Citron Comments on TransDigm January 20, 2017 Page 1 of 10

January 20, 2017

Could TransDigm be the Valeant of the Aerospace Industry?

Wall Street: Be Careful! President Trump has become to Aerospace what Hillary was to Pharmaceuticals

Congratulations to the 45th President of the United States of America -- Donald Trump.

President Trump has promised to end the long-standing, infuriating tradition of “sticking the US Government with tab”. He has already made lowering prices for military aircraft a pillar of his transition into office.

President Trump has already met with the both Boeing and Lockheed Martin, who have promised to lower the prices for Air Force One and the F-35 fighter jet program. These lower prices will no doubt trickle down to subcontractors.

While Boeing and Lockheed Martin have been the "poster children" of this policy initiative, everyone in the aerospace industry knows that one company stands out when it comes to egregious price increases foisted on the government:

TRANSDIGM (NYSE:TDG)

TransDigm's business model is to aerospace as Valeant was to the pharmaceutical industry. TransDigm acquires airplane parts companies (over 50 in total), fires employees, and egregiously raises prices. This business model has made them a dominant supplier of airplane parts to the aerospace industry while burdening its

balance sheet with sky-high debt load: in fact, 6.5x EBITDA leverage.

TransDigm’s single largest customer is the Department of Defense, followed by Boeing and Airbus.

On December 12, then President-Elect Donald Trump told America:

Donald J. Trump @realDonaldTrump 12 Dec 2016 The F-35 program and cost is out of control. Billions of dollars can and will be saved on military (and other) purchases after January 20th.

Citron Comments on TransDigm January 20, 2017 Page 2 of 10

TransDigm, welcome to January 20th !

President Trump, Have a Look at This!

OEM Manufacturer Name

EV / Next 12 Months

EBITDA

EV / Last 12 Months

EBITDA

Gross Margin

Last 12 Months EBITDA Margin

Last 12 Months EBIT

Margin

General Dynamics 11.4x 10.4x 19.9% 15.2% 13.7%

Lockheed Martin 12.8x 12.1x 10.9% 14.1% 11.7%

Textron 9.0x 8.1x 17.6% 11.7% 8.4%

Airbus 7.3x 6.2x 10.3% 8.8% 5.1%

Boeing 9.6x 12.4x 13.6% 7.0% 5.1%

OEM Average 10.0x 9.8x 14.5% 11.4% 8.8%

OEM Median 9.6x 10.4x 13.6% 11.7% 8.4%

TransDigm 13.3x 14.7x 54.5% 47.1% 43.3%

NOTE: Boeing and Lockheed gross margins are 13.6 % and 10.91% respectively.

TransDigm boasts gross margins of 54.5% selling airplane parts to our government.

But you can argue that Boeing and Lockheed are OEM's, while TransDigm is a parts supplier. Fair point. So next we compare TransDigm to its peer group. This analysis shows how much of a gross outlier it has become with regard to the amount of money it is making off the U.S. government.

Citron Comments on TransDigm January 20, 2017 Page 3 of 10

Margin Analysis: TransDigm to Comparable Peers Name EV / Next 12

Months EBITDA EV / Last 12

Months EBITDA Last 12 Months EBITDA Margin

Last 12 Months EBIT Margin

Safran SA 9.3x 7.0x 18.4% 13.50%

Thales SA 9.2x 9.0x 11.5% 8.20%

L3 Technologies 10.2x 12.2x 7.9% 5.90%

Spirit Aerospace-A 6.9x 4.2x 14.1% 11.30%

Zodiac Aerospace 14.2x 17.0x 6.6% 3.90%

HEICO Corp 15.5x 15.7x 23.7% 19.30%

Meggitt PLC 10.0x 10.7x 11.9% 8.80%

Esterline Tech 10.2x 9.2x 13.6% 8.50%

Ultra Electronics 11.0x 10.5x 18.4% 12.10%

Triumph Group 6.1x 5.4x 10.9% 7.30%

AAR Corp 7.7x 12.0x 4.2% 4.60%

Senior plc 8.1x 8.1x 7.3% 7.20%

Average 9.9x 10.1x 12.40% 9.20%

Median 9.6x 9.9x 11.70% 8.40%

TransDigm 13.8x 15.3x 47.10% 40.00%

So how does TransDigm rack up such outsized margins??

