In this week’s episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle discuss monster compounder, Heico Corp. Here’s an excerpt from the episode:
Tobias Carlisle: Should I take it away with Heico? Great article. So I was sort of talking about that a little bit last week that it’s the father Larry who’s 81, and he was an Arthur Anderson accountant. And then the two sons, Eric and Victor who are in their 54, 51 so they approached him, they approached dad in 1990 to say let’s do an LBO because it was still just after the LBO craze had kind of peaked with the barbarians at the gate.
Tobias Carlisle: So they find Heico which basically had one product it was an engine combustion chamber, whatever that is made by Pratt and Whitney and they’d spun it out. So they got control of it for three million dollars. It was half equity, half debt in 1990. Since then there are 47500%, and over the last decade they’ve done 1270% which is five X the S&P and more than five X Berkshire just for kind of context because they’ve both done around 250% which is still no bad of that period of time. So now two point one billion profit 328 million. They’ve acquired 78 companies. Basically what they do is they try to buy something that’s got very fat margins and some of competitive advantage and then they just reduce the margins to price and properly. So they sell 100,000 parts.
Tobias Carlisle: Their target, which I found was kind of interesting, they look for $10 billion in profit margins over 20% and then they try to buy 80% because they want existing management to remain incentivized, and they’ve done about nine acquisitions in the last year, which is sort of a little bit more than they have in the past. But basically the entire engine of growth of this thing is the ability of these guys to acquire companies that do continue to grow and make money over time. So they are really, really good investors. Buying cheaply. And that’s sort of the analysis that’s as simple as it gets.
Jake Taylor: Do you know what their typical multiple is that they pay on that 10 million-ish?
Tobias Carlisle: I don’t.
Bill Brewster: For the acquisition?
Jake Taylor: Yeah.
Bill Brewster: I think it’s roughly eight times EBITDA. is what they target. Interestingly in their 10K they have, you know how Bezos has the cashflow statement upfront. They have on I think pretty prominently on page two disciplined acquisition strategy. Some of these businesses I do think that when you open up the 10K and you just read it, it’s like, oh, these guys know what they’re doing.
Tobias Carlisle: They’re talking about it all the time.
Bill Brewster: That’s right, and they put it in a way that is easy to digest. I read their fourth quarter earnings call and I read the 10K and I read a scuttleblurb his right up on Hy-Ko and TransDigm shout out to scuttleblurb.
Tobias Carlisle: Is that public?
Bill Brewster: TransDigm?
Tobias Carlisle: The scuttleblurb.
Bill Brewster: No, it’s behind a paywall but it’s worth paying for if you’re interested in this stuff. He’s a solid resource. So anyway, it’s just interesting. So there was TransDigm who sort of runs like a levered acquisition strategy and then hikes price and maybe it goes a little bit more aggressive. And then scuttleblurb says something along the lines of like, I love Heico, you love Heico, we all love Heico, it’s a family run company. They do things the right way. They’re trying to save engine or the airlines cost, right? They’re not about pushing price. They actually comment in one of their, I don’t know if it was the earnings call or what, but they say something like, PEs got raise the price because they carry so much debt. Our net debt to EBITDA is under a turn. Like we can play the long game.
Bill Brewster: So I for the longest time had closed my eyes to the name because the multiple and turns out maybe that was dumb.
Tobias Carlisle: How do you value it?
Bill Brewster: I think you’ve got to look at it on free cash flow and then sort of embed some acquisitions in there.
Tobias Carlisle: What sort of yield are you getting at this level? Do you know?
Bill Brewster: Well your entry is only about what? So it’s trading at roughly 35 times free cash flow. So two point eight, two point nine percent out of the gate.
Tobias Carlisle: That used to be expensive.
Bill Brewster: It did used to be expensive.
Jake Taylor: Yeah, that used to be like a puckering number. Now it just seems like-
Tobias Carlisle: That’s half price now. 60 times is the market, 35 is like half price.
Bill Brewster: To be fair. Something that I had been thinking about, and actually I’ve got a mailbag question on this a little bit, is what is an asset like this? What’s your downside risk really in that multiple, because an asset like this in most realistic scenarios that you can underwrite as today’s world exists probably isn’t going to trade at less than 20 times free cash flow.
Tobias Carlisle: I’ll remind you of that sometime over the next five or 10 years.
Bill Brewster: We’ll see.
Jake Taylor: Was that a bag holder quote right there?
Bill Brewster: It could be.
Tobias Carlisle: You don’t think so if your end user is airlines and I know I own one so they are cyclical. They’re still cyclical. You don’t think that the suppliers are a little bit cyclical too?
Bill Brewster: Well they’re going to be a little bit, but even after 911 and in the great depression or the great recession, average seat miles are flown or available seat miles actually didn’t decline that much. We’ll see what goes on with all this flight shaming and whatnot, but-
Tobias Carlisle: Not much is my prediction for what it’s worth.
Bill Brewster: Yeah, I think so too.
Tobias Carlisle: Nobody flies because they want to, you’re basically flying because you’ve got somewhere you have to be and there’s no other way to get there.
Bill Brewster: That’s fair.
Tobias Carlisle: Flying’s terrible.
Jake Taylor: Yeah, but it’s better than all the other forms of transportation.
Tobias Carlisle: It’s better than driving there.
Jake Taylor: That’s right.
