Haike Aviation, another Berkshire Hathaway

Berkshire Hathaway, a company under Warren Buffett, recently disclosed in its quarterly holdings report that they have initiated a position in HEICO Corporation (HEI). In the second quarter of 2024, Berkshire purchased 1.04 million shares of HEICO Corporation, with a stock value of approximately USD 250 million at market price. This move has attracted widespread market attention, but it is puzzling to many as the company's valuation is alarmingly high, with a dynamic P/E ratio of over 70 times and a P/B ratio of around 10 times. Fortunately, the purchase size is not large, almost equivalent to an observation position, so the market's interest in it is not that strong. Most opinions believe that this is definitely not Buffett's personal operation, and some even shout out that Buffett has betrayed value investing. This investment is indeed somewhat unusual, and whether Buffett himself is behind it is truly unknown. However, this company is actually a long-term holding target for many value investors, with shareholders including government pension funds, endowment funds, insurance companies, sovereign wealth funds, etc. It's just that the company's valuation has hardly ever been cheap. What makes this company unique? First, a wonderful acquisition by a value investor HEICO is an aerospace and defense supplier founded in 1957, focusing on niche alternative parts manufacturing for commercial aircraft and defense products. Currently, HEICO's business is mainly divided into two segments: Flight Support Group (FSG) and Electronic Technologies Group (ETG). FSG accounts for 60%-70% of the business, while ETG accounts for 30%-40%. FSG is the world's largest FAA-approved independent supplier of aircraft replacement parts, while ETG designs and manufactures electronic products for aviation, broadcasting, defense, and other related industries. Although the company was founded in 1957, it operated tepidly for about 30 years. The turning point began in 1990 when the current major shareholder and management team, the Mendelson family (father and two sons), took over and brought about a qualitative change. This family of father and two sons did not rise through the ranks within the company to become part of the management, nor did they come from a merger with a large company. Instead, on their investment journey, they discovered this company and decided to buy it. Larry Mendelson is also a value investor, and interestingly, he is an alumnus of Warren Buffett. In 1960, he entered Columbia Business School to study security analysis courses, 10 years after Buffett. In the 1980s, he sent his two sons to study investment at Columbia University. After graduation, Mendelson moved to Florida, engaged in real estate business, made a lot of money, and also made good profits from stock investments using his knowledge of value investing. At the same time, he encouraged his two sons in college to research stocks, and his younger son Victor discovered HEICO in the library of Columbia Law School. At that time, they were looking for a company in Florida with very cheap stock prices, worth investing in but with poor management. They wanted to acquire such a company, replace the management, and run it as a family. HEICO perfectly met this criteria. At that time, HEICO's main business was manufacturing medical laboratory equipment, which they were not interested in, **but HEICO had undergone a series of acquisitions, and in 1974, acquired a company called Jet Avion This company entered the aviation industry in the mid-1980s due to an aviation accident, and the market needed to incorporate new production capacity. It was authorized by the Federal Aviation Administration of the United States to produce burners for general aircraft engine models. With this, they entered the aviation industry, specializing in manufacturing jet engine parts. They saw potential in this business. In the United States aviation industry, any aircraft component production must be approved by the Federal Aviation Administration and relevant international organizations. This is a high-entry barrier business with little industry competition. As a result, the company's business boomed. In 1986, the company's sales were $46 million, with a profit of $7.6 million. Jet Avion accounted for two-thirds of the sales. At that time, the management only saw it as an additional business income, giving the business a boost. However, the Mendelson father and son believed that if this barrier could be crossed, it meant that manufacturing an aircraft component was not as simple as it seemed. Moreover, the burner is a key universal component of aircraft engines. If this could be approved, then the probability of approval for other ordinary components should be high, right? In addition, due to the high entry barriers in the aviation industry, including General Electric, several large companies almost monopolize the relevant market, with little competition and no product innovation. They continuously raise prices significantly to improve their profit levels, and downstream airlines have no choice but to continue purchasing at high prices. The Mendelson father and son believed that they could use HEICO as a platform to produce a series of aircraft universal components, providing airlines with a new choice. By selling at prices 30% to 40% lower than market prices, they could still achieve decent profits and capital returns, with almost no patent or intellectual property constraints on replaceable aircraft components. Furthermore, the market size for replaceable aircraft components is very large, with approximately $50 billion annually at that time, and with long-term growth prospects as the global economy develops and the aerospace industry continues to grow. The three of them thought this was feasible. Although the company's performance improved at the time, the short-term outlook for the aviation industry was downward, and the company also predicted a decline in earnings next year. Due to the bleak outlook, it gave the Mendelsons an opportunity to buy cheaply. In 1988, the Mendelsons began to continuously buy the company's shares on the open market. However, they did not expect that others were also eyeing HEICO. Led by Chicago investor George Fox, H Acquisition Corp. offered $75 million, or $30 per share, to acquire HEICO. So the Mendelsons, together with other investors, increased their share purchases, acquiring 13.6% that year, and by 1989, they had acquired 15% of HEICO's shares. This was followed by a fierce battle for voting rights. The struggle continued