Nick: Well, first, in what we’re going to do, we tend to be much more interested in evolutionary stuff rather than revolutionary stuff. The aerospace industry doesn’t move fast. A new idea can be 15 years or something like that to get somebody to do anything. So, think evolutionary.
The most important thing here and is well-worth investing is you’ve got to deliver on time and you got to be maniacal about it. You got to have product that is technically good. And if there’s a problem, you have to fix it fast. Most things we buy are not focused on that. The delivery is bad. They have good products, but they’re haphazard about servicing them when there’s an issue.
Our experience in this industry is what matters is the product works, you keep up with the technology mostly, which is make the life longer. You deliver them on-time, service the heck out of it. And pricing is a distant third or fourth in the value creation because, once again, these are little things going into big things. What matters is they don’t foul the big thing up. They work and you get them there on time. And if something goes wrong with that, you fix it fast.
Remaining M&A Runway
[00:34:39] Will: And you alluded to this earlier in the hurdle rate discussion, but as you sit here today, how do you think the M&A runway looks going forward? Feels like there are fewer big whales out there. How do you see all that evolving looking forward from today for TransDigm?
[00:34:55] Nick: The real answer to that, Will, is I don’t know. We’re now, depending on the day’s stock price, we’re somewhere in the $52 to $55 billion of enterprise value. Someday, you’ll run out of room. You’re not going to own the world.
There are a few big ones around. We just missed on one, Meggitt that Parker Hannifin ended up buying. But I don’t know exactly how that will evolve.
I do think that the most important thing is that you keep a very value-driven, value-creative culture and management team. And if you do, you’ll figure it out. Someday, you’re going to have to open the aperture. You’re either going to have to stay in the aerospace industry and take less proprietary stuff or you’re going to try and stick with your proprietary aftermarket definition and step out of the industry. And we’ve looked at both of those at different times. We haven’t found something compelling enough and frankly, something has come along we could buy, or the option of giving the money back to the shareholders has looked like a different option for most of them. And I think we’ll continue that as long as you have a value-driven management that is looking at value and not looking at feather in their own nest or keeping their job or something like that.
What’s an end game? I guess an end game is it’s completely run out of room and you can’t give enough money back, you sell the business in whole or in part. In part, I don’t think you ever get there, because I think the whole is valued more than the parts.
Short Seller Assault in 2017
[00:36:32] Will: So, shifting topics here for a minute, as we’ve seen, you guys have been very adept at navigating crises over the years. And one crisis that we haven’t talked about was short seller assault four or five years ago led by Citron. Can you just talk a little bit about what that was like? What it felt like to be a target of something like that?
[00:36:52] Nick: It’s a stressful situation. And of course, that’s part of the game is to try and crank the whole stress to the structure up and hope you’ll pop. And clearly, one of the things they’re after is to destroy the credibility of the CEO, particularly when you’re the name of the company at that time, which is easy to do. It’s easy to start flailing around and answering everything they should. So, I think the things I took from that is one, I did some study into how they work, which helped me. I talked to some of, a number of our big investors, our long-short funds. I could talk to some of them just to see how the mechanics work.
I think probably a couple of things I took away relatively early and I’m glad I stuck with is, one, maintain your credibility. In other words, if you don’t know the answer, you don’t know the answer. If you’ve got nothing to say, don’t say it. The other is, you don’t have to answer them tit for tat. They want to engage you in a public back and forth battle, which you can’t win because you’re stuck with the truthful requirements of an SEC filer and they’re not. So, you just can’t win that.
So, you have to be very careful at what you respond to. You have to be careful not to get too agitated because they’ve also got personal attacks, you have a couple on your family and where you live. Because the whole thing is to get you frazzled, get you striking back at them. You may or may not know this, Will. They went through, for a while, they had all series articles saying that my son’s business was buying companies at a low multiple and reselling them on to TransDigm. No evidence, they just said it.
[00:38:23] Will: And just out of curiosity, what did that feel like, Nick, around the dinner table, in the heat of that, when it first started?
