May 8, 2012

Mazagon Dock Pipavav: First Defence Joint Venture

General
In the inaugural address at the DefExpo 2012, India’s Minister of State for Defence Dr. MM Pallam Raju announced that the Government would encourage Joint Ventures (JV). The Minister also stated that the joint venture route was the most promising for partnerships for co development of products in the country. Dr Pallam Raju stated, “We are looking for partnerships and co-development arrangements and formation of Joint Ventures in the Critical Technology Areas”.

In line with this announcement, the Government of India approved Joint Venture between Pipavav Defence and Offshore Engineering and Public Sector Mazagon Dock for building warships and submarines for Indian Navy in May 2012.  "The government of India has conveyed, vide its letter dated May 2, 2012, that Pipavav Defence and Offshore Engineering Co Ltd has been chosen as its partner for formation of joint venture to build warships for Indian Navy," Pipavav said in a statement to BSE. Mazagon Dock is India's biggest defence shipyard with a report in the Economic Times indicating more than 85% of indigenous defence vessels being built there. The synergy between the Public and Private sector JV may herald a new era in defence industry in India.  An overview of  the trajectory of Joint Ventures in India is as per succeeding paragraphs.

Issue of Guidelines
The Ministry of Defence issued guidelines for establishing joint venture companies by the Defence Public Sector Undertakings (DPSUs) on 17 February 2012. The JV guidelines were a continuation of the Defence Production Policy January 2011 which had opened the way for formation of consortia, joint ventures and public private partnerships within the Government approved framework.  This JV route opens opportunity for companies to jointly develop products with DPSUs in India. The DPSUs in India with their product profile are Hindustan Aeronautics Limited (HAL) – Aircraft and Helicopters, Bharat Electronics Limited (BEL) – Electronics and communication Equipment, Bharat Earth Movers Limited (BEML) – Heavy Vehicles, Mazagon Dock Ltd (MDL) – Ships, Goa Shipyard Limited (GSL) – Ships, Garden Reach Shipbuilders and Engineers Limited (GRSE) – Ships, Hindustan Shipyard Limited (HSL) – Ships, Bharat Dynamics Limited (BDL) – Missiles, Mishra Dhatu Nigam Limited (MIDHANI) – Minerals.

1. The key advantages of establishing JV for Indian and foreign private sector majors are as follows:-
2. Speedy entry into the Indian defence sector by exploiting the potential offered.
3. Large PSU order book that is full with limited capacity for fulfillment in the near term.
4. DPSU’s get orders by nomination which can be a route for entry of private players   thus avoiding the tedious process of competing for defence procurement.
5. For the DPSU, high technology intervention will be facilitated.            

The advantages are most evident in the case of the Mazagon Docks Pipavav JV with the PSU having a large order book, whereas Pipavav has the infrastructure for building ships.  Pipavav has invested heavily in the ship yards and is thus well placed to take up additional ship building orders.

The Opportunities
The range of products manufactured by  the DPSUs provides facilitates joint ventures mainly in the field of aviation, electronics and communication, B Vehicles, ship building, missiles and mineral development. While the field of missiles is regulated, other areas include both high and low technology which include a wide array of products which will provide sufficient scope for Joint Ventures by Indian and foreign private sector players. The advantage of Indian defence is larger off takes. For example with over 350 infantry battalions, the Indian Army can be a huge customer for walkie talkie radio sets, a small but essential item for soldiers in varied operations. BEL will be the lead DPSU for the proposed joint venture by any firm which may generate a huge production line worth thousands of walkie talkie sets. This does not include the FINSAS programme or Future Infantry Soldier As A System under consideration by the Indian Army which is likely to generate huge volumes for various types of say electronics and communication equipment.

Ship building is another promising area where there is scope for a number of joint ventures. Given that the Indian Navy has set into motion a very large modernization programme with  46 ships "on order“ including two aircraft carriers, six submarines, seven guided-missile destroyers, four anti-submarine warfare corvettes, nine naval off-shore patrol vessels and eight amphibious craft there is a paucity of shipyards. Presently four shipyards have been included in the DPSU category.  Thus the Mazagon Docks Pipavav is the first such venture with other shipyards also in the line up which provides more opportunities for others such as the ABG Shipyard and L & T in this sphere.

