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Hindustan Aeronautics Ltd (HAL), which enjoys absolute monopoly in India’s military aviation, is the butt of many jokes. American defence historian and strategist Edward Luttwak refers to it as a “fossil of a company” famous for not delivering “operationally ready Tejas Light Combat Aircraft after 30 years of trying”. Notes Neelu Khatri, head of defence and security advisory services at KPMG India: “HAL is overbooked (with orders). And it is a fait accompli that giants will emerge.”
Khatri is referring to the “emergence” of big private sector players in Indian aerospace. One of them is Reliance Industries Ltd (RIL). “They will focus more on technology partnerships and on building up infrastructure [to start manufacturing products],” she forecasts. Dhiraj Mathur of Pricewaterhousecoopers(PwC) has no doubts either. “As a company that has a track record of working on large-scale projects, it (RIL) definitely has an advantage like other players such as the Tatas and Mahindra. Having deep pockets helps,” he says.
To Replicate Success
RIL, one of the latest major private-sector entrants into aerospace, had cash reserves of Rs 82,975 crore as on March 31, 2013. The Mukesh Ambani-controlled conglomerate recently signed a memorandum of understanding (MoU) with Boeing to grab the offset work when the aerospace giant begins work on supplying P8I naval reconnaissance aircraft to the Indian Navy.
India’s biggest private sector company by revenue is looking to spend $1 billion (almost Rs 5,500 crore) in the sector and hire some 2,000 engineers over the next few years in its aerospace division; it has now agreed to partner with the world’s second-largest aerospace company in the latter’s offset programme — which requires for-eign aerospace sellers to source 30% of its inputs from domestic partners.
RILBSE 0.15 % entered the fast-growing segment two years ago after hiring then Boeing India chief and Nasa scientist Vivek Lall as its head. According to the MoU signed between Boeing and RIL — documents of which are available with the Indian Navy and reviewed by ET Magazine — the two companies may go for “a more definitive agreement” in future. “Like in refining and [oil] exploration, RIL is really in for the kill in aerospace,” says a Mumbai-based defence consultant who has tracked the company for years. “Maybe they are looking to do here [in aerospace] what they did some time ago in oil and gas,” says this consultant who didn’t wish to be named because he isn’t authorised to speak to the media. Neither RIL nor Boeing responded to queries from ET Magazine.
The Long-Haul Game
Built from scratch by Dhirubhai Ambani, RIL went public in 1977 and over the next couple of decades pursued backward vertical integration — from textiles to polyester, fibre intermediates, plastics and petrochemicals. Towards the end of the 90s, the Ambanis had further integrated into refining by commissioning the world’s largest grassroots refinery at Jamnagar in Gujarat.
Soon, it went another step backward — into oil & gas exploration — when it secured a bid for 12 exploration blocks auctioned by the government of India. In 2002, RIL located the largest Indian natural gas field in the Krishna-Godavari basin.
Following the split in the group between brothers Mukesh and Anil in the mid-2000s, the former inherited the oil & gas and refinery business. In fiscal year 2013, RIL — now an oil & gas major with joint ventures with the likes of Chevron and Pioneer Natural Resources for shale gas in the US and a petrochemicals giant coupled with a relatively fledgling organised retailing business and a subsidiary that will soon provide broadband wireless access — had racked up a net profit of Rs 21,000 crore on a top line of Rs 371,000 crore.
RIL posted a 32% jump in its fourth-quarter net profit, the biggest increase in almost three years, as strong margins in its oil refining business helped offset fall in natural gas production. RIL now operates the world’s biggest refining complex in Jamnagar.
“These [oil & gas and refining] are highly capital intensive segments. It is a turf for those who are ready for the long-haul game. I think RIL has demonstrated that ability,” says a senior defence ministry official who didn’t wish to be named.
New Business Frontier?
Another defence official isn’t as excited though. “This [aerospace] isn’t a territory where RIL has any experience. The only plus it has for the time being is that it has at the helm an aerospace expert,” he says. In the four years that Lall, now 44, spearheaded Boeing’s defence business, it won orders worth $8 billion in India, including those for C-17 heavy-lift aircraft for the Indian Air Force (IAF), P-8I aircraft for the Indian Navy and Harpoon missiles for both the IAF and navy.
This official is worried that Indian defence players who acquire technology and develop defence capabilities may find it tough to face shortages and uncertainty of orders. For instance, companies such as Larsen & Toubro, which had hired hundreds of engineers to develop a hull for a nuclear submarine for the India Navy, will soon stare at trouble if orders fall through, he says.
Khatri offers a different viewpoint: being a company with huge financial prowess and networking power is RIL’s real plus in a sector in which it takes years of endurance to make a profit.
Will It Pay Off?
Of course, RIL is not putting all its eggs in one basket: it has already entered into an alliance with French defence giant Dassault to supply components for Rafale fighter aircraft and Falcon business jets. Dassault secured the highly lucrative $15-billion MMRCA (medium multi role combat aircraft) deal to supply IAF with 126 Rafael aircraft two years ago. The fiercely fought bid saw Dassault outbid the likes of Boeing, Eurofighter, Saab and Lockheed Martin. The second defence official quoted earlier said the government of India is ready to spend as much as Rs 15,000 crore initially for a “technology transfer pact” with Dassault.
“The government is taking a keen interest. The finance ministry is ready to give the money if the ministry of defence asks for it,” he said without elaborating.