[00:38:29] Nick: Very stressful. What builds stress also through the organization is… The buzzword is short and distort. That’s what this is. A short and distort is the opposite of a pump and dump scheme, a pump and dump is when you buy a stock, you put out a bunch of fake press releases, stock goes up, and you dump it.
A short and distort, I’m surprised it’s not illegal and there are starting to be rumors about it, but they do just the opposite. In other words, you buy a stock, then you start to put out fake studies and fake news reporters and then keep driving them down. They’ll start spitting these out two a week and each one will have some outlandish allegation. Some of them you have to address.
Here will be a typical situation. You come in, somebody’s written an article, says something bad. You can’t tell whether it’s true or not because you’re a decentralized company. Is anything true? So, you go into a scramble. You got all the operating units getting information up and you’re trying to get it back to you as fast as possible because you really start getting shareholders calls right away about this. Is it true that this terrible thing happened or something like that? So, you want to avoid the calls until you’re reasonably certain. You’re never going to be 100% certain, but you’re going to avoid the calls until you have a high enough confidence level that you can at least start to talk about it. Say, we think this is very unlikely and we’ve done some research. If it’s active enough and you think it’s damaging enough, then you start to take calls from shareholders. So, you do this then you have everybody running around all day Tuesday and you started on Wednesday, come back into work Thursday morning or Friday, same thing. Another allegation, start the whole place cranking up again. People up all night, getting all pissed off, and it goes on and on and on for a while.
[00:40:34] Will: Post attack, stock goes down as much as about 30%. What was the path back to normalcy?
[00:40:40] Nick: I’d say a couple of things, as I told you. One is stay credible, so don’t let them build up. Don’t get tangled up in lies somehow where you’re back and forth in something you can’t win. You’re stuck with the truth requirement and they’re not, so you can’t win that.
Once we got comfortable and once we felt like we understood the lay of the land and we had done a lot of the back and forth, we decided to do a roadshow because one of the allegations was, “You’re jacking the prices up. You got no organic growth. You’re shrinking 10 or 15% a year. And you’re covering it with these price increases.” So, we did a road show mostly demonstrating our positions on the new airplanes, giving some better sense of what roughly might be a price number you could use to deflate. And showing the performance of the company against the other people in the industry to show that there wasn’t a great disconnect. And I think that sold fairly well. It was getting behind us by July or August.
Now, the best defense is, of course, is to keep performing and the businesses kept performing. Then you can just say, “This too will pass.”
[00:42:04] Will: Did anything constructive come out of that whole process?
[00:42:07] Nick: Watch the short-selling numbers, which I never paid any attention to. Now I get it at least once a month. Perhaps we got our shareholder base more comfortable with this. I think we handled it pretty well. We got through it pretty well. I surely wouldn’t choose to do it again as a learning experience.
[00:42:25] Will: Makes sense. And so, talk a little bit about COVID. One of the investors, longtime investor of yours, described it as a worst case living hell scenario.
[00:42:33] Nick: Absolutely.
[00:42:34] Will: Can you talk a little bit about how that felt?
[00:42:36] Nick: Scariest market condition for sure. I would say if you took 9/11 even, 9/11 was a little worrisome, too, just because you didn’t know if it would just keep going on, there’d be a series of these things. I would say the ’08, ’09 timeframe, it was fairly clear to me that this was an economic downturn. It may be deeper and it may go longer than you like, but the world wasn’t fundamentally changing. The COVID thing, I simply didn’t know how to assess it.
We never modeled anything where the air travel cut by 60, 70% in 30 days and then who knows when it was coming back. And the commercial aftermarket is really where all the money is here. So, it hits you in the toughest spot and it was concerning, but a couple of principles won. There’s nothing you can do about the market. It will be what it will be. You can wring your hands, you can make up spreadsheets, but it’s going to be where it will be, so you might as well make a conservative assumption and get to it.
