What Chinese Acquisitions Mean For Competition


Americans love competition, or say that they do. A fundamental assumption of American business is that capital will find the most efficient way to reproduce itself and companies that fail deserve to fail. Plain and simple, it’s economic Darwinism. It’s a universal principle until, that is, it’s your own ox getting gored or you’re subjected to distorted competitive forces with unknown long-term outcomes.

In Tuesday’s blog on Continental’s Chinese-funded expansion in Mobile, I didn’t delve into these specific details about how AVIC’s investment could affect the competitive environment for a critical part of GA in the U.S.: aftermarket parts and services. It’s worth a look.

In the U.S., the GA market is flat at best, but really in decline with regard to OEM manufacturing and overall flight activity. In real dollars and in units shipped, recent trend lines have been downward and sharply downward since 2008. GAMA data shows that 2016 saw $20.7 billion in new aircraft against $24.8 in 2008. There’s no point in sugarcoating the fact that the pie is shrinking. Continental’s business strategy, which has animated its opportunistic purchases of two companies, is to grow by expanding its share of the pie.

In buying Danbury Aerospace/ECI, Continental creates something that existed only in the margins before: direct competition between Continental and Lycoming. In the old order, these two engine companies competed to the extent that they tried to entice OEMs to select their engines, but once that was done, they left overhauls to independent field shops and were satisfied to provide the necessary parts. As the industry declined, both companies aggressively entered the overhaul markets and the field shop universe declined.

More competition arrived in the form of companies like ECI and Superior, which competed with the engine manufacturers in supplying overhaul parts, especially cylinders but eventually major assemblies like crankshafts and crankcases and even entire engines based on PMA parts. If there was a golden age of this PMA competition, I would peg it between 1995 and 2005, when Superior’s Millennium cylinders were a thing and ECI was finally figuring out nickel-treated cylinders. These gave meaningful competition to both Lycoming and Continental and kept prices in check, at least on popular cylinders.

As the market has declined, both of those companies got into trouble. Superior went down with the Thielert bankruptcy in 2007, not so much as a result of market trends but of mismanagement. ECI got caught short after 2008, probably squeezed between soft sales and high internal costs. With U.S. investors uninterested, AVIC saw an opportunity and snapped it up. I suspect the decision was animated by both a longer term view that looks past short-term returns and the overarching goal to build Chinese expertise at all levels of aerospace. That’s another way of saying Textron’s version of the numbers is very different from AVIC’s.

And that gets us to the significance of Monday’s new factory announcement by Continental. As I said Tuesday, $40 million isn’t a huge investment but if it’s huge enough to fundamentally reset the economics of manufacturing parts like cylinders, crankshafts, pistons and the like, it changes the competitive landscape. Continental is now is a position to compete directly against Lycoming on everything, up to and including complete engines if it certifies and expands the Titan line. With a state-of-the-art factory, it may have internal cost advantages that give it a powerful edge.

Of course, Textron could easily write a check to fund similar reinvestment at Lycoming, but is unlikely to do so because it wouldn’t see the return on investment. Heretofore, Lycoming has largely funded reinvestment with its own internally generated capital with the expectation of certain returns. AVIC isn’t concerned about quarterly earnings in quite the way Textron is so if it sounds like Lycoming is competing on a tilted playing field against a state-owned enterprise, that’s exactly what’s happening.

Is this unfair? Probably, but what about real competition is? Any company will quite naturally leverage whatever assets it can bring to bear to beat the other guy in the market. That’s capitalism 101. The short-term effects of this aren’t necessarily predictable. In purchasing ECI, Continental removed one competitor from the market. Less competition almost always means fewer choices and higher prices. On the other hand, an anemic market will tolerate only so much price escalation before it really heads south. We’re already well into the era of cannibalistic competition. The long-term effects are equally uncertain. If AVIC’s acquisitions eventually force more competitors from the market, it becomes the dominant player and can set prices at will. This would be true whether the investment comes from China, India, the U.S. or Japan.

In aviation, we tend to focus on our narrow universe without regard to broader geopolitics. There’s a tradeoff here. Chinese aerospace investments in the U.S. clearly benefit China and serve its goal to become a dominant economic player on the world stage. But the investment has also at least preserved and probably created jobs in the U.S. that might have otherwise gone the way of the textile industry.

So, take your pick. Chinese investments in Europe are nearly double what they are in the U.S., but the U.S. may be unique for less regulation and oversight of such investments. Why don’t we, by government fiat, stop these acquisitions? Wouldn’t that be in the long-term best interest of the country? Perhaps. And perhaps this will be a topic of conversation when President Trump meets China’s Xi Jenping this week. Then again, circle back to the first line: Americans love competition.

Dueling Idiocy

On the way to the gym Friday morning, I heard this report on NPR. I found it dispiriting that western civilization has declined to the point that we consider the idiocy described in this report as sane enough to merit five minutes of radio time. I kept waiting for the reporter to just burst out and say … seriously?

The story is about TFR violations on Florida’s east coast, where the government throws up a 30-mile restricted area when President Trump is at Mar-a-Lago. He’ll be there this week, by the way, just as Sun ‘n Fun gets fired up.

I’ve already opined about this in a VLOG. The dueling idiocy part is that these TFRs are so large and that the security edifice feels so threatened by an errant Skyhawk that they feel the need to intercept with an armed fighter. At least one has exceeded Mach 1 during the intercept. I get the we’re-not-taking-any-chances approach to this, but by now they have plugged enough data into the security algorithm to realize these incidents have a low probability of threat. I’ve argued to make the TFRs smaller and/or provide the airports impacted by them, especially Lantana, with some relief.

On the other hand, there have been 38 TFR violations. For as excessive as I might argue that TFRs are, that’s a degree of cluelessness that stuns even me. It’s not like these TFRs aren’t publicized for anyone who looks even casually. AOPA sends out an email alert on them. There’s really no excuse for busting one and with Sun ‘n Fun coming, the opportunities expand.

So if you do nothing else before flying in Florida, where the weather rarely requires a detailed briefing, at least check the NOTAMs for TFRs. There’s enough idiocy out there without adding to it.