The government is also planning to extend the alliances with other PSUs. Defence Minister Shri AK Antony on 29 February asked the Hindustan Aeronautics Limited (HAL) to realign its business processes for strategic alliances and joint ventures, as also, to step up R&D efforts to remain globally competitive. Addressing a meeting of the Parliamentary Consultative Committee attached to his ministry, Shri Antony said HAL should partner with design laboratories like DRDO and CSIR for the development of indigenous aircraft, engines and systems. He said, what is more, HAL should adopt best practices followed by the global leaders in the field of project management, quality control systems, vendor deployment and supply chain management.

HAL, the leading Defence Public Sector Undertaking, has a turnover of over Rs.13, 000 Crores and is set for a quantum jump with the planned acquisition and production of Light Combat Aircraft, Light Utility Helicopter, Medium Multirole Combat Aircraft, Fifth Generation Fighter Aircraft, Multirole Transport Aircraft, and Basic Trainer Aircraft in its assembly lines in the coming years. However without a JV route it is unlikely to develop top of the line products to meet the vast requirement of the Indian defence sector where the number of helicopters alone may exceed over 1000 in the coming years.

Brief of the Guidelines
As per the Guidelines issued by the Ministry of Defence on 17 February 2012, DPSUs may consider formation of suitable partnerships both with Indian as well as foreign companies in order to harness new opportunities to augment indigenous production (Para 2.1).  The route adopted could be varied from, “outsourcing, subcontracting, formation of consortia, project – specific special purpose vehicles (SPVs), formation of JVs, etc.” This gives sufficient flexibility to the DPSU for selection of the best mode of collaboration with private sector partners to create additional capacities without allowing the existing capacity to idle.  (2.2). However there are restrictions in terms of the capacity to be utilized and orders which are said to be in terms of the, ““Minimum Economic Quantities” (MEQs)”. (2.4).

The JV route also facilitates absorption of, “propriety technologies and/ or projects with the DPSU as the offset partner etc.” (4.1). Thus companies with a strong technology background and able to provide cutting edge skills in various fields have a good scope to be the preferred partner with the DPSU through the JV.

Given the nature of the industry and its strategic implications, a suitable Non-Disclosure Agreement (NDA) is required to be signed with prospective partner(s) before sharing any confidential information concerning the DPSU. (4.2). This may also be applicable for the DPSU where technology is shared by a private entity. When undertaking a JV with an Indian or a foreign company all provisions of the Companies Act, 1956 and the Foreign Exchange Management Act, 1999, as amended from time to time would govern the JV Company and the corresponding share holding agreement (SHA) will be drawn up. (4.5). Suitable exit provisions have also been incorporated in the JV Guidelines providing for safety and security of the capital and interests of the DPSU.

Implications of Guidelines
Introduction of the processes for joint ventures applicable to the private sector to the defence within the overall laid down limits of the guidelines laid down by the Department of Public Enterprises; Government of India should pave the way for entry of private players in JVs. The overall ceiling on such investment in all projects put together shall be 30% of the net worth. The ceiling on equity investment shall be 15% of the net worth in one project limited to Rs 1,000 Crores (USD 200 million) in case of Navratna companies this includes only two, HAL and BEL and Rs 500 Crores (USD 100 Million) in case of Miniratna Category-I companies which includes all other PSUs less the HSL. This restriction may prevent any major project being undertaken through the JV; however the route may be open for smaller companies including technology incubators for productionalising their ventures.

Given the national security implications the guidelines for JVs has given the, “affirmative right,” to DPSU for key JV decisions to include, “amendments to the Articles of Association of the JV Company, declaration of dividend, sale of substantial assets, and formation of further JVs/ subsidiaries.” The affirmative rights of DPSUs have been extensively covered in the JV Guidelines (3.2). This may restrict the flexibility available to the JV partner though it provides for control of the JV in strategic interest.

Given that the orders are to be for MEQs how much this would induce the foreign suppliers to form JVs with the Indian DPSU with restricted numbers being sought remains to be seen. Thus there may be inherent challenges faced for formation of JVs in terms of scope for investment total as well as in a JV and also the supply orders that can be generated.

Likely Contours of Mazagon Pipavav JV
A JV between Mazagon Docks and Pipavav was first announced in September 2011. But the deal was canceled due to objections by  ABG Shipyard and Larsen and Toubro, for lack of transparency.  JV guidelines were established thereafter and the government has finally approved the JV in May 2012 thereby opening the route for more such engagements in the near future particularly in the ship building sector.

The 50:50 joint venture named Mazagon Dock Pipavav is slated to implement part of the existing orders of Mazagon Dock of Rs 1,00,000 Crore ($21.69 billion). The company can bid for future defence contracts in India. "This partnership is formed primarily to fast forward the process of warships and submarine contracts held currently by the MDL," Nikhil Gandhi, chairman of Pipavav Defence had earlier said.

