Episode 5 - Larry Mendelson

The future of the aerospace industry and manufacturing in the US

Chairman of the board and CEO of HEICO, Larry Mendelson, describes his journey taking over an underperforming industrial business with his sons, and transforming it into a “Segment of One” market leader.

Renaissance Age for the US Industrial Tech Sector podcast

Larry Mendelson in discussion with Nick Santhanam

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Nick Santhanam: Welcome to the next podcast of Renaissance Age for the US Industrial Tech Sector Podcast. I’m your host Nick Santhanam, senior partner with McKinsey.

While the past year has been riddled with challenges that have impacted our personal and professional lives, we are witnessing the first signs of returning to normalcy, especially as countries roll out the vaccines. Also coming out of the pandemic, we are seeing the silver lining in the form of democratization of technology as well as the revitalization of the manufacturing and industrial sector in the US. Through in-depth discussions with leading executives at the forefront of this revisitation, we will be exploring not only the drivers fueling this transition, but also the barriers that need to be addressed to sustain this transition for the US economy.

Today, our guest is Larry Mendelson from HEICO. I’m privileged and honored to host one of the pioneering leaders in the aerospace and electronic space. Mr. Mendelson needs no introduction. He has led HEICO, a top-performing public company, for almost 30 years. Larry has been HEICO’s Chairman of the Board and Chief Executive Officer since 1990. During his tenure, HEICO revenues has increased more than 80x from $26 million to over $2 billion. During the past 30 years, HEICO has been a top-performing stock overall and number one in the aerospace sector. Larry has been a member of the Board of Governors of the Aerospace Industry Association (AIA) and was the former Chairman of the Board of Trustees of Mt. Sinai Medical Center in Miami Beach, Florida. In addition, he is a trustee of Columbia University of New York. With that, welcome Larry.

Larry Mendelson: Thank you.

Scaling a business

Nick Santhanam:Let me get started, Larry, by asking you about the real story behind HEICO’s success. Can you give us the views from the frontline, what has been the beginning, and how that has emerged over the last 30 years?

Larry Mendelson: Well, I will try to do that in the best way that I can. My two sons were at Columbia University in the mid-80s and I had been in the real estate business. And while they were in New York, they observed the LBO craze, and they said to me, “Dad, why don’t we take over an industrial company and run it as a family and really build it up. “ So I said, naively, “That sounds like a great idea.” And in fact, we took large positions in a number of American New York Stock Exchange (NYSE)-listed Industrial companies, many of which were truly underperforming, and it was our thesis that there were many underperforming companies that really could use entrepreneurial skills to turn them around and improve their operations, profitability, and so forth. So, without going into the details of the companies that we approached, we had never been successful because every time we approached, we bought a lot of stock, in most cases, we became the larger shareholders, and requested a seat on the board of this underperforming company. And the board of directors invariably treated us like the skunk at the picnic, and they said “No thank you, we can do it ourselves. We don’t need you,” and so forth.

The result was that once we focused a spotlight on these companies, the shares went up because the investors thought there was a takeover coming. Incidentally, in all cases, we sold out at significant profits, but never really accomplished our objective of taking over the company and running it and turning it into a successful operation.

October 1987 saw a market crash, and previously my son Victor had focused on HEICO, a small company operating out of Hollywood, Florida. Stock price was in the mid-30s, market crashes and the stock goes from, say, 35 down to about 15 or 16, and we became the largest shareholders in HEICO corporation.

HEICO had substantial income, because of a crash in Manchester, England. HEICO was able to manufacture the combustor for the JT8D engine. Now, the JT8D engine was the power that powered virtually the whole narrow-body fleet—727s, DC9s, and so forth. And when the crash occurred in Manchester, the FAA said the cause was a failure of a combustor and from there on, every airline would have to replace or repair combustors on a time-certain basis. Pratt Whitney, the manufacture of the JT8D engine, did not have the manufacturing capability to supply approximately 120, 000 combustors immediately. And if an airline could not replace a combustor, the airline was unable to fly the plane. HEICO had the drawings and the capability to manufacture combustors, and all of a sudden there was a boom in the combustor business. So, HEICO’s fortunes boomed, but it was really a one-time event. The combustor was virtually the only significant product that HEICO had. So, we theorized that if they could get the manufacturing approval from the FAA, why couldn’t we get it on other parts that go in the engine and on the aircraft?

