Heico Deep Dive: a Flying Business

Welcome to the 94th Pari Passu Newsletter,

After last week’s pharma industry primer, today we will be taking a look at Heico, a technology-driven company specializing in the industrial and electronics sectors. As a well-established player in the aerospace and defense industry and one of the hottest stocks with a 22% CAGR over the last 32 years, Heico provides a promising source of innovation for the future of global safety and security. Founded in 1957, the company has been changing the landscape of aerospace systems for nearly 70 years.

Given Heico’s resilience in aerospace and defense, global reach, innovation and growth, steady financial performance, and diversification, it is worthwhile to examine the company’s potential and impact on the market. In this summary, we will examine the history behind its rise, an overview of its products and performance, and an outlook on its future.

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Section 1: History 

Founding and Early Development

In order to understand its position as a global leader in aerospace and aviation parts, it is vital to examine Heico’s rich history. Heico’s rise from a small medical laboratory products manufacturer is one of vision, perseverance, and strategic brilliance.

Its roots can be traced back to 1957 when Otto Heinicke founded Heinicke Instruments Co. Heinicke’s vision for this company was far from becoming what it is today. 

• Heinicke Instruments Co. was initially focused on medical laboratory products. This was a crucial time for Heinicke’s development as it would carve out a niche in the medical field.

• The company found some success manufacturing products like laboratory glassware and scientific instruments, but its ambitions far exceeded this original scope.

In 1974, Heinicke made a pivotal move by acquiring Jet Avion Corporation, a manufacturer specializing in jet engine parts, because it wanted to diversify its product offerings and tap into the lucrative aerospace market. 

• Heinicke looked to leverage synergies as it had existing capabilities in manufacturing to apply to Jet Avion’s facilities and foundation.

• The company entered the aerospace sector and shifted its business model towards producing and supplying aircraft parts.

• Heinicke would utilize the growing market for aerospace components to find immense success; the aerospace industry doubled from $25bn in sales in 1970 to $50bn in 1980 [1] [2].

This did not come without obstacles, however. The 1980s were full of challenges and restructuring for the company. This began in 1979 as it faced a legal challenge from the Securities and Exchange Commission alleging that the company was misrepresenting its engineering expertise. Heinicke agreed to include a greater amount of outside representation on its board to settle the case. 

Further, the Federal Aviation Administration (FAA) enforced strict and exacting safety regulations; this was a decade of rapid advancements in the aviation industry, which translated to increased air traffic and an increased focus on safety. This created complexities for companies like Heinicke with the certification process for aircraft parts and strict maintenance and inspection requirements. 

• Heinicke navigated this by investing in quality assurance, focusing on aftermarket parts, building relationships with the FAA, and maintaining high safety standards to earn trust.

• This, along with its deregulation of airline fares, created a notable boost in its business: in 1986, earnings were $7.6mm. The stock showed a return of more than 1,000% over the course of the 1980s [3].

It is also important to note that at the start of the decade, Heinicke came under the control of Tyco Laboratories as it acquired a 46% stake [4]. 

• Tyco Laboratories was a diversified manufacturer of fire-protection and flow-control equipment, packaging materials, and electrical and electronic components based in New Hampshire. 

• The plan was to continue diversifying its business portfolio, reduce dependence on a single industry, and make the most of high growth potential.

Following these moves to diversify its operations, Heinicke decided to rebrand; in 1986, Heico was born. Ironically enough, even this name change saw legal disputes when an Illinois company asserted that the change sparked “unnecessary confusion in the trade and financial communities” in 1989 [4]. As you can imagine, Heico won the dispute.

Heico would continue along its path of success with a stock offering on the American Stock Exchange in January 1987. Later on in the same year, it announced plans to acquire two companies: All Fab Corporation and Germfree Laboratories. 

The Mendelson Era

No discussion of Heico is complete without mentioning the Mendelson family. Unlike many other family businesses and succession stories, the second generation of the Mendelson family has been involved with Heico since the beginning and has continued to play an integral role in its development. The story of the family’s involvement with Heico begins at Columbia University, where Eric Mendelson and Victor Mendelson attended college in the 1980s. With the LBO boom at the time, Eric and Victor formed a dream to use the family’s money to acquire a public company. When Victor stumbled across Heico, they saw a management team that owned no shares and was not incentivized properly but had solid numbers and potential. To them, this was the perfect opportunity. The brothers and their father Laurans “Larry” Mendelson, a former Arthur Anderson accountant and real estate investor in Florida, bought 15% of the business for $3mm, half cash, half debt. This marked the beginning of a new chapter for Heico characterized by visionary leadership and colossal growth.

