The Chinese Take Continental
If there was anything surprising about the announcement of Teledyne Continental Motors being sold to a Chinese conglomerate this week, I guess it would be that it didn't happen sooner. It's not that Continental is an unattractive business prospect, but that it no longer fits with the Teledyne parent. Compared to Lycoming's Textron parent, Teledyne is smaller, but with a lot more pieces—55 companies, most of them in the technology, instrumentation and marine development segments. A maker of piston airplane engines stands out like a polka-dot dinner jacket, so off it goes to the Chinese. At a revenue multiple of about 1.3 (estimated) on sales of about $140 million, the Bejing-based AVIC International got themselves a fair deal on a fully functioning, modernizing aircraft engine plant.
Now what? They pledge to keep the business in Mobile, which prides itself on luring lots of foreign business to the city. Given the nameplate, they'll keep Continental in the name, although obviously, Teledyne will be dropped. Maybe Technify Continental? Or AVIC Continental? We shall see. We're told all of the jobs will remain in Mobile and investment capital, which Continental definitely needs, will be on the inflow. We expect to see some expansion at Brookley, which is a good thing.
But is the sale overall a good thing or just more hollowing out of the U.S. manufacturing base by the Chinese? These days, it's fashionable to decry American companies for selling out to China, but the fact is, China is investing 40 percent of its GDP a year in new industry and that's almost $2 trillion. It's inevitable that some of that cash will land in the U.S. It's the way the global economy works and every company needs an international strategy. Might as well get used to it. Besides, I doubt if Teledyne would have got its $187 million price from a U.S. buyer, given the current market decline. On the other hand, an aircraft engine maker appears to fit into the Chinese master economic plan.
Worth noting here is how difficult it is to be in the aircraft engine business. Both Lycoming and Continental operate on razor thin volumes and both have seen their OEM sales plunge, TCM's by as much as 60 percent. The low-volume/high-mix manufacturing they do doesn't lend itself to meaningful economies. Sales have risen some in 2010, but TCM has still struggled to stay black. You can't blame Teledyne for not wanting to pour a lot of capital into the Mobile plant to develop the diesel technology Continental bought earlier this year from SMA.
To make a go of that engine, they need to fix its cold weather problems, chew down the unit price, develop a high-horsepower six-cylinder version and, oh, figure out to sell it, which SMA never did. Although the future of aerodiesels seems assured, it's not going to happen very fast and I'd guess the investment required has to be in the $5 million range, if not a little more. If you're small potatoes in a bigger mothership and you have to finance projects like that internally, you can see why Chinese money looks attractive. I continue to believe Continental made the right decision with the diesel, but it's the long play you don't see much of in American business.
The aerospace business seems to be positively woozy over the notion that 1.3 billion Chinese represent a bottomless pit of aircraft demand. One popular way of showing the potential is this: In the U.S., with 200,000 airplanes, there's one airplane for every 1500 people. Apply the same ratio to China, and it's north of 800,000 airplanes. But let's get a grip here. Despite torrid growth, the Chinese may have a long way to go to have enough disposable wealth to drive those kinds of numbers. (By the way, for more reading on this topic, I'd suggest The China Price by Alexandra Harney and Poorly Made in China, by Paul Midler.)
But even at a tenth of it over 10 years and that's a nice little business. Many of those airplanes will certainly be powered by diesel engines. With a Chinese parent, Continental could have a natural entre, which is why Teledyne says the AVIC deal positions the engine maker favorably.
It's natural to wonder if Lycoming might be next. Not impossible, I suppose. But Textron has a very different business mix than Teledyne does and Cessna accounts for nearly a third of its revenues. While the big ticket jets deliver the profit, Cessna's schtick has always been a full line, from basic pistons, to high-performance singles to jets. It's hard to imagine them spinning off the piston line into a separate business, packaged up with Lycoming for a nice tidy bundle. On the other hand, when $2 trillion is bouncing around the global economy like a rubber check in a tile bathroom, anything can happen. For all I know, Cessna may have considered that very thing.