Well, the result was, we were the larger shareholders, we were not permitted to have any say in the company. So, in 1989, we launched a proxy contest in March of ‘89. We lost by 1 vote—by 1%, I’m sorry—and ultimately, we decided to sue because in the proxy solicitation process, we discovered what we believed to been misleading information by the board given to shareholders of HEICO to induce them to vote for the existing board. The trial took place in November of 1989 and the trial was really fought very hard by both sides. I became the President and CEO, and we started on our process to develop more parts and to serve the customer. It was very hard, because we were competing with Pratt Whitney, General Electric. HEICO had a market cap of something like $20 or 25 million at that point.

“Today, we do somewhere between 400 to 500 parts a year. The thesis was always extreme quality.”

From a business point of view, we decided that we would develop more parts. We would apply the best manufacturing and quality techniques. We hired somebody who was very experienced in the aircraft parts business, previously who had been with GE and some other companies. And we started to develop parts which we applied to FAA for approval. I think the first year we got five parts approved. Today, we do somewhere between 400 to 500 parts a year. The thesis was always extreme quality, response to our customers, demand—we weren’t trying to sell the customer a part that we liked, but we would say to the customer, “What do you need?” Of course, our philosophy was always to have high margins which generated strong cash flow.

And in 1995, my son Eric was at a conference in Texas. He met the CEO of Lufthansa Technik, a gentleman by the name of Wolfgang Mayrhuber. And Wolfgang said, “Your parts will save Lufthansa millions of dollars.” And long story, Lufthansa became a 20% partner in our parts business, they purchased 20% interest, and we agreed to manufacture parts that they recommended and liked. And so, at that point there was a major turning point because prior to that, competitors such as GE and Pratt Whitney would badmouth our products because they would say, “Well, you’re a little company,” and they would tell customers, “You can’t trust HEICO, it’s a little company and it doesn't have the financial wherewithal that we do,” and “You can’t trust quality.” Well, once Lufthansa became partners—it was known to the industry that if Lufthansa, which is probably #1 in German engineering and so forth—if they were a partner and they were using HEICO’s parts, it must be OK. And in today’s world, we serve at least 19 or the 20 largest world’s airlines.

“the culture is what drives the bottom line. The team members, or employees...are the ones that make it happen.”

The thesis that we went on was really very simple. One: the culture is what drives the bottom line. The team members, or employees—we prefer to call them team members—are the ones that make it happen. They produce the parts, they build in the quality, and we wanted to make sure that they had a strong financial interest in HEICO. Today, we have about 6,000 team members, so we have to create a system where you have internal motivation. So, we have a 401K plan. Team members contribute 6% of their salary as a tax-deferred contribution, and HEICO annually matches it with 5% of their salary in HEICO stock. So, I’m proud to say that we have many factory workers, secretaries, shipping clerks, who are multimillionaires. Result one: very low turnover. Two: an interest in the product and the shipment and the quality, because every part that goes out is their income. They get a percentage of the profit because they own all of these shares in the company. So that’s number one, the belief in the culture, sharing, the wealth.

Number two: give respect to every single person on your workforce. I don’t care if somebody sweeps the floor at night, or he’s the executive vice president. That person deserves the same respect, as long as they perform their function. So, reward the person for performance. Even during the pandemic, we gave the 5% in spite of the fact that sometimes we had to go to a 4-day week. In most cases, we didn’t have big layoffs like some companies.

Next is our focus on high-margin, low-volume parts and products. And high margin because with high margin, it’s much easier to finance without driving up huge amounts of debt or going to the public markets and selling stock. We can self-finance by high margins. One other thing, we are highly decentralized, we select really brilliant people—PhD, electrical engineers, and all types of talent and engineering people. What we do is we go out and we pick somebody that has been in the industry for 20 years—very experienced, knowledgeable, knows his customer, knows everything about the manufacturing process—and then we say to him, “Tell me, what do you think we should do? And tell me what do you need from us to help you? Do you need introductions, do you need financing?