So, we made… I don’t remember exactly, but these are public. We gave them out when we did it. We assumed the commercial aftermarket was going to drop by 60 or 70% and stay there for six months or so. We didn’t say we knew, we just said, “Well, this is our planning assumption.” The commercial transport would drop 25 or 30%. It would drop more, but it just can’t turn down that fast. And the defense would be roughly flat. We did the math and said we got to get the cost down ratably to do our best to hold the margins. That ended up being something like a 33% cut in real volume when you did that math. So, we had to get that amount of cost out and that’s a huge cost get-out in 60 to 90 days. I would say we got the bulk of it out. Some of the foreign countries where they got more notification rules and things like that, it may be dribbled out a little longer, but we surely got it all out within four to five months, and I’d say most of it in two to three months.
Our view there was, we’ll get it down as far as we can and if that’s not enough, that’s not enough. We’re not going to kill the company because we’re not going to try to get the costs out, but we’ll take a deep breath. I think we came pretty close to holding the margins, not perfect. I think we probably leaked a couple of points in margin but, for that level of disruption, not a lot.
[00:44:45] Will: Just extraordinary, honestly.
[00:44:46] Nick: Yeah. My math isn’t very complicated because sales are here and the margin is here. If the margin stays there, then the sales drop by this, the cost base has to go down by that, which is it isn’t that complicated. Getting it done is pretty hard, but coming up on the target isn’t that very hard.
The other thing that concerned me there is, though we had a fair amount of cash. I think we had a billion and a half or something like that. I simply didn’t know where the bottom was. And I thought the only way this company fails, to use the airplane terminology, is it runs out of fuel and it gets in a cloud, runs out of fuel, and can’t get its way out.
So, other than work with Kevin to get this cost moving quick, the thing I did myself then immediately was try and say, “How can I raise money quickly? And how much can I raise?” And I knew we were probably going to have to overpay some for it. As you probably know, the capital markets just froze up for about 60 days. That didn’t look like a good alternative. I went around and tried to do the PIPE stuff with different big PE firms and we could have got that, but it was rapacious pricing. And I thought, “No, I don’t think I’m that scared yet.” Fortunately by dumb luck, maybe dumb luck and maybe because we had enough staying power to wait, within about 60 days, the debt markets opened back up and we sold a billion and a half of high yield bonds.
[00:46:06] Will: What price on that?
[00:46:07] Nick: It wasn’t that bad. I want to say it was 6 or 7%.
[00:46:11] Will: Amazing.
[00:46:12] Nick: It wasn’t nine.
[00:46:13] Will: Mid-single digits.
[00:46:14] Nick: I was taking it no matter what it was, but access was the issue there. So then we had cost down. At least, we thought we were reasonable for what we could guess. And we had, I would guess we had $3.5 billion dollars of cash.
It was hard for us to run a scenario where that didn’t get us through. Now, you come up with a scenario that says the whole world is going to hell and never comes back, there’s never enough money to get you through. But we started feeling pretty good.
As a practical matter, we never ran cash negative. Now, that was helped a little bit by, we started to drag down working capital too.
Approach to Managing through Crises
[00:46:58] Will: So you’ve had to navigate a series of crises that we’ve talked about and have done so successfully within the context of these incredible returns. Any advice to new CEOs about how to manage through crises generally? Any things you’ve learned that you’d recommend to a new CEO or that you’ve shared with Kevin, honestly?
[00:47:18] Nick: Honest and fair assessment of the situation is most important. Don’t start shooting half-cock. You get one chance to lose your credibility with the organization and then outside. And it’s very hard to get it back, so be analytical, be honest, don’t deny reality. People are going to figure it out anyway. You might as well figure it out and be the one that tells them. And then deal with it. You’re not going to smooth your way through it. You’re not going to talk your way through it. You’re going to have to face the facts and deal with them somehow.
Nick’s Transition from CEO to Chairman
[00:47:50] Will: This maybe a good segue into the evolution of your role in the post-IPO era, but you mentioned you worked with Kevin on this… You were executive chair when COVID happened. And so, how did you and Kevin work together to do this? What did your typical week look like post-COVID versus pre-COVID as executive chairman?
