The aerospace-focused PE firm Transdigm acquired its rival Esterline last October for 4B$, its largest-ever deal. Evercore and Goldman Sachs advised Esterline, while Morgan Stanley advised Transdigm. This deal is expected to close this spring and will put Transdigm among the leaders of its industry. As of March, the company’s shares have increased by roughly 30% since the deal was announced and the market is optimistic about the company’s future.
Transdigm is essentially a public PE firm that owns and operates a portfolio of aerospace suppliers. Unlike traditional PE firms, it’s focused on making strategic acquisitions for the long term. They seek and buy out suppliers of proprietary parts and sole-source providers in order to control the intellectual property behind the components. That gives them huge pricing power, evidenced by how they can generate adjusted EBITDA margins of around 50%.
Esterline is a great standalone target and a leader in niche aircraft aftermarket supplies, such as replacement parts for the aerospace and defense industries. Aftermarket sales usually have higher margins than sales to new plane manufacturers. Transdigm’s executive Nicholas Howley said the target's "core aerospace and defense business consists of primarily proprietary, sole source products with significant and growing aftermarket exposure.” The rationale behind the deal is clear, as Esterline expects revenues of $2.0 billion - $300 million EBITDA – this year, a 50% increase in Transdigm’s revenues.
The deal makes a lot of sense in terms of synergies as well. Esterline will be a great addition to Transdigm’s portfolio, increasing Transdigm's market share, competitive strength, and pricing power. Together, they will gain a significant economic moat and sticky, recurring revenues at a time when their core customers are looking to make more parts themselves to cut costs and improve productivity. Transdigm's operating expertise and network can unlock cost efficiencies. For example, Esterline's SG&A expenses total about 19% of sales, compared to TransDigm's 12%, and there are opportunities to sell off some of the less-proprietary assets in the Esterline portfolio.
Speaking of financials, Transdigm will finance the $4 Billion with half cash and half debt, specifically senior secured loans. It will purchase all of the outstanding shares of Esterline for $122.50 per share, at a premium of ~40%. The target will have an implied EV/LTM EBITDA multiple of 14.0x based on the purchase price, above the median multiple of 10.75x coming from precedent transactions. The investment is expected to generate at least 20% return annually and to be accretive to Transdigm's earnings, which I think is achievable due to the reasons mentioned above.
The share price of Transdigm dropped by 3.2% to $340.06 on the day of announcement, mostly due to market sentiment concerning increased leverage and high premium paid in the transaction. I don’t share these concerns as I think Esterline is a great fit for Transdigm’s proven playbook of improving management and cutting costs. Furthermore, the deal is expected to generate and additional $200M cash flows for the company, which will help pay down debt. On the end, I believe that the sky is the limit for Transdigm and the acquisition of Esterline will serve as a turbo boost in its quest to become a market leader.