The Heart Of The Engine: Inside GE Aerospace's New Deal

Welcome to the Chexix podcast. I'm Joe Ensemble, aviation week's editor-in-chief. Aircraft engine's powerhouse GE Aerospace kicked off September with a bang, unveiling a nearly $12 billion deal to acquire consolidated precision products, a Cleveland-based supplier of specialized castings. That got aviation week chief business editor Michael Bruno out of bed early for 6.30 a.m. chat with Larry Kulp, GE's chairman and CEO. Michael joins us today with the details. And speaking of 6.30 a.m., that's the time it is in Colorado, where we're joined by senior propulsor editor Guy Norris. Guy recently visited GE's aircraft engine operations near Cincinnati. And rounding out the conversation is Kevin Michaels, managing director at aerodynamic advisory and a top authority on the aerospace supply chain. Michael, let's start out with you. What is this deal and why? Yeah, so it is a big, big deal. And the news came out early yesterday, September 8th, before stock markets opened regular trading in the United States. GE Aerospace announced that it was going to buy CPP as it's commonly known for $11.75 billion, including $7 billion cash upfront in the rest through debt issuance. And it's a big number. In March, a major multiple for buying CPP, it's about 26 times 2027 pre-tax earnings. But Mr. Kulp and the rest of his team are very confident that their flight deck business operations system and other so-called synergies or cost cuts or risk reductions that they can carry out over the coming years will actually help make the deal worth more like 18 times. So still a high multiple for a company that makes really, really necessary products for both GE, but also for other companies across aerospace and defense. I asked Mr. Kulp, as you mentioned, he gave me about 10 minutes on the pre-dawn hours and I asked him, oh, what motivated doing this deal. And he said, you know, one, first of all, it's going to bring more supply stability to both GE, but probably to the rest of the industry. GE will be able to help invest and grow what CPP does. But also he's looking forward to new airfoil technology that he says the companies can develop together. Airfoils that are going to perform better at higher temperatures, you know, and that's exactly the kind of thing that airlines operators want. So other probably considerations in there that he didn't quite outline media immediately up front. He did kind of go out of his way to make sure that it was stated that he does not see any antitrust issues. This is a kind of a complicated deal as you might imagine with CPP being a provider across industry, and it's going to take antitrust review in the US, who knows where else. And there's some other customary conditions for closing, but Mr. Kulp thinks that all of those can be achieved and GE already has a reputation of being able to provide to other companies across the realm in aerospace and defense. So probably no barriers there. Finally, this, of course, plays right into a major debate about vertical integration that seems to be happening again to some degree in various corners of aerospace and defense. If GE aerospace is going to be acquiring one of its major providers, our other company is going to be providing their own. And I will just wrap up by saying no less than Elon Musk said the other day that he's looking at ramping up his own castings capabilities down in Texas, including for his own rockets. So, you know, there's a lot of interest going on in castings right now. And it's for some good reasons that probably our friend Kevin Michaels can explain a lot better than I can. Kevin, that's a good set up for you. Maybe you can educate our audience on why castings are so important to GE and what your thoughts are on why Larry Kulp made this move. Yeah, good morning. GE could really do that, but I'll take a shot at it and GE can tell me where I'm wrong. But castings are used all over the engine. You know, it's funny. The investment casting process, there's different types of castings, but investment castings is what the most precise form. It's a 5,000 year old process. And castings are used all over the engine, but notably and importantly, the turbine blades and banes, which is where the big money and engines are. Almost all those are investment cast parts. Why are they investment cast? Because at the most extreme, high pressure blade is a technological marvel. It must operate a temperature 700 degrees above the melding point of its materials. It stays alive because it takes cooling air from the high pressure compressor, 1200 degrees, and uses 1200 degree cooling air to keep the blade alive along with thermal barrier recordings. And so to get these internal passages and the precision required, we really need to turn the casting to do this. The inter barriers to this business are, at the most extreme, these are made out of single crystals and are directly solidified. You add to that all the complications of these intricate cooling channels, and it's really, really hard to do. The business overall may be to frame it up a little bit because we've looked at this in the past and my company aerodynamic advisory. You're talking about probably a $9 to $10 billion a year of castings consumed in aero engines and in industrial gas turbines, globally. And how met in precision cast parts are the duopoly. They've controlled 75, maybe 80% of this business. So for the longest time, Pratt and GE and other engine, aero engine and IGTO EMs have been trying to find ways to break this duopoly, you know, to reduce their dependence on how met in precision cast parts who control so much of the market. CPP is the number three in this big equation. CPP might be, you know, seven or eight percent of the market. And then there are others, small, much smaller