Bill Brewster: Where was I going? I’m thinking of flight shaming and how much I’m about to travel over the next three months. I should be shamed-
Tobias Carlisle: Can’t you just buy some carbon credits and offset it? Just tick the box.
Bill Brewster: No, no. That’s somebody else’s problem. Anyway. Heico gets to do the replacement parts. So as long as there’s planes flying in the sky, you’re not going to be able to defer your maintenance. So I don’t disagree that there will be peaks and troughs, but I don’t know I think maybe we’ll see if it ever trades South or higher than five percent free cash flow. I’ll probably be a buyer.
Jake Taylor: Isn’t that kind of the argument though for those, you almost want volatility in the industry because when you have a good acquirer that becomes opportunity for them. Right? So you worry about them being disrupted but maybe more so you want that for them to throw off opportunities for more acquisitions for the weaker hands to get forced out.
Bill Brewster: Yeah. Because they’re in theory going to get much stronger over that. Right. And if PE has too much debt on some of these companies and they have to end up selling these guys could be the buyer. So it’s one-
Jake Taylor: I think cap allocator is an anti fragile strategy I think.
Bill Brewster: Yeah.
Tobias Carlisle: What about the level where they’re shopping, the level where they’re fishing $10 million as profit, that’s a pretty small company?
Bill Brewster: Yeah. They are tiny.
Tobias Carlisle: I think that’s smart. Like there’s probably not a lot of professional private equity hunting at that level. Maybe I’m wrong. I don’t know. But that seems low to me.
Bill Brewster: Yeah. I’m not certain about that. I agree with you though on what two billion of sales, your acquisition target can’t be a massive portion of what your business is if you’re hunting in that size, incentives would matter a ton. Right? So you would want to make sure the two sons understand that like the father does.
Tobias Carlisle: Well they’ve been running it since 1990 right?
Bill Brewster: Yeah.
Tobias Carlisle: It was kind of their idea.
Bill Brewster: Yeah-
Jake Taylor: I got the sense that there’s kind of a Costco element to it as well where it was like didn’t they do a flat markup of cost basically for and then pass that along?
Tobias Carlisle: Yeah, they were 15%, I didn’t read closely enough, it was net margin of 15% I think Costco targets gross margin of 15%, right?
Jake Taylor: Something like that, 15 or 17. But yeah, it’s a fixed amount.
Tobias Carlisle: What are you netting out between gross and net margin? What are they including in that to get to the 15?
Bill Brewster: Well you’ve got-
Tobias Carlisle: SG&A.
Bill Brewster: Yeah, you’ve got SG&A and there’s a little bit of R&D. they’re not a particularly a heavy R&D organization from what I can tell.
Tobias Carlisle: I think they’re trying to buy it in, I bet that’s what they’re trying to do. An R&D through acquisition, but they’re not stopping at either they seem to try to continue on with it once they buy it.
Bill Brewster: Yeah. Like part of my hesitation with paying up for some of these growth companies is, where will it be in the future? And I do think Heico’s one of those that if you can listen to how they talk about their employees, how everybody’s invested in success, the secretaries, retiring millionaires, it’s not a flashy way to talk and I almost think it’s like a very targeted Berkshire, in that if the culture remains, I don’t know that you have huge business risk, if that makes sense.
Tobias Carlisle: I always get a little bit nervous these days when I hear everybody in the firm’s buying stock and everybody’s doing really well. I think Enron.
Bill Brewster: Cycle.
Tobias Carlisle: Enron just destroyed so many people, Meb Faber would make this argument where he says, you’ve already got exposure to that company because you work there, and then to further invest in it, you’re doubling up on your exposure. Maybe you should be diversified. Then if inside and you know that it’s a really good one, you want to be exposed to it, don’t you? That’s how you get really wealthy.
Bill Brewster: Yeah, yeah. I think so. That said, this is not financial advice and you should talk to a retirement advisor. But yeah, I mean sometimes you really do know something and having the ability to understand what the culture is from the inside. That said, sometimes I don’t even know how much the employees know. I mean at Bemo I would have miss assessed a lot of the stuff that was going on in the organization. So I don’t know. What do you actually know?
Tobias Carlisle: I’ve sat in on board meetings and just been kind of astonished at like how little outside directors, how little everybody knows about what’s going on. I don’t think I know anything these days. I’d love to know what it feels like to know something.
Bill Brewster: Yeah. Well, I think knowing that you don’t know anything is probably knowing something. That may be a little circular, but yeah.
Jake Taylor: Galaxy mind right there.
Bill Brewster: That’s great. Well, there’s not false precision in it.
Jake Taylor: True.
Bill Brewster: The scuttleblurb thing real quick about TransDigm and Heico, I like what he said, he said, both companies are decomposed into small autonomous business units with their own P and L is giving rise to a culture of accountability that is often lost down in top down bureaucratic stray structures. We were talking last week about what might IAC and Heico and these other companies that you’re going to go down, what might that have in common and that may be part of the clue.
Tobias Carlisle: Yeah. Decentralization.
Jake Taylor: Don’t have any scale though on like some costs of, I don’t know, even like accounting and backend and things like that or are they fully decentralized?
Bill Brewster: I don’t know enough to answer that. I’m sure there’s some synergies that go on, right? I mean with your accounting system or something like that.
Jake Taylor: I kind of hope so. Right?
Tobias Carlisle: Berkshire doesn’t do any of that or do they, they just,
Bill Brewster: No. That’s why they have a 50,000 page tax return, you know?
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