Kevin Gould, managing director of Alderman & Company, says the sector can expect increased M&A activity in the MRO sector amid 737 production restrictions imposed on Boeing 

Earlier this month, the FAA ordered Boeing to limit production of its 737 aircraft to 38 units per month.

Boeing had planned to build the 737 at increasingly higher rates because global demand for narrowbody aircraft (737 and A320 models) is projected to grow.

Airlines around the world had developed detailed expansion plans which led them to place very long lead-time orders for new aircraft, resulting in years of backlog for Boeing and Airbus.

But the FAA’s freeze on 737 rates will now leave some of those orders unfilled, and Airbus cannot react fast enough to bridge the gap.

Airlines are going to turn to the existing fleet to find alternate sources of narrow body lift, principally by delaying planned retirements or sourcing aircraft from the existing installed base.

Either option will involve upgrading older airframes which will significantly impact the aerospace supply chain and M&A industry.

Certification

To design, manufacture and sell an aircraft in the US, an OEM must obtain a Type Certificate (TC) from the FAA by demonstrating the design meets a series of strict standards set out in the Federal Aviation Regulations (FARs).

Most other countries in the world have adopted similar systems, many of which reflect the approach taken by the FAA.

OEM’s show compliance by completing a series of stringent tasks including submission of the design for review, building test articles that conform to the design, and then conducting a series of static, dynamic and flight tests to show the aircraft meets the relevant standards set forth in the FARs.

Durable Airframes

The TC process is extremely rigorous and thorough, and very difficult to successfully complete.  For the most part, the result has been aircraft designs that are safe, reliable and extremely durable across the spectrum.

Go to any local airport and most of the small aircraft you see are 50-year-old Cessnas and Pipers. Boeing’s 737s have a lifespan of 90,000 flight cycles (the number of takeoffs and landings they can make) or 55,000 flight hours, whichever comes first (although in the US they are limited to 60,000 cycles without special maintenance procedures).

Airbus’ A320 is limited to 48,000 cycles and 60,000 hours, although work is underway to extend that to 90,000 cycles and 180,000 hours (at three two-hour flights each day, that works out to 82 years of useful life).

Suffice it to say, the strict regulatory framework for obtaining TCs has resulted in a fleet of airframes that are incredibly durable.  This is a good thing for those airlines now facing a severe shortage of narrow body lift due to the fact that the aircraft they ordered will not be delivered.

STCs

As airlines scramble to modernise older aircraft in an effort to meet their strategic growth plans, they cannot simply make changes to the airplanes; they must obtain FAA approval to deviate from Type Design, which, for anything other than minor changes, usually requires a Supplemental Type Certificate (STC).

STCs are expensive and time-consuming to obtain in the best of times, requiring the submittal of extensive design, analysis and testing documentation to the FAA for review, comment and approval.

But in recent years the process has become even more arduous as labour and other challenges within the FAA have resulted in extended queues and multiple review cycles.

Luckily, some relief can be obtained by engaging a firm with Organisation Delegation Authorisation (ODA) in which a private company can perform evaluation and approvals on behalf of the FAA.

Upgrades

Thus, to fill near-term demand for narrow body lift, airlines and modification shops will be seeking STC’s for upgraded avionics, cabin systems and interiors in older aircraft whose working lives are being extended.

Part of the demand for newer avionics is driven by technology advances as improved products are developed for navigation, traffic and weather information, data recording and autoland capabilities.

But avionics upgrades are also being driven by obsolescence concerns where older systems are no longer being supported by their original manufacturers.  A similar scenario is playing out in cabin systems, particularly in-flight internet connectivity.

As airline customers prefer and demand faster internet speeds, airlines have to sprint to keep the latest technology onboard.  And finally, the interiors of the older narrowbodies will be upgraded to keep them looking fresh and current.

Most passengers can’t tell and don’t care what make of aircraft they are on, much less what model, they just want it to appear and feel modern.

Accordingly, seats, passenger service units, lighting, stowage bins, class dividers, floor panels and sidewalls of older aircraft will all need to be upgraded with newer products.

What this means for M&A

All this means you should be watching out for increasing demand for aftermarket parts and MRO services, the segment of the industry that provides the upgrades airlines will need to utilise older narrowbody airframes.

Some suppliers will simply be switching customers; instead of selling parts and equipment to Boeing for the new 737s that were going to get built under the higher production rates, they will largely just sell to part 145 Repair Stations for upgrades.

But the repair stations themselves, and the engineering and certification companies that can obtain the STC’s, will be in high demand.

As this segment begins to experience strong growth, both strategic and financial buyers will see opportunities for attractive returns.

Look for a series of rollups and bolt-on acquisitions as MRO capacity begins to command higher multiples and owners jump at the chance to cash out.

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Kevin Gould is a Managing Director with Alderman & Company, M&A bankers exclusively serving middle market sellers of companies in the Aerospace and Defense market. He has more than 30 years of experience in the aerospace industry, including M&A, strategy, and executive leadership. Kevin started his career in the electrical business unit of Boeing in 1988.

After 12 years at Boeing, he went on to become the CEO of Piper Aircraft and then President of the Bendix/King division of Honeywell. Prior to his business career, Kevin was an attorney with McCutchen Black Vergler & Shea.

Kevin holds a JD from the University of Southern California, an MS from Stanford University, and an MBA from Harvard Business School. Kevin has over 1,000 hours as a private pilot, with instrument and complex ratings.