Impact on Defense Sector with the Reliance-Pipavav deal
Posted in Finance Articles, Total Reads: 1228
, Published on 25 June 2015
“Even the tears we shed in this country are not our own? Every tear gas shell used by our security agencies is actually imported!” were the words that our Prime Minister Narendra Modi had said to Mr. Anil Ambani when they met at a conference. These words clearly state the current situation of Indian defense Sector. Indian firms are reluctant to bid for some $15 billion worth of government tenders to make a range of weapons since 2013. The executives cited unrealistic quality demands from a military which was short of planes, tanks and guns as one of the key reasons for their reluctance to bid for projects. Further, the military also does not wish to acquire weapons from Indian firms that have no track record in defense manufacturing.
Thus, the country fulfills 80 percent of its defense needs through imports. A report by Stockholm International Peace Research states that between 2007 and 2011 India has imported equipment worth $12.7 billion. Moreover, in spite of the fact that most of the defense technologies are owned by the foreign companies, the foreign direct investment (FDI) in Indian defense sector was just 26 percent making the sector less lucrative for those companies to invest in. Further, this also hindered the large Indian players to partner with those companies.
However, with the increased in FDI cap to 49 percent in the defense sector and Modi government announcing about “Make in India” campaign, which is nothing but an initiative by the government to encourage and promote companies to produce their products in India, things look bright for Indian Defense sector and the followings can be cited as some of the reasons for the same.
1 Since, 70-80 percent of India’s current defense requirements are presently met by imports, with the change in the policy this sector has been opened for participation of private company providing them good opportunity to enter into strategic alliance with foreign entities having technical expertise thereby, leveraging the opportunities present in India.
2 Moreover, it has been estimated that in the next 7-8 years INR 250 billion will be invested in this sector.
3 The government has also gone a step ahead by allocating USD 37.3 billion for the defense sector in the Finance Budget 2015.
Anticipating the opportunities in this sector, many of the big entities are trying to make their presence in the sector. This was evident when promoters of the heavy debt ridden company Pipavav offered to sell controlling stake of the company. A number of companies, such as Mahindra & Mahindra, Hero Moto Corp. was bidding for the stake. However finally it was Reliance Infrastructure Ltd, a part of Reliance Group owned by billionaire Anil Ambani which managed to get the stake, thus making its debut in the defence sector which it was trying to enter for a few years now
As per the deal, Reliance Infra will initially be investing INR 819 crores for 17.66 percent stake in the company at INR 63 per share. Thereafter, it shall be initiating an open market offer for obtaining an extra 26 percent stake at a price of INR 66 per share (valuing INR 1,266 crore). However, in case the open offer is unsuccessful, the company would then proceed to acquire 7.44 percent stakes from the promoters again at an additional cost of INR 345 crores, so as to ensure that Reliance has at least 25 percent stake in Pipavav.
Having said that it becomes interesting to understand the reasons (enumerated below) why the promoters of Pipavav wanted to sell their stakes.
The firm has reported a massive debt of INR 7000 crore.
There has been Continuous pressure from the creditors asking the company to go for Corporate Debt Restructuring (CDR) while Nikhil Gandhi, the chairman of the company, was against this idea because he was of the view that CDR may affect the valuation of the company negatively.
Pipavav was unable to bring in new investors to infuse more cash into the company. The promoters were also not in a position to bring in more funds into the company.
Since, the cash conversion cycle in ship-building business is very long, any investment in it takes long time to get converted back into cash.
On the other hand Anil Ambani’s Reliance wanted to win this deal for the following reasons:
1 Reliance wanted to get into the defense sectors for quite a few years now and it was the good opportunity for them to do so.
2 This deal would have ensured Reliance entry into the defense sector, which is supposed to be one of the few sectors to be most benefitted by the “Make in India” campaign.
3 Unique prospect for Reliance to participate in Modi’s “Make in India” campaign for the high growth defense sector.
4 Pipavev is India’s one of the few company who has the license to build warship for the Indian Navy. Even in terms of infrastructure it has one of the world’s largest Greenfield infrastructure facilities, extended across 841 acres in Gujarat, with 210 acres of fully established water-front land and 250 acres developed for shipbuilding.