[00:48:10] Nick: Pre-COVID, I would say I was doing the job I hoped to be doing, which is trying to slowly extract myself. The COVID thing, we didn’t have any dispute about this. Kevin also, this is far and away the biggest investment he has in his life and it’s been a great thing for him. We went through a couple of weeks of figuring and trying to make guesses and things like that. Then we, between us, just agreed on a number. He did most of the work on getting it done.
There were bumps in the road along the way and things we talked about. “What about this one? And what timing you think we do here?” But he basically ran that trap once we got it. Talked all the time, but he ran the trap. And I took on the one of going out to raise the money.
[00:48:49] Will: So, let’s maybe talk a little bit about the change in your role. So, the decision on your part to move from CEO to Executive Chairman? How you thought through succession? How you guys found Kevin? How all that worked for you and for the company, the thinking and process around that?
[00:49:07] Nick: I would say succession planning has been a big part of our company. It’s important to us to keep the culture. And we frankly thought we had a pretty good plan for succession. We had at least two, if not three: Ray Laubenthal, the COO, Bob Henderson, who could very well have been COO. They were almost sharing the job. And another was Jorge Valladares, who was only about 40. He was probably too young at that time, but not impossible.
And Ray decided that he wanted to retire. He made a bunch of money and he decided that he and his wife wanted to go and enjoy the money they had. So, boom, there went one successor. A victim of our success and very amicable and he stayed on the board, by the way, still on the board.
Bob Henderson would have been the next one, but Bob wasn’t the perfect age for it. He was a little older than you might have picked. My view on that was academic because Bob also didn’t, at this point said, “I don’t know, if I get enough money, I’m not willing to move out of California. I don’t know if I want to sign up for six or seven years.”
The next was Jorge and Jorge we thought was probably a little young, but he also had come to work with TransDigm right out of college or a year after and he was pretty wealthy. He wasn’t moving out of California.
So then we figured we had to find somebody. It was going to be a tough job because it’s hard, you got to bring somebody into a fraternity. It’s like a successful PE firm. How do you bring in someone to run them? It’s like herding cats.
So, we went through a search process. Most important, it had to be a cultural fit and you had to get somebody that believed in the value creation concept. We didn’t want a bullshitter. It had to be a hands-on guy. We weren’t going to take somebody from one of the big aerospace companies. That wasn’t going to work. PE background might have been nice if we could find the guy, and we just did a search and we came across Kevin. I said in the aerospace business at that time, the only businesses that I believe had a value-based culture were Precision Castparts and HEICO. And HEICO was the family, so the family wasn’t going to jump ship and come work for us.
So, Precision Castparts was one of the ones we pointed the headhunter at. Kevin was one of the successor candidates there. So, we went through a process of interviewing and we interviewed other people, too. And we did a fair amount of it, of introducing to the people, going out to dinner with a different stakeholders. He and his wife were a little reticent to move to Cleveland. I was pretty firm on that. That was a condition of the job.
Then we came to hire him. We brought him in. He transitioned in. We split the company into two. We had two COOs. We had he and Bob Henderson. I can’t remember what we called it, but he had one-half and Bob had the other. And it wasn’t a competition like those normally are, because Bob could have had the job. He didn’t want that job, but he was a big investor. And that’s how Kevin came in. He did a fine job.
And I want to say, if I say this in time wrong, probably 18 months later, we made him COO, then maybe 18 months after that we made him CEO. The biggest cultural issue with him was getting along with everyone else. It was a fraternity. You had to get them to listen to you and just saying do something wasn’t going to get… A lot of these, if you took the seven or eight EVPs, probably five of them were independently wealthy.
[00:52:32] Will: It’s so interesting because I think having, over time, studied a fair number of decentralized organizations, what you guys pulled off successfully in bringing Kevin into that role is really hard to do. Bringing an outsider into a culture as strong as TransDigm. So, it’s interesting. So, you guys targeted search. Precision Castparts was one of the handful of organizations you guys identified that had a similar ethos. And then you brought him in as a co-COO and it was three years between his joining the company before he got the nod.