companies, doncasters, Rolls-Royce does has internal capability, Williams International has internal capability, but strangely GE and CFM does not so much despite the fact that they are by far the biggest customer. Gynorous, you were just at GE and you were asking them actually about castings and they called you yesterday and said, "Did you know something in advance?" Yeah, thanks, Joe. I know you'll take the fifth on that one, but go ahead and tell us about your business. Right. Yeah, well, yeah, it's actually was GE's Lynn facility where I was, which is really the in Massachusetts, which is the center for the military engine products, of course, although I did go to Cincinnati to even Dale earlier this year as well. So I have been to both the key sites. And like every other OEM, as really as, you know, has been mentioned, this has been a massive choke point in the business and whether it's across the commercial or military sites. For example, the castings and forgings, which is sort of like the other side of this equation, have been blamed really by all of the manufacturers for these delays in, for example, the GE and X engine for the seven, seven production line in Charleston. At the root of it, GE has not really been very specific about why the engines have been slow to the production line at Boeing, but this is one of the choke points that we've known and known of. And it was specifically called out, it Lynn, when we were there last week, just to visit the military side of it. And I think the problem is that it's like all of these supply chain aspects. The thing about castings is that it's right at the very beginning, like forgings are, you know, it's the first thing that begins the life of either an engine or in the case of a forging, say a main landing gear leg on an aircraft. You know, it's like the bones of all of these structures start with castings and forgings. So if you've got a handle on those, if you can control your own destiny in some way, then it's a massive part of the answer. And just to quickly sort of round up what they were saying, GE's got this huge plan to more than double production of military engines coming up. In the end, by 2032, for example, they want to almost more than double F110 fighter engines and the same way, they're 404 and some 414. So this is a huge part of that kind of that challenge. And I, you know, I just want to follow up by saying people may wonder why there is such a choke point. And Kevin, again, who's written extensively about this may want to chime in after me. But the long and short of it is these factories that do castings over the next few days. forging are very capital intensive. It takes a lot of money to stand up. But probably just as importantly, they take a lot of skilled workers. And these are not people that you, you know, we're doing making cappuccinos at Starbucks one day and then you bring them in and they're making castings or forging the next day. It can take years, not just months, but years to actually build the skills necessary so that that worker who's new is just being productive. And during the pandemic and during the great resignation, we saw a wave of skilled workers leave that part of the industry like we saw everywhere else, everywhere else in the economy, frankly. And the replacement has been slower and harder as you might imagine. Because again, you don't just find these people anywhere. So the combination of requiring a whole lot of money, a whole lot of skilled workers, you know, the industry has narrowed itself down to a couple of key providers as Kevin mentioned, how met aerospace precision cast parts, which is a little bit of a mystery because it's owned by Berkshire Hathaway and they don't really talk in public anymore and they haven't talked in public for a long time. But this isn't something that companies just go out and build themselves. Unless you're Elon Musk, who said the other day that he wants to hire castings people and create his own capability down in Texas, but nobody expects that is going to be a productive venture for another four years or so. He really won't be probably making his own blades for data centers or whatever or for Raptor engines for probably the 2030s because it will take even him that long to stand up in effective operations. Kevin, I think Guy and Michael sort of hit it on the head when they talked about demand. I mean, the backdrop for this is that the engine makers can't produce enough engines to make demand, right? And GE's just making sure it has enough supply to ramp up. Yeah. So if you look at the demand, I'll look, it's so it's obviously commercial production booming as Guy pointed out. Military engines booming, also what Guy mentioned. Commercial aftermarket, you know, a lot of the demand, maybe most of the demand of HENT is from the aftermarket here. And we all know what's going on in engines right now. Then later on top of that, the AI built out in industrial gas truerons, right? On top of that with dramatic growth plans there. And it all comes back to this funnel, you know, to this, to this very, very narrow base of industrial gas truerons, suppliers. And for those who aren't familiar, you know, Michael alluded to the skilled labor. When you make the most complex castings, say, high pressure turbine blades, you have to make a wax version of each part of each part, a wax duplicate that is then used to dumped in a slurry, a ceramic slurry and creates the female mold. And during COVID, there were significant layoffs of both HOMEN and PCC, 40, 50% of the people, these very skilled people. And it's been, so I think the story really goes back to the COVID shutdown. And what happened there, and then the bullwhip effect where we come back and ramp up. And now we're layering on top of that all these new demands. And I agree with