How Heico's Stock Compounded by 22% Since 1990 | The Mendelson Way of Business (TIP738)

Name: How Heico's Stock Compounded by 22% Since 1990 | The Mendelson Way of Business (TIP738)
Uploaded: 2025-07-17T22:45:01.000Z
Duration: 2 h 2 min 39 s

Haiko: A Leader in the PMA Industry

Overview of Haiko's Market Position

Haiko is currently the largest provider of aircraft replacement parts in the PMA (Parts Manufacturer Approval) industry, holding an impressive 75% market share and generating over $4 billion in revenue.

The management team at Haiko prefers acquiring businesses from entrepreneurial owners, often retaining a portion of ownership to align incentives.

Historical Performance and Growth

Since the Mendelson family took control in 1990, Haiko has achieved exceptional returns for shareholders, compounding at over 22% annually. An investment of $10,000 in 1990 would now be worth over $9 million.

Three members of the Mendelson family hold key executive roles: Larry as executive chairman, and brothers Victor and Eric as co-CEOs. Together they own more than 9 million shares valued at approximately $2.1 billion.

Investment Interest

Notably, Warren Buffett's Berkshire Hathaway began purchasing shares in Q2 of 2024 with a position valued at $245 million. This is considered minor for Berkshire but indicates confidence in Haiko's potential.

Investor Franchawn has also established a significant position in Haiko since 2018, owning around 742,000 shares worth over $150 million.

Understanding PMA and OEM Dynamics

While many may view the aerospace parts business as unexciting, Haiko’s substantial market share and competitive advantages make it noteworthy. They recently acquired their industry's second-largest player.

Over the past decade, revenues have grown nearly 14%, while earnings per share (EPS) have compounded at an impressive rate of 16%.

Company Origins and Evolution

Founded in 1957 as Hineki Instruments selling laboratory equipment, Haiko entered the aircraft industry through its acquisition of Jet Avion during the 1970s.

The aerospace sector consists primarily of OEM manufacturers like Boeing and Airbus that produce aircraft and sell replacement parts alongside PMAs which offer alternative parts for maintenance needs.

Key Milestones in Management Transition

The PMA industry was nascent when Haiko entered it; by renaming itself to Haiko Corporation in 1986 under new leadership from Victor and Eric Mendelson after acquiring a stake with their father Larry.

In a strategic move during college years, Victor and Eric raised $3 million to acquire a controlling interest in an underperforming company leading to their takeover in 1990 when they were just young adults aged 22 and 24 respectively.

Understanding Haiko's Business Model and Growth Strategy

Foundational Insights on Haiko's Formation

Eric and Victor recognized their lack of experience in building a business, prompting them to seek mentorship from experienced individuals.

Upon taking control, the Mendlessons found Haiko generating around $25 million in sales but operating at a loss.

Regulatory Landscape and Market Entry Challenges

The FAA oversees aircraft replacement parts, requiring strict certification for any part sold, making it a highly regulated industry.

The existing management team was replaced due to lack of motivation; initially, Haiko only sold an engine combustion chamber while exploring aftermarket opportunities.

Competitive Advantages in the PMA Industry

The barriers to entry are high due to FAA regulations; however, Haiko capitalized on this by reverse engineering OEM parts without patent protection.

By exploiting the costly development processes of OEMs, Haiko could produce parts at significantly lower costs.

Navigating FAA Regulations

Despite the daunting task of obtaining FAA approval, Haiko's willingness to navigate these challenges positioned them advantageously in the market.

Eric Mendlesson’s dedication included frequent visits to the FAA headquarters to ensure compliance with rigorous approval processes.

Building Customer Relationships and Market Credibility

By 1991, Haiko received approval for its second part; they maintained customer trust by offering aftermarket parts at discounts (30% - 50% off OEM prices).

A strategic partnership with Lufthansa Airlines provided insights into valuable parts for reverse engineering and helped establish credibility as a PMA supplier.

Strategic Growth Through Acquisitions

This relationship with Lufthansa not only accelerated product development but also solidified Haiko’s reputation within the PMA industry.

With over 30 years of operational success without flight failures, airlines are more inclined to purchase from Haiko than smaller competitors.

Current Market Position and Future Outlook

Today, Haiko dominates the PMA industry with approximately 75% market share and generates over $4 billion in revenue through strategic acquisitions since 1990.