[00:53:02] Nick: That’s right. But he came in clearly with the expectation. Each year I talked to him and if it wasn’t moving along, I would have told him. Kevin did a very good job of dealing with that, which was hard and frustrating for him. I told him that coming in this is going to be frustrating. I’m going to be supportive of you. Last thing I want to do is have you fail, but I don’t know how to handicap it.
[00:53:21] Will: When that happens, when Kevin moves into the CEO role, how does your role as executive chair evolve? How is it different? How hard was that for you to make that adjustment?
[00:53:33] Nick: I was pretty well ready for it. I got myself mentally prepared and I would say Kevin did a very good job of managing. He wasn’t overly protective. He was sharing. He would listen. And I think I worked pretty hard not to be overly intrusive. The first thing I did when we made the changes, I left, I get out of the office. We had the same CEO. I’ve been sitting in that CEO office forever, so we have a family office in downtown Cleveland. It’s five blocks from there, the TransDigm office. We expanded that a little bit and I moved over there and got out of the place, so that everybody’s daily interaction was between they and Kevin, not me. I just didn’t see how we were going to stop people from coming to me with every problem if I was sitting there. So, I think that was very helpful.
We set up an every two-week review. It was a standard punch list. And we did that pretty religiously for about six or eight months. But then as we both got more comfortable, we just did it as it made sense.
I’d say, what worked best is we trusted each other. He trusted me to be honestly trying to help him in the job. And I trusted him to talk to me when there was a problem he was concerned about. I’m sure you know that’s how things work.
[00:54:45] Will: Absolutely.
[00:54:46] Nick: You can set up a million rules for things like that, and they don’t work if people don’t trust each other.
[00:54:53] Will: And your focus, once you were in that Executive Chair role, was capital allocation?
[00:54:59] Nick: Capital allocation and, I would say, substantive, if there was a substantive change in strategy. I would say, through the first year or so, if you wanted to change out key management, then clearly would talk to me about that. He and I did the compensation together for the key guys, but mostly capital allocation.
[00:55:18] Will: So then, four to six months ago, you moved from Executive Chair to Chair. Can you talk a little bit about that?
[00:55:24] Nick: Another step back. Kevin is running the business now. I would say there’s a definition of what a Chairman does, but it’s a CEO decision. The wording is in the contract is that I’m the primary director for issues of M&A and capital allocation. But I would say, specific authority now, if he wants to do something, board wants to do it, they’re going to do it. I think, as a practical matter, I think it would be unlikely if I don’t want to do it, somebody will override me at this point. But that’s okay.
[00:55:54] Will: And if, as CEO , you were full-on five days a week, as Executive Chair, roughly, what would the time allocation have been and, as Chair, what is it? Again, very roughly.
[00:56:06] Nick: Executive Chair, probably, one to two. Hard to say, because you’re always available. How often does somebody call you? I did the earnings calls. I did shareholder visits. For probably the first half of it, I did, there’s an every-two week operating call, for probably the first half I sat and listened to them. It probably started more and ended up at a couple of days a week or something. And I’d say Chair, half a day to a day.
Managing Personal Liquidity
[00:56:30] Will: Let me ask, on the personal front, how have you thought about, given the extraordinary returns over a long period of time at TransDigm, how have you thought about managing personal liquidity?
[00:56:43] Nick: Well, for many years, all of our net worth was in TransDigm. As I joke with my wife, for many years, it was 110% of our net worth or something like that. We did start to draw it down. Still far and away our largest investment.
What we do with our other money is we have a fair amount of money in probably somewhere at equal to TransDigm investment in very low risk stuff. Frankly, Vanguard runs most of it in their private wealth thing, mostly ETF index funds, very broadly based. We have TransDigm Investment. We run a private equity firm out of our family office that my son, Michael, runs primarily, who you know, Will. That’s almost all our money and we run a private foundation that mostly invests in Inner City education. A lot of scholarships, 700 many, that puts out somewhere between $10 and $20 million a year and it’s ramping up.