So, it’s that type decentralized trust for our people. And not only do we get good results, because they’re smart people, but they see that we respect them. And working again, the market has seen how we really run the company, they’ve rewarded us, so that’s sort of the story of HEICO. We continue to acquire companies, we are not a financially stressed company, never had debt more than two times EBITDA—never been at 2x EBITDA—and we have been able to grow bottom-line net income at 19% annually compounded growth.

Surviving the pandemic and disruptions

Nick Santhanam: So, Larry, let me ask you this question. Over a 30-year period, you’ve navigated multiple crisis. You started off obviously, as you said, with the 1987 crash, then there was the rise of ‘99, the crash of 2001, the crash of 2008. But then you look at the pandemic crisis this last year and it hit the aerospace Industry big time—people stopped flying, a lot of the airlines started filing for, I wouldn’t say bankruptcy, but pretty close to bankruptcy. How did you navigate that crisis?

Larry Mendelson: That’s a very good question, and the answer is the diversification. Five or 6 years after we took over management, we felt that being only an aerospace company subjected us to large swings in fortune. I attribute that to the decision to be diversified both in product and customer and product line. When we did it, we had a lot of criticism. Don’t forget that ETG today has a higher operating margin all in than aerospace. But they’re both very strong margin businesses, protected environments. As Buffet might say, there’s a moat around the castle and it’s very difficult to compete, which helps us maintain our good margins and permits us to develop new products. We have enough money to do whatever R&D we need and we’re never strapped for dollars.

Nick Santhanam: So Larry, let’s look forward. And even without the pandemic, there’s been a lot of big disruptions—technology disruptions, globalization, return of manufacturing to regions because every country wants to have its own manufacturing or has its own industrial sector. What do you think is going to be the impact of these disruptions on the mid-cap companies? Is it good, is it bad, or is it neutral?

Larry Mendelson: I don’t see any reason why US manufacturing can’t succeed. In our business, I simplify it by saying there are three legs to our business. There's design and development, there’s the manufacturing process (the machining and building of it), and then there’s the marketing. HEICO makes money in the first and third. Yes, we have a good manufacturing operation and we’re efficient, but it starts with the design and the development. If we have the technical ability to design superior products, we will succeed. The world has always come to us, not because we’re the greatest manufacturer, but because we have products which are unusual. For example, when we make electronics that go on satellites that go to the moon, this latest Mars mission, four of our subsidiaries had electronic products on that. That is very complicated stuff. So, it’s not the manufacturer of those little electronic components, it’s the design, the development, the brilliance of how to do it.

Taking a look back

Nick Santhanam: So Larry, I want to come to the last two questions. You’ve been wildly successful over the last 30 years. What are the things you would you do differently if this was a conversation you and I were having in 1990?

Larry Mendelson: Well, I think that when I look back, I think that I would not have done anything different, with the exception, maybe I would have been a little bit more aggressive on some of the acquisitions.

So, I think the basic decisions we made were right. And again, key to this to me, has been to associate ourselves with the best people you can find. We’ve looked at acquisitions where the companies looked great, and when we thought about the person running the company, we said we don’t want to be associated with these people. So, we’ve turned down a number of acquisitions where we just didn’t feel that the people were right. But I can tell you, I’m honored to be associated with the people that run our businesses, because they have integrity, they're brilliant, they're hard working, they’re educated—these are very smart people, and they treat their team members well. They handle them nicely and I think all that culture is very, very important. And Nick, so I don’t think I would do very much different than what we’ve done.

Nick Santhanam: Thank you so much for your time, Larry. We really appreciate your thoughts and candor. To all the listeners, stay tuned for the next episode of our podcast Renaissance Age for the US Industrial Tech Sector.

The situation surrounding COVID-19 is evolving daily. For the most current information and insights on the implications of COVID-19 for your business, please visit Coronavirus: Emerging stronger from the coronavirus pandemic, a regularly updated collection of McKinsey briefing notes.

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