Private firms vie for larger chunk of defence deals

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The Mahindra Group has scaled up its ambitions for its defence business, hoping to be able to take on bigger rivals such as Tata group and Larsen and Toubro Ltd ( L&T ) when large defence contracts are finally bid out to local companies that are outside government control.Private Indian defence firms, many of which pale in terms of technical capability when compared with foreign rivals, currently only deliver non-critical vehicles such as trucks to the military and supply parts and equipment to state-run establishments that cater to the more advanced requirements.


But Mahindra and other private domestic defence companies are hoping to be called to bid for larger and critical projects after the government expanded the scope of its defence procurement policy in June last year.

“Our goal is to have critical mass and scale which will allow us to have a diverse portfolio of different technological skills which together will allow us to take up large projects,” S.P. Shukla, president, group strategy and defence sector, Mahindra group, said in an interview.

“Typically, that means a critical mass of Rs.500-1,000 crore in revenue, as by the time you reach that level you have diverse and complex technologies with you to undertake large projects,” Shukla said.

Shukla didn’t disclose the revenue of the unit.

Mahindra Defense Systems began as a division of Mahindra and Mahindra Ltd (M&M) in 2000 and was later carved out as a separate company in July 2012. Larger rivals Tata Sons’ wholly-owned subsidiary—Tata Advanced Systems—was set up in 2007 as a vehicle to extend the Tata group’s business operations to the national security and defence sector, while L&T, which is currently the largest private firm in defence, has been active in the defence business for decades.

Mahindra Defense Systems has three main divisions—Defense Land Systems India, a joint venture between M&M and BAE Systems Plc; Mahindra Telephonics, a joint venture with US-based Telephonics Corp.; and Mahindra Defence Naval Systems.The company also has a risk and security consulting division called Mahindra Special Services Group (MSSG).

Shukla expects much of the defence company’s revenue in the near term to come from so-called offset projects, and refurbishment and operating programmes.Offsets are obligations mandated on foreign vendors selling their products to India. As part of Defence Procurement Policy (DPP) 2005, counter-trade obligations were imposed on foreign firms that are awarded defence contracts worth more than Rs.300 crore by way of transfer of critical technologies and production of components in India.

According to the defence ministry, as of 31 March 2013, 23 offset contracts worth $4.6 billion were at various stages of execution. The first of these was signed in 2007.
“The offset opportunities are expected to be around $15 billion within next 10-15 years, assuming that the proposed acquisitions, which are under different stages, are completed on time,” said Amber Dubey, partner and head-aviation and defence, at consultancy KPMG India.
Shukla said offset contracts would bring in revenue for Mahindra’s defence business till it starts winning large projects. In the process, he said, the company will build capabilities and eventually prepare the group to participate in more complex projects under the Defence Procurement Procedure (DPP) 2013, which urged private firms to bid for defence procurement projects.

There are about two dozen private firms in India fighting for different segments of the offset business, including the likes of Godrej Group, L&T, Pipavav Defence and Offshore Engineering Co. Ltd, Tata group, Wipro Ltd and Infosys Ltd.

According to a March 2013 report by Roland Berger Strategy Consultants, India had the world’s 10th largest annual defence budget in 2011-2012. But the country had the third highest growth rate in defence expenditure after Russia and China, at a compounded annual growth rate of 9.3% from 1998-2011, it said.

Finance minister P. Chidambaram, while announcing the interim budget for 2014-2015 on 17 February, proposed enhancing the allocation for defence from about Rs.2.04 trillion for 2013-14 to Rs.2.24 trillion for 2014-15.

“The defence market in India offers a $180 billion opportunity during the period 2013-2020,” said Dubey of KPMG.One large project that private defence firms anticipate could come up for bidding is the futuristic infantry combat vehicle (FICV) programme, although there is no clarity on when that’s likely to happen.

“The FICV project can be estimated to be in the range of Rs.60,000-75,000 crore, depending on the number of vehicles and average unit price. When one project alone can be so large, you can visualize the size of this sector,” said Shukla. “And, like this, there are several projects that will come up as per DPP 2013.”

Forecasting revenue from such projects, however, is difficult, he said. “The gestation period can be spread over several years, starting from the expression of interest to prototype evaluation to final order and commercial production,” he said.

A top executive with a rival firm, requesting anonymity, said there would be more than 6-7 bidders for FICV when it is announced, and not just the Tata’s, Mahindra’s and L&T’s.
According to media reports, Tata group firms generated Rs.1,700 crore revenue from the defence sector in fiscal 2013. In a January 30 story by Business Standard, Tata Sons’ group executive council member Mukund Rajan said Tata group’s revenue from the sector is expected to rise to Rs.2,400 crore in fiscal 2014.

M.V. Kotwal, a whole-time director and president (heavy engineering), L&T, told The Economic Times in November 2013 that the firm expects total revenue to the order of $3 billion from shipping and defence by 2020.Another expert, requesting anonymity, said it was obvious that firms with a presence in metallurgy and vehicles will have an edge in bidding for such projects.

Shukla said Mahindra group plans to leverage its core engineering skills to cater to needs of all three service arms—army, air force and navy.Mahindra Defence Naval Systems last week opened an underwater systems and naval applications manufacturing facility in Chakan near Pune, where the company will develop its own technology.

“With the new facility, the group completed its troika of all three segments (naval, land and air) under our defence vertical,” said Shukla, while not sharing the investment that will go into the facility. He explained that on average half the country’s defence budget is spent on capital expenditure, and the other half on operations.

Private firms vie for larger chunk of defence deals | idrw.org