So, that’s personal investment is TransDigm, very low risk investment, and private equity investments. Pretty diversified private equity by the way. It’s a bunch of direct stuff, secondary positions, some GP stakes.
[00:57:53] Will: Nick, as you’ve thought about personal liquidity and achieving that by selling TransDigm stock from time to time, what’s your approach been?
[00:58:02] Nick: I have mostly done it with what they call 10b5-1 plans, which you set up and then you have a scheduled sale that goes on every month. I’m in no rush to get the money out. I think it’s a wonderful investment with a lot of legs, but it’s just, as I get older, it makes no sense to have all your net worth tied up in something.
What I generally do is I don’t sell options until they come due because frankly you get taxed 50% on the gain when you do it and otherwise, it can grow as an option. Before the option becomes due, I set up a 10b5-1 plan that just sells it ratably over the next 18 months.
[00:58:59] Will: Got it. And if you feel the stock has been hit, do you slow that down?
[00:59:05] Nick: I could, but I probably will not. Because it is such a large part of my personal investment that I think I’d be very surprised if I could put it into anything that gets that return. Just as a practical matter, there’s a portfolio effect here. At my age, I don’t think it should be any bigger.
The Howley Foundation
[00:59:23] Will: Do you mind talking a little bit about the foundation? How it evolved? What you guys are doing there?
[00:59:28] Nick: It evolved in somewhere around the early 2000s, we felt like we had enough wealth that we ought to try and give something back. And we tried to decide what made sense to us. And both Lorie and I believe that the only thing we ever could give our children that made any sense or had any lasting value was an education of some quality, some moral sense or compass of right and wrong or something like that, and some work ethic. The world doesn’t owe you a place.
And we started to look around and say, “Where do kids really need that?” And what we mostly came to focus on was the inner cities. We looked at, not to get tangled up too much in the politics, but we looked at the public school systems and they’re just dysfunctional in many of the big cities. So, you take a population of children whose only ticket out is an education, you force them into a dysfunctional system. So, that’s where we decided to focus.
We started in Cleveland and then expanded to Philadelphia, which is where I grew up. And we started with scholarships, mostly getting students out of the miserable situation and try and get them into some private school alternative. Over time, we picked up more and more, mostly at high school level.
[01:00:42] Will: So, going into ninth grade, Nick? Is that typically the…
[01:00:45] Nick: Mostly going into ninth grade. Coming out of eighth grade going into ninth grade. And we started with one student, which somebody asked us to cover. It’s an interesting story. It’s a young woman who, 15 years ago, so she was 14, I guess, 15 years ago. Last year, she got her PhD in Microbiology, which is really cool. And she’s teaching in college, stayed in touch with Lorie the whole time.
[01:01:05] Will: That is so cool.
[01:01:07] Nick: Now, by the way, when you’re dealing with that population in inner city, you don’t get that success all the time. So, we build it up in Cleveland, we build it up in Philadelphia. We then expanded to national networks, which I became very involved in what’s called the Cristo Rey Network of 40 inner city schools around the country. I was Chairman of that for quite some time and we’re the biggest funder there now. In various other networks, we fund math programs, we fund the reading enrichment programs, all sort of things.
We run it like what they call venture philanthropy. We’re not ridiculous about it. We know sometimes everything isn’t perfect, but we’re funding the math program. If the math scores aren’t going up, we stop funding the math program. If we’re putting kids into college prep school and they’re not getting them into colleges, we stop putting kids there. We tone them down and so, we’re quite analytical about it. We have a staff, three and a half people now, full time on it. We’ve expanded. We probably have a hundred kids in college now and we’re picking that up, too.
It’s a significant part of my effort to do this, to get the money out. Writing checks is easy, but to get it out thoughtfully and with metrics and tracking the metrics, it’s a little foreign to the nonprofit world. It can be frustrating. It takes a little time.
[01:02:20] Will: How many students a year, Nick, are benefiting from this?