5 Pipavav is having an order book of INR 12,000 crore apart from having a tie-ups with global defense companies such as DCNS of France, SAAB of Sweden, Sembcorp Marine of Singapore and JSC Zvyozdochka and Roseboro. Moreover it is also in joint venture with Mazagon Dock Ltd, The largest defense shipyard, Ministry of defense, to build the warship for Indian Navy. Thus demand for its products does not seem to decrease in near future.
Impact of the deal on the Defense Sector:
1 Defense sector requires deep commitment from the companies for the simple reason that it is a very specialized business. Most of the successful global players have been in this business for more than 5 decades. Perhaps, this is one of the several reasons why the big players hesitate to invest in this sector even 9 months after the announcement of “Make in India” campaign.
But subsequent to this bold move of Reliance Infra there is a definite possibility that more companies will be encouraged to invest into this sector. For instance, Mahindra and Mahindra is in talks to acquire cash-strapped ABG Shipyard, India's largest private sector shipyard.
2 The entry of Reliance into the defence sector means that it would lock horns with the likes of Tata Group, L&T and M&M. Since the Indian defence and aerospace market is estimated to touch $100 billion over the next ten years, the defence ministry has identified certain areas where it wants the private players to get into. These areas includes the development of Naval Light Utility Helicopter, Utility Helicopter, submarine, and Naval Multi Role Helicopters. It is also anticipated that Reliance will try and form strategic alliance with companies like Sikorsky of the U.S, Euro copter of France and Kamov of Russia, so as to use the technology available with these companies. In fact, as per the industry sources, Reliance is already in touch with these and some more international organisation. If Reliance is able to get into alliance with them, it will not only benefit Reliance but the Indian Defence Sector as also. Further, Reliance will also leverage the five airfield that Pipavav is currently having for manufacturing, testing, and simulation and training facilities. Again, this will help the defence sector and economy as a whole to develop and prosper.
3 The country spends about 2.4 per of its GDP on the defense need and this total spending has been the ninth largest in the world. The biggest concern is that major chunk of this budget are spent on import of defense equipment. Though the continuous increase in the spending can be attributed to India’s attempt to secure its border from the neighboring countries. But this is also impacting the country due to the continuous leakage of dollars. The table below can be referred to see how India has been aggressively spending the money for its defense requirements.
Now the question is are these funds are properly utilized or are we getting the maximum returns from this investment? The answer is “NO”. Because most of these capital spending is done through inter-governmental purchase which is actually a bilateral agreement and are generally non-competitive. There has been number of issues with this kind of procurements which stops us from realizing the maximum return.
Allegations of kickbacks have been very frequent in the past few years, because of which the government either delays or cancel the contracts. In both cases the final delivery of the equipment gets delayed and by the time it reaches it becomes obsolete due to technological advancement. Therefore, with this kind of structure of deploying defense equipment one is not able to provide the right product at the right time to the armed forces, which is a serious concern as it is related to national security.
After this deal, the above issues can be addressed. More so because of the fact that Pipavav is one of largest shipbuilding company of India and is known for its expertise in making warship, naval ships and other naval equipment. The only thing missing here was the government support and the necessary capital to run this business. But after this deal Pipavav seems to acquire both.
Now we can expect the same set of equipment not only at the right time (In-House production) but also at lower price as there won’t be any leakage of money due to corruption. Though this deal would cover only small part of India’s effort to become self-reliant but the journey to a world class defense manufacturer has begun and one can expect a turnaround change in next 10 to 15 years.
However, with any kind of large involvement of private players in the defense sector would require a clear road map for engagement, with clearly identified thrust areas. Thus, it now becomes important to form a joint working group with representatives from the private sectors and key decision makers in the government, who will work collectively right from the planning stage so that private companies have a clear idea of the areas in which they need to invest. However, these changes carried out by the government look very promising, thus leading to the prediction of huge growth in this sector. Investors should now be looking at this sector as a source of revenue which is why they want to get into this sector through various partnerships. Also, giving tax incentives to companies engaged in manufacturing aerospace and defense components and sub-systems will be an icing on the cake.
The article has been written by Chandra Bhushan Upadhyay and Ankit Kumar Barnwal, TAPMI Manipal.