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Feb 15, 2017

S3 BLACKLIGHT: TransDigm Group Short Interest Tops $2 Billion

Short interest in airplane component manufacturer TransDigm Group Inc. (TDG US) spiked significantly over the last week even as they reported positive quarterly results. EPS came in at $2.57 vs. estimates of $2.50 and revenues were up 16% to $814 million. TransDigm raised its full year guidance modestly and reported $1 billion of cash on hand giving it the opportunity for $1.5 billion in additional acquisitions.

Short interest averaged $912 million in 2016, but grew to $1.3 billion by the end of January, a 46% increase. Shorts continued to grow their positions in February, with short interest topping the $2 billion level for the first time. TDG short interest is now $2.04 billion, up 89% for 2017.

Even though the stock is up slightly for the year, up 1.35% prior to yesterday’s $2.01 stock price drop, short sellers have timed their sales well and are up $28.8 million, or 2.75% for the year as of February 13th.

Andrew Left of Citron Research issued a report on January 20th likening TransDigm’s business model to Valeant Pharma’s (VRX US), that being growth dependent on acquisitions, cost cutting through employee layoffs and increased margins through product price hikes - a model that may be exposed and threatened by the Trump administration.

With  $6 billion in debt, TransDigm is already dependent on high margin parts sales to the airline industry to service their debt and with 30% of their sales going towards government related production there may be a greater emphasis on fairer pricing which could squeeze TransDigm’s margins to dangerous levels. In addition to this potential backlash against high prices there may be a drop in actual demand with both Boeing and Airbus cutting near term output.

A final obstacle to TransDigm’s continued profitability is the Trump administration’s pursuit of tax reforms that may impact the tax deductibility of corporate interest. If TransDigm’s ability to write off over $6 billion of debt service is threatened, their business model may not be able to produce the net revenues needed to support their present valuations. TDG’s cash flows from operations have been increasing every year, but if they stumble and TDG cannot continue to grow its revenues through new acquisitions, its growth rate will plateau as the firm has already maximized margins by cutting costs and headcount and increasing product prices at the onset of new acquisitions. In order to continue to grow its revenues, TDG needs new airplane parts manufacturers to come under its umbrella. TDG is more of a private equity firm in manufacturer’s clothing, and as such, liquidity is king and the shorts are betting that TDG’s cash flows and credit access will not support the valuations of this pricey stock. 

For more information on the above analysis, please contact:
Ihor Dusaniwsky, Head of Research, S3 Partners, LLC     Ihor.Dusaniwsky@S3Partners.net
The information herein (some of which has been obtained from third party sources without verification) is believed by S3 Partners, LLC ('S3 Partners') to be reliable and accurate. Neither S3 Partners nor any of its affiliates makes any representation as to the accuracy or completeness of the information herein or accepts liability arising from its use. Prior to making any decisions based on the information herein, you should determine, without reliance upon S3 Partners, the economic risks and merits, as well as the legal, tax, accounting and investment consequences, of such decision.

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