[01:02:23] Nick: Today, there’s about seven to 750 in the program right now, getting a scholarship of some kind. And we track them. They have to write reports. And I don’t read them all now, but they have to write reports. They have a GPA target. If they’re missing it, we have to ask the school, “What are you doing to remedy it?” Now, we’re not looking to throw kids out, but if your target is 3.0 and you go 3, 2.8, 2.5, 1.2, we’ll drop you if you’re not doing something.
[01:02:48] Will: Five years from now, how many students would you want to be?
[01:02:50] Nick: Double, double.
Snapshot of TransDigm Today
[01:02:57] Will: We’re going to move to our lightning round here. And I thought before doing that, we’re going to do a snapshot of the company earlier this year when you moved to Non-Executive Chairman and we’ll compare that to a snapshot of the company at IPO.
Today, super roughly, the business has $5 billion of revenue. At IPO, that was $435 million of revenue, roughly. Today, EBITDA is about $2.2 billion. At IPO, that was $170 million. Enterprise value today is $52 to $55 billion. At IPO, that was $1.8 billion. Net debt to EBITDA today is in the seven times range. At IPO, that was four and a half times. Employees today are 14,000. That’s almost exactly 10X what they were at IPO, 1,400 employees. Total corporate headcount today is 50, and it was about 15 at IPO. So, in other words, the ratio of headquarters employees to total employees has actually gone up. It’s grown at a lower rate, that’s all very consistent. It’s just a remarkable journey since ’06.
I’m curious if we go all the way back to those original businesses, the original Aviation Components Group you bought from Imo… If you flash forward almost 30 years later to today, how are those businesses performing those product lines today?
[01:04:24] Nick: You can’t get quite as clean a shot as you could then because we put some other products in and things like that. But we still separate product lines out and track them pretty closely. They probably pick up half a point or a point of margin every year still. We grind it out of them.
[01:04:48] Will: Yeah, it’s pretty remarkable, 30 years. Thirty years later, to still have growth in those businesses. Think about the long-term math of creating value in a company like TransDigm, having those early foundation stones continuing to have some organic cash flow growth is a key piece of the equation.
[01:05:10] Nick: That’s right.
[01:05:11] Will: So, let’s transition to some lightning round questions, looking back over the whole period here. So, when you look back at the last coming up on 29 years now, what are you most proud of?
[01:05:24] Nick: A couple of things. I feel quite good that I could bring a bunch of people along with me, but I think they are uniquely value-trained managers who are able to also train down to an organization and they became rich, so I feel pretty good. It’s not the same as this saying was 40 years ago, but we made many, many, many, many millionaires across the company and I don’t mean just officers. And I’m proud of that.
Well, I’m just proud of the size and the magnitude of the business we’ve been able to build to state the obvious.
I’m proud of the value culture. I think we have been able to build a culture that feels like a very value-generative culture as we got bigger and bigger and bigger. The vast majority of organizations that I’ve had experience with at some point in their size, as I like to say, the organization and culture turns rancid. And it’s usually well before $50 billion of enterprise value or $55 billion enterprise value. I’m proud that we’ve been able to sustain that.
If I had to say what is the biggest value-destroying risk going forward is, you can’t sustain that. You can’t get the people and you can’t get a culture that sustains that. I think we’re in pretty good shape for the foreseeable future. We’ve reset the management in the main and I think we’ve got a very similar crew that have been at it for a while. But those are probably the things I’m most proud of.
[01:06:52] Will: Okay, so what was the single most challenging phase in building TransDigm? Specifically, when did you have the most sleepless nights?
[01:07:01] Nick: I think I went through a few of them before. There was an airplane crash in ’95 or ’96 or ’97, which could have just killed us easily, that was stressful. I would say the 9/11 time was stressful. Clearly, the COVID was. I would say for personal stress, probably that short-selling attack was as much as the highest stress level I had. Because you got the whole mix of personal attack, company attack, trying to tear the thing down. Then, they drag your family into it. I’d say that was probably the most stressful.
[01:07:31] Will: And just on that Nick, was the board supportive during that short-selling period?
[01:07:35] Nick: Yes, very supportive through.
[01:07:37] Will: Yeah, which was helpful.
