Investing in Aerospace Companies in the Lower-Middle- Market … a Shifting Landscape Tim Grein October 26, 2018 Confidential
Agenda ▪ Background & Experience ▪ What are an Investor’s Objectives? ▪ Aerospace OEM Landscape ▪ Defense Industry Highlights ▪ Commercial Aerospace Highlights ▪ Major Transformational Moves Amongst the Strategic Players ▪ Shifting Landscape in the Industry … ▪ The Environment is Challenging for Tier 1/2/3 Companies ▪ PE Buyers and their Declining Returns ▪ An Alternative Strategy to Achieve Attractive Returns ▪ Intro to Walbar Engine Components ▪ Observations on doing business in Mexico ▪ Conclusion Disclaimers: 1. These are purely my views, based on my experience and interpretation of the data 2. I will focus on the areas I know best – commercial aerospace & private equity 3. I don’t have a staff to prepare this for me, so my apologies for the basic presentation 4. References: Virtually everything in here came from somewhere else… my apologies from not having everything perfectly referenc ed to the original author Confidential 2
Background & Experience Company Role Length of Reason for Departure Time US Army Platoon Leader 5 Years Career change • • Company Commander GE Power Systems Operations – “Six Sigma Black Belt” 4 Years Desire to shift to PE role; went to • • Strategic M&A experience business school Focus on gas turbines and power • generation equipment/technology Avery Weigh- Finance / Strategy / Transactional 1 Year Successful sale of the company; • Tronix Helped facilitate sale of company to moved to new PE firm • new PE owner Platte River Identify and complete investments 10 Years Response to shifting industry & • Equity • Focus on aerospace, specialty metals investing landscape and industrial service investments • ~50% of time spent within portfolio companies developing and executing strategy and operational improvements Walbar Engine President & CEO, part-owner 2 Years + No plans to leave… • Components Confidential 3
What are an Investor’s Objectives? Strategic Buyer …. 1 + 1 = 3 + The Private Equity (PE) Buyer … Buyer Low, Sell High Strategic Buyers seek acquisitions for many Every PE Investment is made with an Exit in ▪ ▪ reasons: mind ▪ PE Fund structure is typically 10 years ▪ Most PE buyers claim to have a system to find Growth the “proprietary” deal, but few exist Objectives There are multiple strategies to attempt to ▪ Economies of Cost achieve desired returns Scale Synergies ▪ Employ their Industry knowledge to “time” Reason for the market, or invest through cycles Acquisition Buy-and-build – “pay - up” for a platform ▪ Acquire company and buy/integrate smaller Access New Technologies Markets or Products companies at lower multiples Focus on “Value Creation” by implementing ▪ Response to Competition a firm’s “playbook,” or by employing Operating Partners to drive change Exit / Sale of the company is not typically in Financial engineering through use of ▪ ▪ their analysis maximum leverage The focus of my remarks will be from the perspective of the PE Buyer / Investor Confidential 4
Aerospace OEM Landscape Airframe OEMs Engines / Propulsion Military Aircraft Missiles Space Large Commercial Regional Jets General Aviation Confidential 5
Defense Spending is Strong and Projected to Continue Positive Outlook for Defense Spending Global Defense Spending Projected to Remain Strong International demand for defense and military ▪ products is increasing in the Middle East, Eastern Europe, North Korea and the East and South China Seas ▪ In the US, the largest budget increases went to areas outlined in the National Defense Strategy (NDS) Notably, increases from FY17 to FY19: ▪ ▪ Ground Forces (+59%) Space Systems (+48% in unclassified accounts) ▪ ▪ Missiles & Munitions (+32%), including missile defense and strategic nuclear deterrence RDT&E overall (+24%) ▪ ▪ The key for growth is being tied to the right programs that already have long-term funding US DoD Funding is Strong & Steady ▪ F-35 UAVs ▪ Various missile programs ▪ ▪ Ground force modernization initiatives B-21 LRS bomber ($2.3bn) ▪ ▪ Columbia-class submarine ($3.7bn) Confidential 6