The management team prefers acquiring businesses from entrepreneurial owners rather than full buyouts, allowing continued leadership from original founders.

Understanding the Mlessons' Acquisition Strategy

Overview of the Mlesson Family's Approach

The Mlesson family focuses on aligning incentives and seeks companies with growth potential, strong cash flow, and fair pricing.

Eric Middlesson explains their unanimous decision-making process among family members for major strategic choices, which helps avoid significant mistakes in acquisitions.

Success Rate of Acquisitions

Out of 100 acquisitions, 98 are deemed successful (defined as a single, double, triple, or home run), showcasing an extraordinary hit rate.

The diverse perspectives within the family help identify blind spots and ensure thorough evaluation before making acquisition decisions.

Leadership Qualities and Values

The Mlessons exhibit humility and a commitment to continuous learning; they treat Haiko like a family business and prioritize shareholder capital.

Their history of successful acquisitions reflects their ability as capital allocators who avoid destroying shareholder value through poor investments.

Investment Philosophy

They adhere to Warren Buffett's principle of not losing money in investments, contributing to their exceptional track record.

The Mlessons empower entrepreneurs by granting them autonomy post-acquisition while ensuring alignment with Haiko’s values.

Importance of People in Business

Eric emphasizes that good businesses cannot exist without good people; they prefer partners who align with their ethical standards.

Larry Mendlesson states that talented individuals thrive without excessive oversight from corporate offices, highlighting trust in leadership at acquired firms.

Long-Term Ownership Mindset

Retaining Founders Post-Acquisition

Approximately 80% of Haiko's subsidiaries are still led by original founders; this retention strategy fosters continuity and stability.

Unlike private equity firms focused on short-term gains through cost-cutting, Haiko aims for long-term growth by preserving existing structures and relationships.

Next Generation Leadership

Eric and Victor serve as co-CEOs while preparing the next generation for leadership roles; David Middlesson is already involved in acquisitions within the flight support group.

Educational Background Influencing Strategy

The Mlesson family's finance background equips them with skills necessary for effective capital allocation and value generation for shareholders.

Haiko's Business Strategy and Structure

Overview of Haiko's Acquisition Strategy

Haiko is likened to a miniature Berkshire Hathaway, focusing on acquisitions that maximize shareholder value through centralized capital allocation while allowing subsidiaries autonomy.

The Mendlesson family views acquisitions as a means to compound cash flow rather than fulfilling strategic visions, emphasizing long-term profitability over short-term gains.

Unique Market Positioning

Haiko targets businesses with unique characteristics in protected or niche markets, ensuring competitive advantages due to technology and entrepreneurial management.

Acquired businesses must possess unique traits that make them difficult to compete against, thereby securing good margins and strong cash flow.

Long-Term Vision and Culture

Investments made today may not yield immediate returns but are accepted if they promise future benefits; the company's current success stems from decades of strategic sacrifices.

Eric Mendlesson highlights that Haiko avoids short-term earnings boosts, fostering a culture focused on long-term results which differentiates it from typical corporate cultures.

Share Structure and Investor Considerations

Haiko employs a dual-class share structure (A shares with less voting power vs. B shares with more), allowing the Mendlessons to maintain control while enabling investor participation in growth.

A shares trade at a significant discount compared to B shares despite the voting rights difference, suggesting potential value for investors considering A shares.

Business Segments of Haiko

Flight Support Group (FSG)

FSG constitutes about 70% of revenue, focusing on designing and selling PMA parts for aircraft engines at substantial discounts compared to OEM prices.

The segment also provides MRO services, creating recurring revenue streams by serving 19 of the top 20 global airlines.

Electronic Technologies Group (ETG)

ETG accounts for approximately 30% of revenue, supplying high-tech products primarily to military agencies and defense contractors like NASA and Lockheed Martin.

This segment has seen slower growth compared to FSG and relies heavily on acquisitions for expansion.

Regulatory Advantages

Haiko holds an Organizational Design Authorization (ODA), allowing internal certification of parts—a rare privilege that enhances market entry speed and reduces regulatory costs.

Introduction to the Tip Mastermind Community

Overview of the Community

Clay Fink introduces the Tip Mastermind community, aimed at value investors seeking connection and discussion about stocks.

The community addresses the challenges of value investing, providing a supportive environment for members who are often entrepreneurs or portfolio managers.