A person close to the matter said RIL is in “advanced talks” with Airbus Military for collaboration in the run-up to the bid to secure the Rs 13,000-crore IAF deal to replace its 56 ageing fleet of Hawker Siddeley 748M Avro aircraft. The request for proposal (RFP) from IAF requires contenders to deliver 16 aircraft from abroad and build 40 of them in partnership with an Indian company. Madrid-based Airbus Military, owned by EADS, declined to comment to queries.
Meanwhile, a Jerusalem-based senior executive of a defence company is of the view that the “RFP issuance by IAF” to eight foreign aerospace vendors is a big departure in the history of Indian military aerospace. “HAL has been sidelined in the process,” she said, requesting anonymity.
Battling Monopoly
State-owned HAL has often attributed complaints from overseas partners — that HAL supplies them inferior quality products — to the latter’s “business interests”. “We need to take their [overseas original equipment manufacturers' or OEMs'] comments with a pinch of salt and give due credence to our national interests,” an HAL spokesperson had told ET Magazine when quizzed about “inferior quality of its components” and delays.
However, Thursday’s decision by the Indian Air Force to offer RFPs to overseas companies — in a project that will also see several local companies emerging as manufacturers of aircraft parts — must be an eye-opener for HAL, which had monopolised the segment in free India, says a government official who spoke on condition of anonymity.
HAL’s mistakes are many, admits this official. While the likes of Luttwak call for privatising HAL, he says its biggest blunder is that “it tried to be many things at the same time”. He elaborates: “In aerospace, if you are an integrator [a company that assembles all compo-nents made by tier-1 companies to make an aircraft], you have to be an integrator, not a tier-2 or tier-3 company. HAL wanted to be all of them at the same time. In the process it ended up exposing itself and its inefficiencies.”
According to the government official, who has worked closely with HAL, tier-1 companies are those that make engines, fuselages, wings etc. Tier-2 ones, he says, are those that make components for engines, fuselage, etc. Tier-3 firms are those that make nuts and bolts, the most basic of components, he explains.
American defence consultant and lawyer Robert Metzger echoes the concerns of overseas players: “There is a perception that HAL has received too large a share of the government’s assignments for aircraft development, build and support and too large a piece of the funding pie.” He adds: “Many have observed that HAL’s projects take longer and cost more than expected but produce less performance than needed. It is time to face these facts.”
“Companies like RIL could play the role of an integrator,” says PwC’s Mathur, emphasising that in the “supply chain” even the very small player can coexist with big ones. “It is a winwin situation for all,” says he. “In that role, staying power is crucial,” notes the government official, adding that it isn’t economically viable to do “everything that goes into the making of an aircraft. Nobody in the world does it”.
The Dream & Hopes
It is too early to say that defence PSUs such as HAL can be battered “in direct competition”, says the Mumbai-based consultant. However, private-sector defence companies are emboldened by the recent changes to India’s arms rules that analysts say are “highly encouraging” for them. Promising “winds of change”, defence minister AK Antony brought in many amendments, including doing away with the “process of nomination” in defence procurement policy (DPP) for choosing companies that maintain, repair and overhaul (MRO) aircraft.
Private players have welcomed the DPP amendments cleared by the defence advisory council (DAC), saying that they open up a lot of opportunities for them. Thanks to outdated technologies, ordinance factories and defence PSUs had to do work frequently on aircraft and other defence vehicles, incurring high costs.
Several private-sector companies are already in pacts with overseas ones (see Other Key Foreign-Local Aerospace Partnerships) to tap an opportunity in the Indian military aerospace segment that KPMG says will be worth $94 billion by 2020. As the armed forces of India, the world’s biggest arms importer, step up their modernisation drive and replace obsolete weaponry, the annual growth rate of the aerospace OEM market in the country over the next five years is expected to be 20% (see Big-ticket defence…
.According to a person close to the matter,RIL — whose entry into aerospace followed that of private companies such as Mahindra, Tatas, and L&T — has big dreams in the aerospace sector. RIL’s “vision”, he says, is to finance tier-2 and tier-3 companies and nurture them to supply them components. “They are looking for a country-wide outreach either to search for or set up such companies,” he adds asking not to be named.
Challenges Galore
How does such financial support benefit RIL? “The companies they incubate can be a support base for RIL, which can get the best commercial terms from them,” said this person.
The first defence official quoted earlier says that what sets RIL apart is that it has the appetite for such a business. “Who is ready to wait and that too for many years before even breaking even? Only big companies with huge cash reserves can,” he says. “It is possible only for companies that are ready for a leap of faith,” he adds with a philosophical flourish.
This official emphasises that any partnership that replaces Avro aircraft for IAF will have to sell at least 150 aircraft to even start breaking even. “It is not for the fainthearted,” he insists. Metzger, too, has words of caution: “RIL is a formidable player. But reliance upon Dassault as the principal partner and MMRCA as the keystone project could prove to be a mistake. It is taking much longer than most expected for the MMRCA contract to be resolved and some believe MMRCA will prove too expensive for India in the end.”
Besides, he feels that there are more differences than similarities between the oil and gas markets and aerospace markets. “Even elite Western companies have found that it takes many years to accumulate necessary expertise and to create and operate necessary (aircraft) production facilities.” Metzger is also anxious about the wariness of India’s leading private-sector companies to “commit”, and about rigid government policy. Other analysts say that since there is no “required integration” between the military and educational institutions, unlike in the US, companies may face huge talent shortage.
Khatri, for her part, feels that companies such as RIL are known for their powers of persuasion with regard to policies. “It is an opportunistic move for sure for them [to enter a new segment that is expected to see a lot of business and policy changes], but in this journey they do seem to have a latent desire to stay on [the ride],” she says. It is going to be a long journey .