Immediately, the family launched a proxy vote to oust the management team. Although they lost the vote, they sued for proxy solicitation violations and won the case. Thus, in 1990, they took control of Heico. 

• Since then, through strategic acquisitions, operational efficiency, and a steadfast focus on customer satisfaction, Heico has generated a total return of 47,500% [5]. 

• Their leadership style has been one of collaboration and family-oriented unanimity, fostering cohesion across the company.

However, this era of growth had a rough start. At the time, Heico’s primary product was its engine combustion chambers. In 1989, United Technologies Corporation sued Heico for $100mm alleging infringement on patents used in the combustion chambers of its Pratt & Whitney engines. Considering that Heico only had a market cap of $25mm at the time and its main product line was being threatened, this was a very dire situation. Luckily, they were acquitted of these charges. The court found that Heico did not infringe on United’s patent and that the claims of infringement were not supported sufficiently; Heico filed 17 counterclaims, including claims based on alleged false statements United made regarding Heico and its products, claims for declaring patents invalid, and claims for unfair competition and monopolization [6].

After these events, the Mendelsons recognized the potential in the aerospace replacement parts market. They saw an opportunity to expand the product line from just engine combustion chambers by reverse engineering existing parts. Even better, there were high barriers to entry for any competitors given the strict FAA regulations that Heico had learned to navigate. This was no cakewalk; Eric worked endlessly to develop a relationship with the FAA and practically came to live in the hallways of the FAA’s Washington, D.C., headquarters. 

Once they gained approval from the FAA, Heico began offering replacement parts at heavily discounted prices - one-third to one-half of those charged by equipment manufacturers - to major airlines and defense customers. The Mendelson brothers were resolute in their decision to keep margins low, at around 15%, to continue to win over more customers. By exploiting a customer-centric pricing strategy, Heico developed long-term loyalty and positioned itself as the preferred supplier in the market. This strategic realignment played a crucial role in the Mendelsons’s outlook.

As stated earlier, the Mendelson brothers had identified Heico’s management's lack of proper incentive to produce returns as an opportunity to improve efficiency. This idea became a cornerstone of the family’s operating philosophy and strategy. Heico started sharing its success with employees through its 401(k) plan and its policy of matching employee contributions with Heico stock. Not only did this incentivize improvement, but it also elevated employee wealth, reflecting a dedication to rewarding its workforce.

From there, the Mendelsons exploited inorganic growth with an aggressive acquisition strategy to expand Heico’s capabilities and market reach. Heico would acquire 49 companies.

With the 1990s being a period of acquisitions for Heico, they also attempted to diversify further and explore opportunities outside of the aviation industry, which stalled at the start of the decade. Heico branched out to form MediTek Health Corporation in an attempt to enter the medical imaging field. Although this venture was short-lived and resulted in a sale to United States Diagnostic Labs Incorporated in 1996 for $23mm, it perfectly displayed the Mendelson's mindset of daring innovation and aggressive growth [10].

Another notable development in Heico’s growth occurred in 1997 when the Mendelsons formed a relationship with the Chairman and CEO of Lufthansa Airlines, a major German airline and one of the largest airlines in Europe. They pitched Lufthansa on the value proposition they could bring to maintenance repair and overhaul capabilities. Lufthansa would invest $26mm in Heico, buying a 20% share in Heico Aerospace. This gave Heico a unique information advantage as it could utilize Luthansa’s technical data. Having such a major customer also gave Heico a marketing advantage as it gave it credibility to sell out to other airlines. In 1999, Lufthansa invested an additional $3mm and their investment would total to $38mm [11]. This relationship ultimately launched Heico to be a leader in the space.

In January of 1999, Heico shares began trading on the New York Stock Exchange. The following month, a secondary stock offering raised $64mm [12]. 

• In Q1 1999, sales increased by 43% reaching $896mm as the company reported record profits. 

• Over the preceding five years, revenues had increased by more than 50% every year

• Within the next five years, management wanted to reach $1bn in yearly revenue.

Recent Developments

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