The favorable financial impact of airline consolidation in North America in the past five years has been well documented on carriers’ balance sheets, with a series of mergers and acquisitions credited for being the catalyst for improving profitability. While the effects of consolidation have not been as profound in the commercial aftermarket—an industry viewed as open for more merger and acquisition (M&A) activity—it is a market in good health, and 2016 still saw some important amalgamations of MRO companies, primarily in the mature North American and European markets.
Much of the M&A activity of 2016 was driven by companies looking to expand their capabilities and grow their share in an industry valued at $73.4 billion by Aviation Week’s 2017 Commercial Fleet and MRO Forecast. “A number of businesses have expanded, or sought to expand, their offerings by the purchase of MRO or other service-supply companies to add a further string to their bow,” says Daniel James, senior associate at UK-based law firm Stevens & Bolton.
According to James, financiers have also become more receptive to investing in the commercial aftermarket, with their interest piqued by factors such as the lower cost of debt financing along with a seemingly plentiful supply of private equity money. “This is a result of a restoration of confidence following the aftermath of the 2008 financial crisis,” he says of the financial industry’s interest. “MROs are developing more services, and with aircraft and engines spending increased amounts of time in the air and living longer lives, the revenue stream for MROs remains healthy and represents an attractive target for investment,” he adds.
Ken Herbert, managing director and senior aerospace and defense analyst at North American investment bank Canaccord Genuity, believes interest in traditional MRO companies is different from other strands of the aftermarket. “The classic MRO, wrench-turning space is a bit of a mixed bag,” he says. “But the broader aftermarket—think areas such as distribution, logistics and data management—has garnered a lot of interest from buyers across the board.”
A vibrant modifications market
One commercial aviation MRO sector seeing a lot of hype is modifications. ICF International predicts the segment will grow at a compound annual growth rate (CAGR) of 5.2% over the next decade—outstripping the projected 4.1% CAGR of the air transport MRO sector. Jonathan Berger, ICF’s vice president of aerospace and MRO advisory, argues that the industry is experiencing “a golden age of aircraft cabin interiors.”
Confidence in the modifications segment has seemingly fueled M&A activity, with large players drawn to its growth potential. A recent series of large-scale deals underpins this notion. In October 2016, Avionics giant Rockwell Collins announced a definitive agreement to merge with aircraft cabin interior products manufacturer B/E Aerospace for $8.3 billion.
This acquisition was followed at the turn of this year by a blockbuster European deal: French engine maker Safran agreed to an €8.5 billion ($9 billion) acquisition of compatriot Zodiac Aerospace, a manufacturer of seats, toilets, emergency equipment and other cabin items, subject to shareholder approval. If finalized by the projected date of early 2018, the union would create the third-largest player in the aerospace industry. The aftermarket potential generated from a combined entity could potentially prove lucrative. Despite Zodiac’s publicized struggles, which included a fiscal first-quarter -5.7% drop in aerosystems revenues, a robust quarter in its aftermarket-services division offset a larger decline.
On the smaller yet still significant end of the modifications scale, Estonia’s Magnetic MRO integrated MAC Interiors into its business in 2016 with the intention of making the UK-based company into a one-stop shop for aircraft interiors solutions. The acquisition continues the company’s drive toward adding to its in-house capabilities, with plans to add a new paint hangar at its Tallinn base scheduled for October 2017.
The proposed buyout of seat specialist Zodiac Aerospace could lead to the creation of a powerful European entity. Credit: Zodiac Aerospace
“The primary goal of the MAC buyout was to fill the gap of older aircraft full-refurbishment programs, an area in which interiors always were problematic but equally very important for our clients, as this was the only capability not covered in-house.” says Andrius Norkevicius, chief operating officer of engineering services at Magnetic MRO and managing director of MAC Interiors.
He foresees further consolidation in modifications, particularly for companies looking to perform work on mature aircraft. “With fuel prices staying quite low and not forecast to have any sharp rise in [the] near future, older, less fuel-efficient aircraft make a lot of commercial sense for operators,” he says. “Maintaining such aircraft is attractive to passengers, and interiors- retrofit programs are needed to do this.”