Pipavav Defence has been promoted by Nikhil Gandhi and  Bhavesh Gandhi amongst others. The Promoters are holding 45 percent of the shares as on 31 March 2011 up by over 6 percent from the previous year. 25 percent is held by body corporate and trusts. The profit before tax of the company in 2010-11 was Rs  48.16 Crore and Net Assets stood at  Rs 3782. 06 Crores. Pipavav has experience in the infrastructure sector promoted by SKIL. It has also established a JV with the Indian Railways known as  Pipavav Railway for gauge conversion and extension of the railway lines from Surendranagar to Pipavav, a 286 kms. long private railway line built under Public Private Partnership model as per the Annual Report of the company for 2010-11.  SKIL the promoter of Pipavav where Mr Nikhil Gandhi is the Chairman had conceived the Maha Mumbai SEZ (MMSEZ) and won the bid for the Navi Mumbai SEZ (NMSEZ),  which  has been taken over by the Reliance Group with minority stakes at present by  SKIL.

Pipavav company has Mr. Ajai Vikram Singh a former Secretary in the Ministry of Defence as  a Non-executive Independent Director of the Company. SKIL also has a former Secretary in Ministry of Defence Mr Ajay Prasad on its board of directors. Pipavav has Sembcorp Marine Ltd as one of the promoters.

Mazagon Docks is India’s largest PSU shipyard with Net worth of Rs 1159.12 Crores and PBT 366.05 Crores for the Year 2010-11.  As per the JV Guidelines, 15 percent of net worth of Mazagon Docks can be invested in the equity of JV with Pipavav. This would denote Rs 175 Crores with an equal capital by Pipavav the equity investment can be up to Rs 350 Crore. The JV will thus have to induct capital from other sources including debt and public financial institutions to build a large enough corpus for undertaking ship building contracts. While some of the orders of Mazagon Docks are likely to be offset to the JV how this will be structured remains to be seen and further clarity is awaited.

There are concerns whether the JV would generate sufficient value and the partnership would be fruitful.  In the case of the JV between Mazagon and Pipavav, the PSU’s PBT is 31.6 percent of Net worth while that of Pipavav on a much larger Net worth just 1.27 percent. Thus how synergy will be created and what value addition Pipavav will be able to provide in the JV is not clear.  The JV once formed should provide clarity on this and related issues.

Comments and Analysis
Joint Ventures in the public sector defence undertakings are the route proposed by the government to open up defence sector for private firms. This  may provide scope for even foreign firms to gain an entry into the protected defence sector in India for there have been many proposals that could not move forward due to challenges faced of restrictions of 26 percent FDI in defence. This is a slow and steady step that has been taken to open up the defence sector and should provide an impetus for overall growth and a road map for entry for many private players. With 9 PSUs many of whom are making huge profits on low net worth as is evident in the case of Mazagon Docks

Due to captive markets there should be scope for entry of the private sector in the days ahead. On the other hand the government has quietly dropped the proposal for nomination of private sector companies at par with the public under the RUR or Raksha Udyog Ratna category.

An important aspect of India’s defence production capability is Ordnance Factories. As Laxman Behera of the Institute of Defence Studies and Analyses indicates, the main thrust for modernization and indigenization has to be the Ordnance Factories for which JVs for an important route which has not been considered in the Guidelines. Hopefully the Ordnance Factories will be included in this paradigm in the days to come.

As India grapples with the challenge of indigenisation of defence production without whole sale privatisation of defence industry the route adopted now appears to be a JV between DPSUs and private players. These JVs would have greater autonomy vis a vis the parent PSU and should provide scope for private enterprises participation in the defence sector. While it has been felt by the private players that the DPSUs are having unfair advantage as they have the monopoly and first rights on all defence contracts, the challenge may to an extent be overcome as a JV with a DPSU would provide scope for more fair play. On the other hand this would bring into public sector better technology, greater accountability and efficiency which have been the bane of the past.

On the whole India would have to work out a Defence Production Indigenisation Strategy in the long term thereby providing measurable milestones towards achieving full scale indigenous R & D and defence production capability over the next two to three decades. While there is a lot of debate on an autonomous national strategic trajectory, till defence indigenisation is achieved, this will remain taps on the armchair strategist’s keyboard.

[Email author  rkbhonsle@gmail.com]

Related Tags

• India
• Mazagon Docks
• Pipavav
• Joint Venture
• Ship building

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