Citron has sifted through the Haystack Gold database, the leading defense parts and logistics management system, reviewing historical prices of over 50,000 aircraft parts. The price differentials from pre-acquisition and post-acquisition, when TransDigm acquired their prior manufacturers, are there for all to see.

Company Part Pre-Acquisition

Price

Post-Acquisition

Price

% Price Raise

Aerosonic Vibration Panel 67.33 271.00 302.50%

Arkwin Pawl 972.00 1,950.00 100.62%

Harco Cable Assembly 1,837.03 7,863.60 328.06%

Skurka Connector 310.00 1,109.85 258.02%

Whippany Motor Rotor 654.46 5,474.00 736.41%

Citron acknowledges The Capitol Forum for assembling just a small snapshot of the impacts of this game. The TransDigm business rests on the dangerous acquire/leverage/price-raise maneuver that has become too eerily familiar on Wall Street. After watching Valeant's stock go from 250 to 15, Wall Street learned a lesson about operating leverage.

Citron Comments on TransDigm January 20, 2017 Page 4 of 10

So Where is TransDigm’s Stock With a bit of Scrutiny?

Citron starts with Wall Street's consensus model for TransDigm. Using the analysts numbers who base their models on raising prices, Citron gets to a valuation of $166 a share if they are merely pre-empted from further price raises … this has nothing to do with rolling back any prior ones.

The ugly underbelly of TransDigm's business is that aggressive year-over-year price increases are the only thing shielding TransDigm from revealing negative organic growth of close to -10%. Any combination of U.S. Government pressure and/or OEM's pressing on their own supply chains will expose their business to actual gross revenue contraction and a devastating cut in EPS, followed by multiple contraction.

This Model Changes Nothing Except Zero Price Increases!

From Company Investor With No Price Increases

Presentation Nov 2016

Low High Low High

1. Net Revenue 3515 3565 3,164 3,209 FY17 guidance

2. Adjusted EBITDA 1671 1695 1,320 1,339 FY17 guidance

% margin 48% 48% 42% 42%

3. Cash Cost Base (1-2) 1,844 1,870 1,844 1,870

4. D&A 121.5 122.6 (1) 121.5 122.6 FY17 guidance

5. Net Financial Result 580 580 580 580 FY17 guidance

6. Adjusted Pre-tax Profit (2-4-5) 970 992 618 636 FY16 adj, for 20mm non-op exp.

7. Adjusted Taxes 301 308 192 197 Implied from FY17 guidance

% effective tax rate 31% 31% (2) 0 0

8. After tax adjustments 0 0

9. Adjusted Net Income (6-7+8) 668.96 684.78 426 439 Implied from FY17 guidance

10. Share count 56.5 56.5 56.5 56.5 FY17 guidance

11. EPS (8/ 9) 11.84 12.12 7.55 7.77 FY17 guidance

12. P/E 21 21 33 32

(1) Implied from tax rate Nominal P/E 22 22

(2) Pg 6 of Nov 2016 presentation Target Price 166.04 170.86

Downside -34% -32%

Consider this: If TransDigm were to operate with the same EBIDTA margins as HEICO, their next closest competitor on EBITDA margin, which is still double that of the rest of their peer group, its EPS falls 85% and the

stock is $40 a share. We do not even project the margin compression

that would be inflicted on TransDigm if, and when, they experience this type of pricing pressure. That would tank the share price to even lower levels.