Weekly live Zoom discussions include Q&As with podcast guests, social hours, stock presentations, and member spotlights.

Upcoming Events

In-person events will be hosted in New York City in October for networking and stock discussions.

Interested individuals can join the waitlist at investorspodcast.com/mastermind due to limited spots available.

Exploring the Intrinsic Value Podcast

Podcast Insights

The Intrinsic Value Podcast is recommended for its detailed analysis of individual stocks by hosts Shaun Ali and Daniel Mona.

Each episode includes real-time building of an intrinsic value portfolio, focusing on companies like John Deere and Airbnb.

Haiko's Competitive Advantage in Aerospace Parts

Quality and Reliability

Haiko has sold over 80 million parts without any service bulletins or airworthiness directives issued, showcasing their reliability in aerospace.

Barriers to Entry

Haiko's strong competitive position is attributed to industry expertise in reverse engineering parts cost-effectively and navigating FAA approval processes efficiently.

Trust and Scale Advantages

Building Relationships

Haiko benefits from first-mover advantage by establishing trust with airlines, making it difficult for new competitors to enter the market.

Economies of Scale

Their scale allows them to offer competitive pricing while maintaining quality, creating a positive feedback loop that enhances customer loyalty.

Niche Market Dynamics

Dominance in Niche Markets

Haiko operates within niche markets where they dominate despite being a large conglomerate; this limits competition due to small market sizes.

Competition Landscape

The primary competition comes from OEM manufacturers; however, Haiko’s extensive part offerings (over 19,000 parts) solidify their leading position.

Understanding Haiko's Business Model and PMA Market

Haiko's Revenue Stream and Investment Thesis

Haiko benefits from a "sticky" recurring revenue stream as airlines have little incentive to stop using PMA parts once they switch, which is central to their investment thesis.

The commercial aircraft parts market is largely dominated by OEMs, with only 2-4% of the market consisting of PMAs, highlighting the potential for growth in this sector.

Size Comparison and Market Potential

Despite being in business for over 30 years, Haiko sells around 19,500 parts compared to Boeing aircraft that can contain over 1.5 million parts, indicating significant room for PMA penetration.

Barriers to Adoption of PMA Parts

Airlines may hesitate to adopt PMA parts due to concerns about resale value; some regulatory agencies may not accept planes equipped with these components.

OEM threats can deter airlines from using PMAs; if an engine has PMA parts, OEM repair teams might refuse service due to lack of cooperation.

Perceptions and Risks Associated with PMAs

There exists a perception that PMA parts are inferior compared to OEM parts; this belief can hinder adoption despite cost savings.

Decision-makers at airlines face career risks when considering switching to lower-cost providers like Haiko, especially for critical airplane components.

Competitive Dynamics Between OEMs and Haiko

Airlines may find it challenging to switch suppliers if existing relationships are strong; OEMs might reduce prices temporarily to retain customers against competitive offers from Haiko.

Economic Cycles and Cost-Saving Opportunities

Economic downturns often lead airlines to seek cost-saving measures such as switching to more affordable products offered by PMAs like those from Haiko.

Pricing Discrepancies in Aircraft Parts

A conference example illustrated how basic aircraft part pricing varies dramatically between OEM ($50,000 vs. $100,000 for new versions), emphasizing the high costs associated with limited competition.

Challenges Faced by Airlines

The airline industry operates on high fixed costs with thin profit margins and faces volatile demand influenced by external factors like fuel prices.

Labor Relations Impacting Airline Operations

Airlines frequently encounter labor union issues affecting operations; recent protests highlight ongoing challenges related to compensation and working conditions.

Aerospace Industry Dynamics and Haiko's Strategic Position

Cost-Cutting Strategies in Aerospace

In response to financial pressure, companies often enter cost-cutting modes, with maintenance costs being a primary target for reduction without compromising safety.

Haiko emerges as a countercyclical beneficiary; as airlines face challenges, they find Haiko increasingly attractive for partnerships.

Acquisition Strategy and Growth

In August 2023, Haiko made its largest acquisition of Windor Group for $1.9 billion, financed through cash and stock at a 13x trailing EBITDA multiple.

The cultural alignment between Haiko and Windor contributed to the success of the acquisition, leading to better-than-expected performance.

Financial Management and Shareholder Value

Over the past decade, Haiko has consistently increased revenues except in 2020; growth accelerated post-Windor acquisition.