Michael, I wish Elon Musk well in developing turbine blades and veins, but this is harder than most of the stuff he's done, believe it or not. And I, you know, I like this anecdoter, this humor that Paul Adams, the former president, went to share with me, puts it in the context, says, you know, how many countries can build nuclear bombs, at least seven, right? At least seven probably a lot more. How many countries can make high pressure turbine single crystal blades from castings to the US and the United Kingdom? I mean, world class. That's how hard it is. It is, and by the way, it's at the center of what China is trying to do in developing its own engine business as well as to master this. And it's all about yield. You know, when you develop a new blade design, you are lucky to get yields of 40 percent, 50 percent in the early time of production. So it becomes very uneconomic. Imagine throwing one out for everyone you keep. And in the learning curve for each new design, it takes a long time to get to those higher yields. This is the element of black art production. Like if you're looking at black art and Wikipedia, if it doesn't have investment castings, then there it should. Kevin's absolutely right. I mean, for example, the Chinese, you know, plans to develop their own version of the CFM leap, for example, the CJ1000. That's taking a huge amount of time. Of course, they're doing this very, very carefully because they have to try and basically sell at the C9-1-9 with the same level of safety and efficiency as they can as with the A320 Neo or the MAX, M370 MAX. But the heart of the issue, as Kevin says, is getting this sort of black magic, right, with the heart of the engine, which is the hot section, high pressure turbine. And without that capability, then, you know, that's the long pole in every development tent, frankly. Kevin, this week, obviously, everyone's talking, is the anniversary of the 9/11 attacks, 25th anniversary. Got me to thinking, if you go back 25 years, the darling Wall Street was Jack Welch, the chairman of General Electric, which was then a conglomerate, bowing actually towards self-apart 25 years ago to try to emulate the old General Electric. Larry Kolp is almost the opposite of Jack Welch. His approach is really, he obviously broke up the conglomerate, focused pure play aerospace, GE aerospace. This just seems to be another step in that direction that Kolp is taking the company into a pure play aerospace. Yeah, I mean, Larry Kolp is a big believer in organic growth, which is the harder road. He believes in sticking to your knitting and being the best at what you're at. And he would rather invest money and being better at what he does today than going into a adjacent market, that may not be terribly related. So he's been very, very disciplined this way. But you know, I think there's another part of this. It's not just the supply chain bottlenecks. To me, it's a Venn diagram. High pressure turbine blades are at the center of what it's going to take to develop the next generation of engines. You know, we're getting to the end, the Brayton cycle is getting tougher and tougher as we learned on the leap. We turned up the turbine inlet temperature by 400 degrees Fahrenheit, right? Those particles, those particles in the air in dirty environments that easily got through the high pressure turbine blades on a CFM, guess what? They melded in a leap. So you had to redesign the turbine blade, which meant that GE had to go back to its suppliers cap and hand, really, and say, "Hey, we need to do another version of this. Can you work with me on this?" And it slows it down. And so given where things are headed, this is going to allow GE to speed things up a bit, you know, on next generation engines. And this is not an ill-guided vertical integration move. This isn't like Boeing saying they want to get into auxiliary power units, right? This is something that with flight deck, GE can make better and more productive. And by the way, engine OEMs design the turbine blades. They just don't make them. They design them. And GE is using super computers to model the airflow within the turbine blades. And again, it is an art to keep these blades alive. And especially the temperatures that leap in future engines will be operating at. So it's a strategic capability. And Rolls-Royce has done this very quietly. He's had a lot of internal capability. Rolls-Royce makes the majority of its turbine blades and veins today. So it demonstrates that an engine OEM can have this vertical capability. And that screw things up. So given are there any implications for GE's competitors? You mentioned Rolls-Royce and obviously Pratt and Whitney. Where are the implications for their competitors? Well, here's where it gets interesting is now that in time, as the contracts expire between GE and HOMAT and PCC. And by the way, I look this up yesterday. This is astounding. HOMAT's market capitalization is $92 billion. $92 billion for the number two player in investment casting. PCC is buried in Berkshire Hathaway. So it's astounding. But what it means is when that business starts migrating from PCC and HOMAT to internal GE, how are they going to respond? They're probably going to raise their prices. And so who's buying from them? So it's going to hit companies like Pratt. It's going to hit companies like Honeywell. Those that don't have vertical capability, presumably, it's probably going to impact them the most. It will impact Rolls-Royce last because of its internal capabilities today. So that's going to be something To watch and you know, I know guy and Michael have thoughts on this But what we could see is the beginnings of a land grab, you know in the engine supply chain It doesn't mean everything, but it certainly points to things like forging's or maybe certain supergaoys