Another segment that is starting to show signs of consolidation through M&A is the burgeoning MRO software market. In December 2016, Sweden-headquartered IFS made a play for a bigger slice of the North American market by acquiring Canadian software company Mxi Technologies from private equity group Moelis Capital Partners.
Mxi owns the web-based Maintenix software platform, primarily used by MROs, OEMs and airline operators to cover configuration management, integrated workflow, planning and execution and data-sharing. Customers include Qantas, Southwest Airlines and Icelandair, along with MROs such as AFI-KLM E&M, Joramco and HAECO. Graham Grose, IFS’s aerospace and defense lead, says acquiring Ottawa-based Mxi will grow its head count in North America while adding a number of civil and defense aviation operators to its customer base. Kurt Larsen, managing partner of private equity firm NexPhase Capital, says the sale was concluded quickly after IFS approached its parent company. “The acquisition presented major upsides for Mxi—IFS can make it a best-in-class product in the MRO space,” he says.
M&A in North America
With the exception of the IFS-Mxi deal, much of the North American M&A activity of the past year has involved domestic MRO companies aligning with one another. In late 2016, Arizona-based aircraft repair specialists Marana Aerospace Solutions and Ascent Aviation Services confirmed plans to merge and form a new MRO entity for widebody and narrowbody jets in North America. The combined company will offer maintenance, flight line, storage and reclamation services out of two facilities in the state.
Also changing ownership was Florida-based aftermarket specialist PEMCO, an airframe and component MRO that boasts a substantial passenger-to-freighter conversion program, acquired in December 2016 by Airborne Maintenance and Engineering Services (AMES), a subsidiary of Air Transport Services Group (ATSG).
According to ATSG representative Paul Cunningham, the acquisition of PEMCO presents a chance for the group to expand across all of the markets they serve. “PEMCO was chosen for acquisition in order to broaden and strengthen AMES’s existing portfolio of aircraft maintenance products and services, while expanding access to maintenance service for all customers of ATSG’s fleet,” he tells Inside MRO.
China to buy into the West?
Outside North America and Europe, intriguing new entrants into aftermarket M&A are companies from China. The wider scale of activity by Chinese companies was illustrated by a Mergermarket Group report issued in the summer of 2016 noting that China-based companies had already surpassed their annual record for outbound M&A investment by August of that year, completing 173 deals valued at $128.7 billion.
Switzerland’s SR Technics, among Europe’s largest independent MRO providers, became one example of this trend when conglomerate HNA Group acquired an 80% stake from Abu Dhabi state investment fund Mubadala in July 2016. Before the deal was announced, HNA already held shares in other non-MRO aviation assets, including a 20% stake in Virgin Australia and a $2.8 billion buyout of airport luggage handler Swissport International, completed in July 2015.
The SR Technics acquisition has fueled speculation as to whether more Chinese companies could be looking to acquire Western MRO providers as part of a drive to expand their aviation interests. “Despite some turbulence with its own economy, China remains a huge source of investment and wealth,” James says. “If the right facilities are available for investment, no doubt companies in China may be interested, but in my view this is unlikely to be part of a wider strategy to corner the market in MRO services. It may just be that China has the cash to make the biggest offers.”
Ken Herbert also sees the SR Technics Chinese buyout as more of an isolated case rather than the start of an East-buying-into-the-West trend. From a North American perspective, he believes such direct investment from overseas could only be spurred by airlines seeking to keep more work in countries like the U.S. to ensure market access or the ability to work on those aircraft in the event of new protectionist trade measures. But Herbert adds that he is unsure about whether such a scenario will come to pass.
More M&A activity to come?
In any case, Herbert believes MRO consolidation will continue. “In the heavy maintenance segment, there is steady pressure from overcapacity, and labor rates aren’t seeing much price increase, while in engines, there’s a lot of legacy, independent MROs that could be struggling and looking for other ways to align themselves with OEMs,” he says.
Stevens & Bolton’s James, meanwhile, predicts consolidation could occur through the growing number of businesses moving into end-of-life solutions, particularly those taking an aircraft during the last year of its lease to retire and tear down the airframe. “There is room for consolidation in this model, but it may need a high volume of transactions to make investment in an MRO or parts-supply company worthwhile,” he says.