TDG - Transdigm

[Schwab711]

https://khanna.house.gov/media/press-releases/release-rep-khanna-calls-investigation-aerospace-defense-contractor-business

Well that was fast! I bet whistleblower claims are going to be the next big alpha-driver for hedge funds. You get a free option on the possibility the government uses your research to collect $ and it helps your short position.

[Jurgis]

https://khanna.house.gov/media/press-releases/release-rep-khanna-calls-investigation-aerospace-defense-contractor-business

Well that was fast! I bet whistleblower claims are going to be the next big alpha-driver for hedge funds. You get a free option on the possibility the government uses your research to collect $ and it helps your short position.

Cause it worked so well for Ackman wrt HLF. 

[Schwab711]

Let's assume for a second that TDG is ripping off the USG.  Any speculation as to what the USG can do?  These parts have no alternative suppliers.  So besides ground aircraft in need of miantence, can they force a private company to supply parts?

This is a good question and I'm not sure what the answer is. Obviously there's this call for an investigation, but I think the USG's only recourse is clawbacks of overpayment + some fine for overcharging. Maybe they could cancel some contracts and/or block them from bidding in the future but that would only be on a limited basis and not until alternative parts are available. Best I can tell, TDG doesn't rely on patents as much as they do relationships/LT contracts. Best I can tell, TDG is still entitled to 'reasonable profit' (which seems to vary between 8% and 12% - I'd guess they mean pre-tax margin?).

One of the issues I have with getting negative on TDG compared to VRX is TDG's business is legitimately great. They truly do have the best-of-breed suppliers and deserve a lot of their monopolies. I would buy them at some price. I keep going back and forth on whether TDG faces any real threat to their operations. Even if they were fined and EBITDA contracted, they could always raise more equity to continue to earn above average ROE. Current shareholders would definitely feel the pain but I don't see $0 as a realistic outcome. This is definitely in the too hard pile for me, but it's interesting to look at.

Cause it worked so well for Ackman wrt HLF. 

Too soon!

[Jurgis]

Perhaps USG could squeeze TDG contracts to cost+ based on "monopolist provider" rule. Someone can do math of how much profit TDG would lose on that.

If TDG contracts went to cost+, USG would not need to cancel their contracts with TDG and look for alternative suppliers. Win win. 

[Larry]

Just jumping in here. I dont know why we are talking so much about their defence business, some shorts are even speculating that this would sink the company. Last time I checked commercial aftermarket still makes almost 40% of their revenue and I bet it's much higher % of their EBITDA. That segment has always been the most important reason for me to be invested in Transdigm and I haven't seen any reason this story would have changed somehow.

[cmlber]

Perhaps USG could squeeze TDG contracts to cost+ based on "monopolist provider" rule.

Can you clarify what you mean by the "monopolist provider" rule?

[Schwab711]

Perhaps USG could squeeze TDG contracts to cost+ based on "monopolist provider" rule.

Can you clarify what you mean by the "monopolist provider" rule?

According to DoD policy, all sole source contracts should be cost+ (same as 'reasonable profit' I've been saying). If there are multiple suppliers then the former does not necessarily apply (though it could). I think this is what Jurgis was referring to.

[Jurgis]

What Schwab711 said. 

[cmlber]

Perhaps USG could squeeze TDG contracts to cost+ based on "monopolist provider" rule.

Can you clarify what you mean by the "monopolist provider" rule?

According to DoD policy, all sole source contracts should be cost+ (same as 'reasonable profit' I've been saying). If there are multiple suppliers then the former does not necessarily apply (though it could). I think this is what Jurgis was referring to.

Can you link to a source on this?  I'm not aware that this is a policy.  I believe the policy is sole source contracts above a certain cost require the disclosure of cost information so that the DoD can negotiate cost+ deals effectively.  I haven't seen anywhere that would prevent a supplier from refusing to do a cost+ deal though. 

[writser]

Just jumping in here. I dont know why we are talking so much about their defence business, some shorts are even speculating that this would sink the company. Last time I checked commercial aftermarket still makes almost 40% of their revenue and I bet it's much higher % of their EBITDA. That segment has always been the most important reason for me to be invested in Transdigm and I haven't seen any reason this story would have changed somehow.

Well, as a counterargument, think about second-level effects. If it turns out that they are ripping off the DoD you can be sure that other customers will start monitoring their bills more closely, at the very least (and it makes it more likely they are cheating other customers too - seldom one cockroach bla bla). Philidor was only a small part of Valeant but the ensuing scrutiny brought down the entire company. Transdigm also has to pay ~500m cash to their lenders annually. A small drop in EBITDA will affect equity holders disproportionally.

Just stating the obvious here .. Not too hard to envision a bad scenario.