until December, when they finally secured four seats on the company's board, and Mendelson became the new CEO. After taking office, he immediately sold the original main medical laboratory business for $17 million, focusing only on the core business of replaceable aircraft components. In the early 1990s, the global aviation industry stagnated, and the approval of their parts did not go as smoothly as imagined. For nearly 10 years, only a few non-critical aircraft components received official production permits annually The aviation industry is strictly regulated, with safety being the top priority because any issues are not minor. For officials of the Federal Aviation Administration (FAA) in the United States, they do not want parts companies they approve to have problems, and procurement managers of airlines do not want the parts they purchase to have issues either. Therefore, it is best to avoid trouble, and maintaining cooperation with large companies as before is the safest option. Although HEICO's products are cheaper, there is no trust foundation between HEICO, the FAA, and airlines, resulting in slow overall progress. The key to HEICO's breakthrough is gaining trust in the industry, so they have always produced the highest quality aircraft components. In the mid-1990s, as the aviation industry recovered, HEICO also slightly improved and gradually gained some customer recognition. By 1997, the large German airline Lufthansa recognized the quality of HEICO's products and acquired 20% of HEICO's subsidiary. As part of the acquisition agreement, Lufthansa began bulk ordering aircraft general components produced by HEICO. With the rigorous German airline as a guarantor, HEICO's aircraft component business became much easier. Today, almost all overseas airlines have a cooperative relationship with HEICO. At the same time, HEICO continues to acquire companies with aircraft component product lines, achieving both internal and external growth. After the Mendelson family took control of HEICO, the company, which had revenue of only $26 million in 1990, had reached $2.97 billion by 2023, with a net profit of $400 million, demonstrating a high annual compound growth rate of 15%. The annualized return on the stock price is over 20%, far exceeding the S&P 500 index. II. Berkshire Wearing the HEICO Coat In 1990, HEICO only had a single aircraft component, but today the company has over 14,000 component categories and maintains internal growth by developing about 500 new categories annually. At the same time, the company has completed nearly 100 acquisitions, continuously expanding its product line. Although HEICO appears to be clearly in the aviation business, Larry Mendelson often tells the company's stock investors, "HEICO's business is not aerospace, but generating cash flow, except that this cash flow happens to come from the aerospace industry." When he says this, you will remember that he is an excellent investor himself. It can be seen that his understanding of investment is similar to Buffett's, and they are actually doing similar things. Both Buffett and Mendelson acquire a bunch of cash flow companies. Buffett uses Berkshire, while Mendelson uses HEICO, just that his acquisition field is more concentrated. Because the field HEICO is in is a large market, and although HEICO continues to develop, it only occupies a small share The global commercial aircraft fleet has increased from less than 10,000 aircraft in the 1990s to the latest 28,400 aircraft in 2023. Looking ahead, it is expected that the global aircraft fleet will exceed 36,000 aircraft by 2034. There are approximately millions of components on an aircraft, with numerous component manufacturers active in their respective niche areas. Despite the astonishing growth in sales over the past 30 years, HEICO's market share in the aircraft components market was less than 5% in 2020. With HEICO's current growth rate, the race ahead seems long and challenging. Following this path, the company's acquisition and growth logic is relatively clear and visible, without the need to acquire outside the industry. It appears to be a company focused on the aviation business. HEICO's components have never caused an accident, and their products are priced much lower than the market price. With low costs, high quality, and years of customer trust, HEICO's business is thriving, occupying a good share in various segmented component categories, each equivalent to a cash cow. For new players looking to enter this industry, meeting aviation industry regulatory requirements and gaining industry trust to smoothly conduct business may take at least 10 years or more, while also facing competition from HEICO. In other words, high barriers to entry combined with competitiveness can enable HEICO to continuously gain monopoly profits and maintain a long-term advantage. The company uses generated cash flow to acquire other cash flow companies in the industry, and retains the original management team of the acquired excellent companies, granting them full authority while retaining minority shareholder shares for incentives, much like a replica of Berkshire Hathaway. As Buffett said, "I am a good investor because I am an entrepreneur. I am a good entrepreneur because I am an investor." Mendelson himself is an excellent investor, and HEICO is a tool for Mendelson to create value, creating value for customers on one hand, saving costs for customers; and creating value for shareholders on the other hand, accumulating wealth for shareholders. The Mendelson family remains a major shareholder of the company, aligned with shareholder interests, possessing good management skills and investment knowledge, and a clear understanding of the capital market, which is rare in the market. Ordinary management is often unable to think and act like business owners, focusing more on how to benefit from the company rather than benefiting shareholders. Additionally, it is important to note that Mendelson has been the CEO of HEICO for over 30 years, demonstrating remarkable achievements, and he is not eager to retire. Even if he retires, his two sons are likely to succeed him, ensuring the long-term quality of the company's management. Conclusion

HEICO's intrinsic compound growth and management philosophy align well with contemporary value investing. What the market can agree on is that this is a high-quality company, but reaching a consensus on the price paid is challenging. In the past, only extreme circumstances such as the global pandemic and aircraft grounding provided a relatively significant opportunity for bottom fishing