TransDigm set to acquire Esterline

CLEVELAND—After acquiring the Kirkhill elastomers business from Esterline Technologies Corp. earlier this year, TransDigm Group Inc. has entered into a definitive agreement to buy all of Esterline for about $4 billion.

TransDigm plans to purchase all outstanding shares of common stock of Esterline for $122.50 per share in cash, and expects to close the deal sometime in 2019, TransDigm Executive Chairman W. Nicholas Howley said during an Oct. 10 conference call. The deal, approved by both companies' boards of directors, includes the assumption of debt. TransDigm expects it to be financed through cash on hand and new term loans.

"Esterline is an attractive and complementary business for TransDigm," Howley said.

Esterline is a specialty manufacturer split into 28 business units across eight platforms. Those are grouped under three segments, according to Howley: Avionics and Controls at 42 percent of the revenue by segment, Sensors and Systems at 36 percent, and Advanced Materials at 22 percent. Avionics and Controls includes avionics systems, control and communications systems and interface technologies. Sensors and Systems includes the manufacture of high-precision temperature, pressure and speed sensors. Advanced Materials is made up of military defense technologies and commercial aerospace, nuclear and industrial end markets, with elastomer products.

"The core aerospace and defense business is made up primarily of proprietary and sole-source product positions with significant aftermarket content," Howley said. "This fits well with our longstanding strategic focus. We expect this investment to generate private-equity-like returns, the same as we always target."

The company expects the acquisition to be accretive to TransDigm's earnings per share within the first year of ownership, he said.

"Though this is larger than many acquisitions we make, we believe this is an effective and very attractive allocation of our capital," Howley said.

Esterline expects to generate about $2 billion in revenue, about $300 million EBITDA in 2018, and has about 12,500 employees globally. Esterline runs a decentralized organization, similar to TransDigm.

Howley said TransDigm will evaluate Esterline's "non-core businesses, and it very well may make sense for us to sell certain of them going forward. But it's too soon to be specific or speculate at this time."

The company will use a value-generation model, which will focus on bringing new business to market, driving productivity and value-based pricing opportunities, given the sole-source, proprietary nature of Esterline's business, said Kevin Stein, TransDigm president and CEO.

"Although we believe this business will generate significant value in accordance with TransDigm's value generation goals, a slower pace of improvement should be expected due to product mix, contractual positions and military business," he said.

Esterline is "largely a misunderstood business with higher aftermarket content," Stein said, with significant synergy opportunities, given TransDigm's experience with Kirkhill.

TransDigm acquired Kirkhill, headquartered in Brea, Calif., in March for a total purchase price of $50 million in cash. The company consists of about 800 employees and is a supplier of engineered aerospace elastomers. The firm had annual revenues of about $90 million at the time, according to a TransDigm release. About 50 percent of its revenue came from commercial transport airframes at the time, with the remainder mostly from defense aerospace applications.

Taking on Kirkhill helped TransDigm re-evaluate Esterline's businesses, Howley said.

"We are significantly more comfortable with the makeup of the portfolio," he said. "What I call aerospace and defense business is much closer to the kind of businesses we like than what we probably anticipated from the outside looking in, and that is probably in essence why we got much more interested."

As a company, Kirkhill was also misunderstood in terms of its capabilities, and Esterline's potential for aftermarket growth is similar, Howley said. Especially for the aerospace and defense markets, which make up the bulk of the business, the opportunity for aftermarket "is in our view significantly above the number that's generally been bandied about," Howley said. "We think, in what we call the core business, it's well over 25 percent, though not as high as the TransDigm business at 50."

Howley said it is too soon to speculate, but TransDigm does not have plans to sell the majority of Esterline's businesses. TransDigm has been "pretty positive" about Esterline's product lines and programs, Howley said.

The company will assess each business under Esterline that it considers "questionable" based on value generation opportunities and market price, Howley said. He declined to specify which of Esterline's businesses TransDigm describes that way. TransDigm does not have a buyer lined up for any businesses under Esterline.

It's too early in the process to outline cost synergies, but there will at least be savings to find in the duplication of corporate costs and expenses, Howley said. After the acquisition is completed, TransDigm Vice Chairman Bob Henderson will oversee the integration and operations of Esterline. Howley did not disclose any planned changes to Esterline's management.

Esterline reported net sales of $500 million in its 2018 third quarter financial results, down from $504 million for the same period in 2017. For the nine-month period, net sales increased 2 percent to $1.5 billion.

Net earnings attributable to Esterline for the third quarter, in the same year it sold Kirkhill, were $27.8 million compared to $30.9 million in the same period last year, down 10 percent. Since the beginning of the year, net earnings were $16.7 million, down 79 percent from $81.1 million for the first nine months of 2017.

By segment, Avionics and Controls reported net sales of $211 million, up from $209 million for the three-month period in 2017. For the nine-month period, net sales grew about 2 percent to $626 million. Performance in the segment more than offset lower year-over-year sales and profits resulting from a 13-day work stoppage in Montreal, Esterline said. Segment research and development spending was lower in 2018 as some airliner products moved from development to production.

For Sensors and Systems, net sales were $191 million for the three-month period, up from $185 million over the same time last year, an increase of 3 percent. For the year-to-date, net sales climbed 5 percent to $565 million. The segment benefited from strong sales and above-average margins, Esterline said.

The Advanced Materials segment posted net sales of $98.2 million for the three-month period, down from $110 million in the year prior, a decrease of 11 percent. For the year-to-date, net sales dropped 4 percent to $309 million. Kirkhill was divested from Esterline in the second quarter of fiscal year 2018, and would be included under this segment.

TransDigm reported net sales of $980.7 million for the third quarter 2018, compared to $897.7 million, an increase of 9 percent. For the year-to-date, it reported $2.76 billion in revenue, up 7 percent from 2017.

Net income for the period grew 28 percent to $217 million for the third quarter of 2018. Year-to-date, TransDigm reported a 64 percent increase in net income to $728 million. The boost reflects the increase in net sales, lower effective tax rate and improvements to operating margins resulting from proprietary products and continued productivity efforts, the company said. The growth in net income was partially offset by higher interest expense.

In July, TransDigm completed the acquisition of Skandia Inc. from Graycliff Partners L.P. for about $84 million, including the assumption of debt. Skandia is a provider of highly engineered foam, foam fabrication, flammability testing and acoustic solutions with applications in the business jet market.