That are unique to gas turbine engines and are critical, you know to the supply chain Right, I mean who who knows whose next is it can be downcasters Kevin who you never know, right? Yeah, and doncasters is more structural castings than you know, then blades and veins and engine parts But you know, but yeah, but doncasters is out there and they're probably sort of the number four You know in this market after CPP. I do think one other point we're stating is Because CPP is number three and it's definitely in the second tier It's probably less likely to attract antitrust will there be divestitures or could be there could be some of that But what's interesting about it is it's not as if GE bought Homet or PCC and now instantly all their customers Stop buying from them because GE owns it. They've bought a number three for whom they are the biggest customer You know CPP is the you know GEC FM's the biggest customer is CPP So it's very savvy in that way that it's the number three and not the number one or number two In this which would could take years to work through all the antitrust let alone the ramifications of customers Turning away from them because GE owns them and Joe I just wanted to jump in after something that Kevin mentioned about he mentioned flight deck Which is being GE sort of operating model that sort of they've been using Really to completely transform the way they do business since you know basically Since they became the stand-alone enterprise and one of the things that's intrigued me about the the impact really of these Supply chain chain shortages is the fact they've used this model to figure out ways around it and to Basically help every other aspect of the business to compensate in some parts for for these sort of shortages and Roadblocks that they've encountered They've also brought in a lot of new processes. They're beginning to look at using additive manufacturing to replace a lot of Things that in the past word cast or sometimes forged you know They've got this sort of a new approach to materials and the the other thing is they're able to bring in a lot of automation and robotics to that's the next Wave of improvements. So a lot of what we've seen as a result almost of The hardships that they've been through since covid on the supply aspect is this innovation that's gonna Sweep through the business and the timing of it is actually pretty good in terms of how on earth are they going to accelerate To meet these demand cycle the demand cycle that we're seeing both on commercial and Military so it's kind of weird, isn't it? They you see what the fallout is has been of these problems, you know It's the ingenuity and innovation of the market really is responding well Well, you talk about innovation guy. I mean someday Airbus and Boeing are gonna launch new narrow bodies So does this set GE up this position GE better for when that day comes because those new narrow bodies are gonna need new engines Yeah, well, and as Kevin mentioned you know the the demand on so on the performance you know, we're looking at higher operating pressure ratios Higher sort of Higher thermodynamic capabilities probably although the lessons learned of the leap and GTA for sort of and to and the Trent family to to be frank have also forced the industry to rethink exactly how they're going to do that probably put a lot more emphasis on the Propulsive efficiency rather than another thermodynamic gain. However, all that said yes I think you're right. It's gonna put them on the front foot when it comes to being at least confident more confident And certainly the ramp up side of things because as we all know whatever comes next is gonna come racing into the business At sort of unparalleled production rates at least that's that's what we think anyway if you're gonna replace Something like a 320 neo or a max in terms of production rates It's gonna be like changing the wheel while you're in them on the freeway so You know, we know that whatever's gonna help in that regard is and this is one of them beefing up a key aspect of their supply chain Guys, we got to wrap this up Kevin. Is there anything we missed? I Think we've hit the main points. I mean, it's it's I don't think this means that the engine companies are gonna go and buy all their suppliers But but but there are certain critical elements that they'll look at and This may sound kind of like a strange analogy, but actually what happened this week isn't dissimilar from aircraft OEMs deciding the wings need to be vertically integrated Wings are critical to future designs that used to you know Boeing famously outsourced and so forth What happened last week bombard a bought Mitsubishi heavy industries Canada kind of lost in the headlines I'm sure Michael covered it. We're wing capability for the for some of their globals Wings are in house. You you need internal capability. They're gonna be composite and High pressure turbine blades are not too dissimilar. So in other words, yeah, we are gonna see more vertical integration But it's but it's really at the nexus of things that differentiate the product where the OEMs can create competitive advantage and Supply chain bottlenecks so I don't think it implies that Everyone's gonna buy everything. It's gonna be more of a scalpel more Precision I think but we'll see we'll see not gonna fix from this Undoubtedly Well a great way to bring us to the finish line Kevin Michaels. Thank you as always for taking the time to to join us Thank you to Michael and thank you to Guy that is a wrap for this edition of the check six podcast a special Thanks to our podcast editor in London Guy Ferny Ho It thanks to Guy Norse for the real-time correction of me. He was in Lynn Massachusetts Not Cincinnati and to our viewers. We thank you for your time and join us again for another check six