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| A forward defensive stroke |
| Devangshu Datta / New Delhi Sep 06, 2009, 00:28 IST |
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Consistent procurement of defence equipment should throw up some multi-baggers in the next few years.
The Second World War started exactly 70 years ago, on September 3, 1939. The toll was between 55 million and 80 million deaths – even the lower estimate is over 3 per cent of the global population of the time. The UK, Germany, Japan and the USSR all allocated over 50 per cent of respective national GDPs to defence, while the US was committed one-third of its GDP.
Much of the military equipment was privately designed and produced. All the major powers, except the Soviet Union, followed a process of setting specifications and letting private manufacturers compete for orders on tender. Key WWII discoveries that found their way to “Civvy Street” include nuclear power, jet engines, rockets, antibiotics, chemotherapy, radar, autopilots, etc.
The US, which accounts for over 40 per cent of 21st century defence spending (around 5 per cent of its GDP), still tenders out military research to university labs. It still sets specs for its equipment and lets the private sector do the supplying. In many other nations as well, the private sector holds significant marketshare in defence.
Unfortunately, India firmly excluded the private sector. What could not be designed, or manufactured under license in PSUs, is imported. There have been huge cost-time overruns in defence projects. There have been many scandals related to procurement and occasionally, there have been crippling issues with sanctions leading to spares shortages and licensing problems.
India spends Rs 55,000 crore per annum on defence equipment procurement. About 70 per cent is imports while 22 per cent is sourced from the public sector. The private sector's share amounts to 8 per cent – mostly low-end component supplies from over 4,000 companies.
In the new Homeland Security sector, which was created after 26/11, the Government intends to spend $10 billion per annum in equipment procurement between 2010-2015. This includes stuff like communication gear, body armour for policemen, coastal patrol boats, radars, etc. Around 70 per cent of this procurement is to be sourced from the domestic private sector.
By 2012, Assocham reckons defence procurement will be over $30 billion - that's 170 per cent growth. Add in the new Homeland Security procurement and it's close to Rs 200,000 crore. A large chunk of that booty should come to Indian industry. The concept of (public-private partnership) PPP, which has worked in infrastructure projects and the space programme, will be applied.
Another key concept is “offsets”. Overseas armament exporters must offset 30 per cent of their order values by placing orders with Indian manufacturers. This means joint ventures and transfer of technology. Over Rs 7,500 crore of offset contracts have already been signed this fiscal.
The lion's share of offsets could come to the private sector. Foreign entities can hold 26 per cent in an Indian defence JV. There could be substantial FDI inflows. If offsets create a globally competitive Indian defence industry, there could be exports as well. Quite a few of the usual suspects will be beneficiaries if this unfolds.. Several listed PSUs such as Bel and Bhel could become bigger players in defence. In the private sector, companies that have already entered, or are seeking to enter defence, include Larsen & Toubro, Tata Group, Mahindra & Mahindra, Bharat Forge, Infotech Enterprises, etc. L&T played a role in building INS Arihant, the first Indian nuclear submarine. Infotech Enterprises is in a JV to develop avionics with Dasssault Aerospace, which manufactures Mirage aircraft.
A second tier of potential winners consists of smaller specialised component suppliers like Astra Microwave Products, which makes components for microwave radars, and Encore Software, which developed the handheld Sathi computer for the army. Then, there's the privately-held MKU, which manufactures equipment ranging from body armour to Unmanned Aerial Vehicles.
Apart from being a huge new market, defence-security spending is less cyclical than other high-tech industries. Obviously defence contracts will make more of a difference to relatively smaller concerns.
One problem in financial analysis will be the complex structuring of most defence JVs. Exactly how the market will discount such entities or rather, how it will discount listed part-owners of such entities is unclear, as of now. But a new market opportunity this large should nevertheless throw up some multi-baggers.
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