Minimal share dilution is noted as a positive sign of management’s awareness regarding financing costs; share count has increased less than 1% annually.

Debt Management Practices

Following the Windor deal, debt levels rose but remained conservative at around two times EBITDA, reflecting prudent financial management.

Long-Term Growth Potential

Despite generating $4 billion in revenue, there remains significant growth potential within the aerospace industry due to its vast market size.

Pricing Strategy and Customer Loyalty

Management intentionally restrains price increases beyond cost pass-throughs to build long-term customer loyalty rather than maximizing short-term profits.

Eric Mendelson emphasizes leaving money on the table now to foster permanent relationships with customers.

Balancing Market Share and OEM Relationships

Haiko must balance capturing market share while maintaining good relations with OEM partners to avoid retaliatory pricing actions that could harm their business.

Revenue Visibility Through Product Lifecycle

The long product cycles in aviation provide Haiko with substantial revenue visibility due to decades-long usage of commercial aircraft engines.

Diverse Product Offering

With over 19,500 PMA parts available—significantly more than competitors—Haiko maintains a dominant position in the industry.

Company Culture and Ownership Mindset

The unique culture at Haiko promotes an ownership mindset among employees which contributes positively to their operational effectiveness.

Haiko's Unique Corporate Culture and Growth Strategy

Employee Ownership and Team Culture

Haiko promotes a culture of ownership among employees, with the Middlessons owning 8% of the company and employees holding 2% through an employee stock ownership plan.

The terminology used is intentional; they refer to staff as "team members" instead of employees, fostering a sense of belonging and mutual respect.

This cultural shift was initiated by Eric and Victor Mendlesson when they took over in the early 1990s, emphasizing humility over authority in leadership.

By creating a team-oriented environment, Haiko encourages individuals to feel like owners rather than mere cogs in a machine, enhancing engagement and commitment.

Larry Mendlesson highlights that many factory workers have become millionaires due to their stock options, aligning their interests with those of shareholders.

Decentralized Structure and Trust

Despite being a nearly $40 billion public company, Haiko operates with a family business mindset, favoring decentralization and autonomy for subsidiary leaders.

This approach empowers local decision-makers closest to customers, fostering innovation and accountability within teams.

During acquisitions, they value founders who know their employees personally—this reflects the type of culture Haiko aims to cultivate across its operations.

Financial Performance and Market Expectations

Haiko trades at high multiples (P/E ratio of 76), indicating market expectations for significant future growth akin to elite athletes delivering consistent performance.

From 2015 to 2021, there was an expansion in valuation metrics despite recent contractions; however, the stock has doubled since then due to strong earnings growth.

Revenue growth has been driven by both organic means (mid-teens percentage increase), alongside strategic acquisitions contributing positively to market share.

Global Trends Impacting Growth

The global air travel industry is projected to grow at around 4–5% annually; this trend benefits companies like Haiko as more people enter middle classes worldwide.

Aging airline fleets are also advantageous for Haiko due to delays from OEM suppliers like Boeing and Airbus leading airlines to retain older aircraft longer.

Haiko's Business Insights and Market Position

Financial Performance and Growth Potential

Haiko's maintenance needs are increasing, driving strong demand for replacement parts. The company's return on capital, excluding goodwill before the Wincore acquisition, was in the 25-30% range.

Despite Haiko's durable business model and competitive position, it is trading near its all-time high valuation. Continued double-digit growth over the next decade is necessary to justify this valuation.

Berkshire Hathaway initiated a position in Haiko in 2024 at $150-$180 per share. Estimates suggest that sustained double-digit growth will be required for more than ten years to validate current valuations.

The CFO of Haiko stated a goal of growing cash flows by 15-20% annually, a target they have consistently met for 35 years.

Market Comparisons and Valuation Risks

Other aerospace companies like GE and Transdime trade at elevated multiples (39x and 51x earnings respectively), while Haiko trades at an even higher multiple of 75x earnings due to amortization write-offs affecting reported earnings.

PMAs represent a small segment of the aerospace aftermarket industry, allowing room for Haiko to grow as a high-quality provider offering lower prices than OEM counterparts.

Investment Considerations and Risks

Investors should be cautious about adjusting financial models based on emotional attachment to businesses like Haiko; it's wise to add them to watch lists instead of rushing into investments during optimistic market conditions.