[01:07:38] Nick: It’s a stressful enough time for everybody that you got to be sure you keep communicating with them. They get and sometimes, some would get a little agitated. You ought to be out there answering more and be more in the public eye. I had a very strong view on that. I can’t win that race. I’m not going to do it.
[01:07:55] Will: What was the hardest negotiation during your tenure at the helm?
[01:08:00] Nick: Realistically, the hardest negotiations I had through the years were all about the equity cut, option cut, how they vest. Those were the most antagonistic times or the testiest at times.
Most of the other stuff, M&A issues, we’ll talk a lot, play a lot around on the edges, but we’re pretty value disciplined and I’m pretty value disciplined. We’re going to pay what we’re going to pay. We’re not going to go way outside. Those get pretty repetitive after a while, as you know, Will.
I would say customer negotiations. The big Boeing one comes up every five years. It can be a little testy, but it’s like a play you run through that you get over it all the time.
There’s some people things that can be difficult. But again, there’s only so many versions of them. After you’ve seen them a while, you know how to play ends.
[01:08:45] Will: Those equity conversations, negotiations with the PE firms specifically, Nick?
[01:08:50] Nick: Usually. And a little bit when we went public, but that was still with the PE firm, but a little bit when we went public and it isn’t very complicated. We’re just cutting up the pie and, “How big is my piece, how big is your piece,” or as I like to say, “We don’t have to get too lofty here guys. We’re just pigs at the trough pushing around.” It’s no more complicated than that.
[01:09:13] Will: So, looking forward into the crystal ball, what do you think TransDigm looks like 10 or 20 years from now?
[01:09:18] Nick: I don’t know. If you can keep the value-generated culture, I think people will figure it out. I can’t see that far ahead. I think it is probably unlikely you can keep the same play running, same proprietary aerospace, significant aftermarket. So, somebody, me or somebody else or Kevin, or somebody is going to have to make the trade-off as to whether we open that aperture up. And, if so, how we do it. We’re not there yet, but we keep looking at it.
We’ll keep being very efficient allocators of capital. As long as we can keep the management team that gets the culture and we don’t have good use, we give the money back or buy it back. The other alternatives, as I said, are sell the company in whole or part. So, I’ll say again, I think it’s most important that you keep this value-generative, value-focused decentralized culture. If you lose that, I just think you turn into another marginally performing public industrial company. If you keep that, you’ll figure it out.
TransDigm’s Influence on Nick’s Life and Investment Philosophy
[01:10:18] Will: How has the broader experience building TransDigm overall impacted your broader life and then, relatedly your investment philosophy? So, you’ve migrated over the last dozen years or so to being an investor yourself.
[01:10:33] Nick: Well, it clearly gave me a lot of flexibility. I never expected this company to be this big nor did I ever expect this level of personal wealth creation. So that gave me more flexibility at different points in my life than I ever expected to have.
For me, personally, I’ve gotten increasingly involved in this foundation we run. It’s getting to be a bigger and bigger part of my life. This year we’ll give out… This year, not just cumulative. This year, we’ll have probably almost 800 students in scholarships that we’re tracking and tracking their grades and tracking their performance and trying to move them along. We’re probably funding five different school startups of interesting ideas or expansions all for inner city kids. If you look at that like investing, which is I do, it’s time consuming. It’s easy to give money away. It’s hard to give it away effectively.
I think on investing, I’m pretty comfortable that you want to buy good businesses. Bad or poor businesses, you buy cheap. Usually, it doesn’t work out. Every now and then one works, but usually, no. Particularly, if you have any long-term horizon.
[01:11:39] Will: How would you define a good business as an investor? What’s the short checklist for that?
[01:11:44] Nick: I would say growth, solid cash flow and EBITDA margins, and a sustainable position. We can elaborate. I happen to like the what I call “small thing into big thing”—the value you provide is very high to the overall thing, so it’s much less price sensitive.
[01:12:00] Will: All right, Nick, thank you so much. This has been an incredible conversation and look forward to seeing you soon.
[01:12:07] Nick: Okay. Thanks, Will.