Citron Comments on TransDigm January 20, 2017 Page 5 of 10

Citron adds that our commentary of "firing employees and raising prices" is not just Citron's narrative, but is also the subject of lawsuits of companies TransDigm has acquired. Organic growth goes down, profits go up. TransDigm was sued in 2011 by the seller of Dukes Aerospace for raising prices, cutting head-count aggressively, and causing Dukes to get pushed out of programs that required future R&D.

http://www.cleveland.com/business/index.ssf/2012/03/TransDigm_faces_lawsuit_arisin.html

How the Government Can Easily Crack Down on TransDigm

The obvious response to this Citron criticism would be that the government can't do anything about TransDigm's pricing policies. If that were the case then why would Boeing and Lockheed BOTH agree to lower pricing in the context of just a single presidential meeting?

The truth is that the government has already been down this road -- scrutinizing the price gouging perpetrated by TransDigm. It now simply has to enforce what it already knows is wrong. Just to show that the mechanism for a Government crackdown is already in place, here are excerpts from a Dept. of Defense Office of Inspector General audit in 2006:

"In his lawsuit, Huffman said that unbeknownst to him, TransDigm pursues a financial strategy of slashing costs and increasing prices at acquisitions in order to increase profits on each sale and boost the stock price of the Cleveland aerospace company.

"Because TransDigm is focused on margin and earnings growth, not revenue growth, it was a fraudulent inducement to plaintiffs to enter into an earn-out agreement with revenue growth as the measure," the lawsuit contends. "

Note: In the past 18 months, nothing has fundamentally changed for Valeant as a company, beyond a torrent of negative news coverage. Their pharmaceuticals are still sold worldwide. Bausch and Lomb is still the premiere name in eye care. What has really changed is the stock price. Wall Street is now forced to deal with the company’s inability to raise prices while being burdened with extreme debt levels.

Citron Comments on TransDigm January 20, 2017 Page 6 of 10

http://www.dodig.mil/audit/reports/FY06/06-055.pdf

For example, on contract SPO740-04-C-4647, the DSCC contracting officer purchased 578 oil pump assembly housings (NSN 2990-01-259-0589) used on the F-15 fighter aircraft at a unit price of $3,663.36 in December 2003. The unit price for the item, in March 2002, was $2,132.82; thus, the unit price increased 71.8 percent in 21 months. ... The Director also commented that supply chains have been asked to report on the suitability of reverse engineering TransDigm items.

Citron Comments on TransDigm January 20, 2017 Page 7 of 10

TransDigm's Audit-Defeat Department at Work Here are some of the ways TransDigm thwarted this excessive cost audit.

You have to ask yourself if these kinds of stonewalling tactics would work in the Twitter era, against the force of a fierce cost-cutter and bullshit-cutter-through-er.

From the same audit report, we read:

http://www.dodig.mil/audit/reports/FY06/06-055.pdf

• TransDigm does not provide informal cost breakdowns or cost data for small purchases (2 instances).

• TransDigm is unable to provide a cost breakdown for orders under $100,000 (2 instances).

• TransDigm no longer offers cost breakdowns.

• TransDigm does not provide cost data for purchases under $550,000.

• TransDigm considers this item proprietary and commercial and will not provide any cost breakdown.

• TransDigm accepts the Government counteroffer instead of providing a cost breakdown.

• Due to the total dollar value of the request for quote, an informal cost breakdown cannot be prepared at this time. The prices quoted are based 16 on TransDigm’s current material costs, labor, overhead, and general and administrative rates, which have been audited by the U.S. Government.

• TransDigm is unable to provide informal cost breakdowns due to limited accounting resources.

• TransDigm’s quote is based on increases in material and labor costs. Material has escalated 12 percent while labor and overhead has increased close to 12 percent.

• TransDigm did not respond to the request (6 instances).

• TransDigm stated it is not the company’s policy to give cost data (2 instances).

• TransDigm offered a lower unit price only if that price is found fair and reasonable by the contracting officer.

