[HEI/A – HEICO Corp] Niches get riches; Part 2

That TransDigm, a proprietary, sole-sourced parts provider with a business model narrowly designed to maximize shareholder value should, well, produce tons of shareholder value, is perhaps unsurprising.  That HEICO, with an opposing value creation ethos, generates comparable returns on capital selling generic PMA parts, is less intuitive.  A PMA part is an aircraft or engine component deemed by the FAA to be of comparable quality to the one produced by the original manufacturer…and the parts really are of comparable quality – HEICO has shipped more than 70mn of them over the last 20+ years; one has yet to be faulted for a service failure or shutdown.  A non-OEM can either strike a licensing agreement to manufacture the part according to an OEM’s specs or, in HEICO’s case, reverse engineer the product.  Either way, the non-OEM avoids the upfront cost of design and development and so can sell the part at a 25%-45% discount to the original¹. 

The HEICO that we know today was created in late 1989 when accountant-turned-real estate investor Laurans Mendelson, backed by an investor group, took control of the company’s Board, ousted the management team, placed himself at the helm as CEO and installed his two sons, Eric and Victor, in key leadership positions².  Shortly thereafter, HEICO divested its legacy medical diagnostic imaging business and concentrated its resources on jet engine replacement parts and aerospace equipment, bolstering its position through several acquisitions.  By 1996, 3/4 of HEICO’s revenue came from selling and serving PMA parts for Pratt & Whitney’s JT8D engine, a dependency that was whittled down as HEICO extended its reach to engines manufactured by GE, CFM³, and to a much lesser extent Rolls Royce⁴. 

Over the last ~decade, engine manufacturers have responded to HEICO’s encroachment with anti-competitive tactics, bundling replacement parts into long-term contracts to obscure price transparency and refusing to support customers using alternative parts.  According to Laurans, GE and/or Pratt have gone so far as to illegally threaten to cancel the warranty on any engine that included a non-OEM part.  This has made it increasingly difficult for HEICO to participate in a market that once comprised the substantial majority of its revenue.  Fortunately, 20 years ago, HEICO’s airline customers began dragging the company into PMA approval for brakes, wheels, electronics, hydraulics, and airframe components that have not been subject to the same retaliatory response⁵.  Also, the company has expanded into other areas like distribution, repair and overhaul services (16% of revenue)⁶, specialty products like insulation systems (13%), and even OE electrical and power components (40%), such that engine PMA parts account for ~< 15% of HEICO’s revenue today⁷.