High expectations surrounding Haiko mean that any slowdown in growth or broader market corrections could significantly impact share prices negatively.

A decline in new aircraft deliveries could reduce tailwinds for the aftermarket industry, potentially impacting Haiko’s performance adversely.

Regulatory Challenges

Potential regulatory bottlenecks from the FAA may slow down approval processes or reduce approvals granted, posing additional risks for investors considering Haiko's future prospects.

Industry Context: Competitors and Market Dynamics

Overview of Key Competitors

Joseph Shaposnik discussed various companies within the aerospace aftermarket industry during episode 731. Notable competitors include Transdime (OEM supplier), GE Aerospace (jet engine manufacturer), Lore Holdings (new IPO with both OEM and PMA segments), alongside Haiko itself.

Performance Metrics

Transdime has shown remarkable performance since its inception in 1993 with over 750x returns through 2022, achieving an impressive IRR of 36%.

Investment Strategies

Brian Lawrence holds significant investment positions in Transdime. Both he and Joseph Shaposnik highlight how shares have compounded at high rates over decades within this sector.

Debt Levels Comparison

Transdime operates with much higher leverage compared to Haiko; their net debt-to EBITDA ratio exceeds six while Haiko maintains around one. This difference indicates varying approaches towards pricing power within their respective business models.

Transdime and Haiko: Contrasting Business Strategies

Overview of Transdime's Growth Strategy

Transdime has achieved significant growth through acquisitions, having acquired over 90 companies since its inception. This positions them as an aggressive player in the aerospace industry.

Unlike Transdime, Haiko is a family-run business that prioritizes durability and moderate compounding returns over high leverage and aggressive growth.

Market Positioning and Competitive Advantages

Both companies operate in markets with high barriers to entry due to the costly FAA approval process for new parts, making it difficult for competitors to replicate their products.

Transdime's focus on proprietary products accounts for approximately 90% of sales, with about 80% coming from sole-source products, ensuring predictable revenue streams.

Leadership Insights from Nick Howie

Nick Howie, founder and executive chairman of Transdime, emphasizes honesty regarding his motivations; he stated he is primarily driven by financial gain rather than altruistic missions.

His candidness reflects a competitive spirit within the company culture that values winning above all else.

Compensation Structure and Employee Motivation

The compensation plan at Transdime incentivizes hard work; product line managers can earn significantly more than their counterparts in average industrial businesses.

This structure fosters a highly motivated workforce dedicated to maximizing returns.

Case Study: Amsafe Acquisition

The acquisition of Amsafe illustrates strong market control; they dominate the aircraft seat belt market with over 95% share due to regulatory barriers preventing competition.

Despite seeming simple, airplane seat belts are highly profitable under effective management like that of Transdime.

Long-term Performance and Market Stability

Prior to COVID disruptions, Transdime was recognized as the best-performing stock in industrial sectors since its IPO in 2006, increasing roughly 50 times including dividends.

The lack of innovation in aviation components benefits investors by reducing competition while maintaining high margins for established players like Haiko and Transdime.

Value Drivers in Transdime's Strategy

Three primary value drivers underpinning Transdime’s strategy include value-based pricing which leverages their market position without necessarily exploiting customers.

Transdime's Economic Strategy and Business Model

Key Value Drivers

Transdime emphasizes earning an appropriate economic return, focusing on the value of parts produced. As older planes are retired, they seek compensation that reflects not only direct costs but also the expenses related to maintaining production lines with skilled labor and machinery.

The company aims for productivity by increasing prices above inflation (currently at 3%) while keeping cost growth below this rate. They foster a culture of innovation, encouraging businesses to achieve more efficiency year after year.

Since 2015, Transdime has improved its net profit margins from 16% to 22%, indicating effective cost management and operational efficiency.

New business development at Transdime is strictly pursued only if there is a clear path to profitability. This disciplined approach has led to successful new business generation efforts in next-generation aircraft markets.

Industry Insights

For those interested in Haiko, studying other successful companies in the industry can provide valuable insights. The aerospace sector is large enough for multiple winners, highlighting the potential for diverse success stories.

The speaker draws parallels between Haiko and other companies like Copart, Costco, and Hermes, noting their unique cultures and long-standing management teams that contribute to their competitive advantage.

Conclusion

The episode wraps up with appreciation for the audience's time and attention, hinting at future discussions on growth versus value investment strategies as exemplified by figures like Peter Lynch.