Citron Comments on TransDigm January 20, 2017 Page 8 of 10

Citron asks if TransDigm investors riding the gravy train of highly leveraged profits based on a “price jacking” strategy even know the U.S. Office of Inspector General runs a "Department of Defense Hotline" for pricing complaints? We think this entire report plus the spreadsheet attachments should make a good submission….we did it with Valeant.

http://www.dodig.mil/hotline/

The TransDigm/Philidor Moment

The easiest way for the government to encourage competitive bidding would be to audit the bidding process. They will find how TransDigm has been able to use the guise of multiple shell distributors, who have no pricing power, to make a bid seem competitive

when in reality they are all shills for TransDigm -- this will be addressed in future reports. TransDigm has perfected the sole source model that understands

government thresholds that avoid scrutiny- FOR NOW.

Citron Comments on TransDigm January 20, 2017 Page 9 of 10

Every TransDigm investor should read the company's own disclosures from its 10-K. They are a chilling forecast of their inherent business vulnerability under an administration seeking to save money by creating better deals for the U.S. Government.

Note from these disclosures, that the U.S. Government already has enormous power and leverage in its relationship with TransDigm:

https://www.sec.gov/Archives/edgar/data/1260221/000126022116000107/tdg2016-09x3010xk.htm

We are subject to certain unique business risks as a result of supplying equipment

and services to the U.S. Government.

Companies engaged in supplying defense-related equipment and services to U.S.

Government agencies are subject to business risks specific to the defense industry.

These risks include the ability of the U.S. Government to unilaterally:

• suspend us from receiving new contracts based on alleged violations of

procurement laws or regulations;

•terminate existing contracts;

•reduce the value of existing contracts; and

•audit our contract-related costs and fees, including allocated indirect costs.

On contracts for which the price is based on cost, the U.S. Government may review our costs and performance, as well as our accounting and general business practices. Based on the results of such audits, the U.S. Government may adjust our contract-related costs and fees, including allocated indirect costs. In addition, under U.S. Government purchasing regulations, some of our costs, including most financing costs, amortization of intangible assets, portions of research and development costs, and certain marketing expenses may not be subject to reimbursement.

Most of our U.S. Government contracts can be terminated by the U.S. Government for its convenience without significant notice. Termination for convenience provisions provide only for our recovery of costs incurred or committed, settlement expenses and profit on the work completed prior to termination.

Furthermore, even where the price is not based on cost, the U.S. Government may seek to review our costs to determine whether our pricing is “fair and reasonable.” Our subsidiaries are periodically subject to a pricing review. Such a review could be costly and time consuming for our management and could distract from our ability to effectively manage the business. As a result of such a review, we could be subject to providing a refund to the U.S. Government or we could be asked to enter into an arrangement whereby our prices would be based on cost or the DOD could seek to pursue alternative sources of supply for our parts. Any of those occurrences could lead to a reduction in our revenue from, or the profitability of certain of our supply arrangements with, certain agencies and buying organizations of the U.S. Government.

Moreover, U.S. Government purchasing regulations contain a number of additional operation requirements, which do not apply to entities not engaged in government

contracting. Failure to comply with such government contracting requirements could result in civil and criminal penalties that could have a material adverse effect on the Company’s results of operations.

Citron Comments on TransDigm January 20, 2017 Page 10 of 10

There are other important macro headwinds facing TransDigm that are evident today These are some but not all of the issues:

TransDigm’s profitability will be severely impacted by high-profile supply initiatives by Boeing (Partnering for Success) and Airbus (SCOPe+).

The emergence of PMA (Parts Manufacturing Authorization) - allows for the approval and manufacturing of “generic” parts, which can be 40%-80% cheaper than the OEM after-market parts.

TransDigm will have difficulty finding larger acquisitions that they need to materially impact revenue growth (A key Valeant dilemma)

Their product mix is overly dependent of older airplane platforms that are at risk of being retired

Conclusion

President Trump: Do you know when your 757 plane “Air Trump” is down for a day and you wondered why a replacement air filter, valve, pump or coffee maker cost $20,000? The reason was TransDigm. While you are looking to Boeing and Lockheed, the easiest way to drain the swamp in the aerospace industry can be relegated to shine some sunlight on: TransDigm.

Cautious Investing To All