Commercial Aerospace has Attractive Characteristics ▪ Unprecedented historical backlog extending for 7+ years, ▪ Continued strength driven by new, energy efficient aircraft and emerging market demand ▪ Industry is dominated by large, well-capitalized aircraft manufacturers (Boeing & Airbus) and a small group of engine OEMs ▪ If you focus on specific aircraft platforms, you can see a clear path to growth ▪ End Markets have balanced global exposure (significant sales to ME & Asia) ▪ Historically, the industry was very fragmented and there were many attractive target companies where predictable margins could be achieved Huge Industry Backlog Narrowbody Aircraft Drive the Market Aerospace Valuations have Outperformed Boeing & Airbus Build Rate Forecast 2,500 A380 A350 2,000 A340 1,500 A330 A320 1,000 B787 B777 500 B767 B747 - B737 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 Today’s commercial air transport fleet of ~28,000 aircraft are Questions: dispersed throughout the world 1. Will trade tensions and the backlog is equally as compromise the backlog? distributed 2. What about oil prices? Confidential 7
Major Transformational Moves Are Occurring in the Industry The airframe duopoly (Boeing & Airbus) is extending their reach: ▪ Airbus agreed to buy a 50.0% stake in the Bombardier CSeries program ▪ ▪ Boeing formalizing ties with Embraer ▪ Boeing and Airbus both continue to seek to vertically integrate (after years of pushing outsourcing) Boeing pursuing the airframe services market, building on their 2006 acquisition of Aviall ▪ A fragmented supply base responding with rapid consolidation to counter the strength of the OEMs ▪ ▪ UTC’s (owner of Pratt & Whitney) $30.0 billion acquisition of avionics leader Rockwell Collins ▪ Safran’s acquisition of interior business Zodiac Precision Castparts long-running acquisition history prior to its acquisition by Berkshire Hathaway ▪ ARCONIC’s multi -year acquisition spree (and rumors of a PE buyout) ▪ ▪ Private equity firms have aggressively tried to consolidate the supply base with multiple buy-and-build strategies, particularly in component manufacturing and support services This has led to a healthy M&A environment within the A&D sector for both Strategic and PE Buyers ▪ Confidential 8
The Environment is Challenging for Tier 1/2/3 Companies Five Forces 2000 - 2012 Emerging Threats: 2012 - Present Threat of New • Capital intensity deters new entrants • Emerging technologies disrupting incumbents Entrants • Long-term agreements provide strong visibility (composites, AM, electric motors, etc.) • Scale creates significant fixed cost leverage • Older machinery is becoming obsolete • Customer Approvals and industry certifications • Automation is drastically reducing the value of are expensive and difficult to maintain skilled labor • OEMs vertically integrating Buyer Power • Large OEMs and Tier 1 customers • Significant consolidation of OEMs (Boeing • If Quality and Delivery performance are Embraer, Airbus and Bombardier) and Tier 1s maintained, there is no strong motivation to move • Boeing and Airbus implementing painful cost the work reduction targets throughout supply base Supplier Power • RM is often largest component of COGS, but large • Dramatic consolidation throughout Tier 1s and OEM customers provide protection for suppliers raw material suppliers (PCC, Arconic, CPP) • RM supply was a very fragmented industry with • Manufacturers are forced to purchase material few large players from OEM suppliers. There is no flexibility • Customers increasingly asking smaller Tier 1/2s to take over full inventory control Treat of • Qualification Process for new parts is expensive • Advancements forcing FAA to respond to Substitution and time consuming accelerated approval processes (AM parts flying • FAA approval process is long and cumbersome on engines years ahead of expectations) Competitive • Somewhat stable; LTA’s generally are extended in • Customers want shorter LTAs Rivalry perpetuity if quality and delivery performance are • Nearly every product is dual or triple sourced maintained • OEM’s have improved their understanding of • Partner-type relationships are common “should costs” and drive their suppliers to very • Sole-source situations are not uncommon thin margins Takeaway: With the changing landscape, many aerospace companies have become less attractive at the same time that PE interest continues to increase Confidential 9
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