The Aftermarket Takes Flight: Interest Grows in a Rapidly Changing Segment of the Aerospace Market
While the current wave of aerospace M&A began with an intense focus on the manufacturing supply chains supporting the production of record commercial aircraft backlogs, the current phase is being defined by a shift in focus to the businesses that keep the world’s growing fleet in service.
In this article we share the full story on this and other trends observed by Harris Williams & Co. Aerospace, Defense & Government Services Managing Director Chris Rogers and Directors Doug Kinard and Chris Smith at the recent 2018 Aviation Week Maintenance, Repair and Overhaul (MRO) Americas convention.
The Aftermarket Coming into Focus
“Over the last 18 months, there’s definitely been a transition in M&A focus from airframe, engine and component manufacturers to companies that repair, replace and service those platforms, subsystems and components,” says Rogers. “While OEM order books and build rates are still very positive, and there remain massive backlogs to produce, the sheer size of the global fleet is now driving new interest in all things aftermarket.”
Certain subsectors are especially attractive to buyers. “Where we’re seeing the most activity today is in component repair, which allows operators to remove a part from the aircraft and send it out to get fixed,” says Kinard. “These businesses are typically not capital-intensive and they have healthy margins. There is also a high level of fragmentation in the space, providing the opportunity to execute roll-up strategies.”
Specialty distributors and supply chain services companies that serve these maintenance and repair businesses are also attracting attention, adds Kinard, as they play a critical role in the larger aviation ecosystem.
What truly sets one aftermarket business apart from the rest, however, is what it brings to the table in addition to its business model, says Rogers: “In the aftermarket, scale matters, customer access matters, and leverage within the supply chain matters, whether that’s through unique capabilities, proprietary authorizations or intellectual property on certain parts. Each of these advantages is difficult to build organically, making M&A more appealing.”
“There’s actually a scarcity of differentiated assets,” adds Kinard. “Buyers are looking for companies with differentiated process expertise, the proven ability to generate solid margins and the potential for additional scale via add-on acquisitions.”
OEMs Transforming the Landscape
Landmark shifts in aerospace OEMs’ strategic priorities—followed by major deal announcements—have been key catalysts for the now evolving dynamics within the aftermarket landscape. “The role of the OEMs in the aftermarket is definitely getting a lot of attention,” says Rogers. “Many companies are focused on figuring out the right strategy for this changing environment.”
Increasingly, aftermarket companies are adopting growth strategies in one of three categories: OEM-aligned, OEM-alternative or a hybrid. Each has its pros and its cons.
The OEM-aligned model takes advantage of the fact that OEMs are actively seeking partners to provide aftermarket services to their large customer bases. The model typically involves a royalty- or fee-based structure with an OEM, which, in turn, provides access to customers, discounts on OEM parts and, in some cases, designation as an OEM-certified business. While that can generate differentiation and price protection for MRO suppliers, it also entails recurring costs and requires close cooperation with the OEM.
OEM-alternative businesses include Parts Manufacturer Approval (PMA) firms, which produce less-expensive, FAA-certified versions of OEM replacement parts, and companies providing Designated Engineering Representative (DER) repairs, which restore components back to their initial design requirements, often at lower cost than OEM repair services. The OEM-alternative model is free of royalty costs, but lacks the support and authorization of OEMs. This can create challenges related to customer access and building scale. There are also hybrid businesses that straddle the divide, strategically combining OEM-sanctioned and independent work.
Smith explains that the choice of business model is linked to an MRO’s portfolio of customers: “Companies that service newer planes still under warranty might choose to be OEM-aligned because the airlines have incentives to use them versus independent shops. At the other end of the spectrum, MROs that serve customers with older planes or more diverse fleets might be better off as independents. And, in the middle, are certain airlines and MROs who partner with both OEM-aligned and OEM-alternative providers to find the optimal solution.”
Rogers adds that the choice of business model is also an increasingly important driver of M&A strategy, guiding the types of add-on acquisitions and divestitures under consideration by larger aftermarket companies, as well as the range of future exit alternatives for private-equity backed or founder operated companies.
Technology Enabling New Business Models
According to members of the Harris Williams & Co. Aerospace, Defense & Government Services Group, business models centered on data and advanced technology are now on the rise. “Due to regulation and other factors, the aftermarket has historically been cautious in terms of many types of technology enablement, particularly in areas such as big data and advanced analytics, as well as more emerging capabilities such as artificial intelligence and autonomy,” says Smith. “But the momentum seems to have really picked up over the last few years.”
“Technology-enabled services are where we’re expecting to see the biggest multiples in the years ahead,” continues Smith. “Buyers are interested in solutions that make MROs more efficient, including platforms that perform real-time diagnostics and quickly get that data back to maintenance crews.”
Other tech-driven MRO applications include predictive maintenance, drone-based aircraft inspection, and platform-level fault isolation software, which helps automate the identification of repair and maintenance items. The continual shortage of qualified maintenance technicians could support ongoing technology adoption, says Smith: “A lot of these solutions take people out of the loop, so more can be done with the available workforce.”
An exponential increase in the volume of data being generated is another important driver. “There’s much more data being created and collected today by the aircraft and its systems than before,” says Kinard. “Businesses are thinking about who owns and controls that data, what they can do with it and how to protect it.”
Rogers agrees: “Businesses focused on data, technology, and software are going to be much more relevant going forward than ever before. I think we’ll be seeing several new business models emerge with aerospace data at their core.”
Strategic acquirers and private equity investors active in aerospace are likely to keep most of their near-term M&A attention focused on opportunities in the aftermarket, looking for differentiated platforms that keep today’s growing fleet operating more efficiently and more cost-effectively. The entire market is adjusting to the implications and opportunities created by recent shifts in the aftermarket strategies of the largest aerospace OEMs, adopting OEM-aligned, OEM-alternative or hybrid growth plans. On all sides of these dynamics, data and advanced technology will be playing a more important role in the aerospace aftermarket than ever before, as the volume of information generated by aircraft reaches new highs and tech-enabled offerings provide opportunities for unprecedented insights and efficiencies.