The world’s largest weapons importer, India, has mandated original equipment makers (OEMs) to source at least 30 per cent of their inputs locally. Though localisation efforts have seen little success, this time, many things are falling in place.
Madhukar V Kotwal, president of heavy engineering at Larsen & Toubro (L&T), says: “While the government’s thrust on domestic procurement is visible, for it to translate into stable ordering, the government will have to prioritise programmes and fund those. Projects have accumulated through the years, but for these to become opportunities for Indian companies, they have to be funded. That depends on how the government prioritises them.â€
Many, however, believe favourable regulatory changes will accelerate investment flow into the sector.
Citi Research says defence manufacturing in India is at an inflection point, with a capital expenditure opportunity of $245 billion (Rs 15,57,819 crore) through the next decade. Key regulatory changes in the sector are expected to see increased sourcing of equipment from Indian companies and kick-start investment in the manufacturing, heavy engineering and design segments. Mohit Khullar of Equirus Capital, says: “Indian companies that didn’t have strong capabilities earlier are investing to gain these capabilities. So, now you have the Make in India campaign, a good macro-economy, and companies with capabilities, which is driving investments.â€
The big opportunity seen is largely based on India’s annual budgetary allocation to defence and a pressing need to modernise systems that date back to the Soviet era. About 10 years ago, the government consciously took steps to increase local procurement and introduced the offset clause, under which global OEMs had to have 30 per cent local content in imported weapons systems. However, 10 years later, only a few contracts have been awarded under the offset policy. Also, domestic companies have built capacities through joint ventures and technology transfers to bid for large projects, though little ordering has happened. This probably explains India’s emergence as the largest importer of weapons between 2009 and 2013.
Between 1999-2000 and 2014-15, India’s defence budget has grown at a compounded annual rate of 10 per cent. However, the amount allocated towards capital expenditure has consistently declined.
But that is set to change. Capital expenditure on defence is expected to be in the range of $15 billion (Rs 95,377 crore) in FY16. Aditya Narain, chief strategist, Citigroup Global Markets, India, says: “As a sector, defence should see large and sustained investments. We have done fairly detailed work and see defence as a $245-billion (Rs 15,57,819 crore) opportunity through the next 10 years. The impact it will have will be more back-ended on companies’ order books or earnings.â€
For domestic companies, a big opportunity lies in artillery, aircraft, helicopters, warships and submarines. Large companies such as the Kalyani Group and L&T have already built capabilities in warships and field guns. The Indian Navy has a budget of $18 billion (Rs 1,14,452 crore) for fleet acquisition, which many believe is a low-hanging fruit for companies. Artillery is expected to be the next big opportunity for domestic companies.
Investment bankers and analysts say given the government’s thrust on indigenisation, the offset policy could prove significant, as more than half of India’s defence equipment is obsolete and needs to be modernised. A lot will depend on which programme the government decides to roll out first; that will determine order flows for different domestic players, who have built capabilities across segments. O3Capital, which has structured some mergers and acquisitions in the sector, estimates Indian defence capital expenditure at $250 billion (Rs 15,89,611 crore) through the next decade. At 30 per cent of the total capital expenditure, the defence offset market is estimated at $75 billion (Rs 4,76,883 crore) in revenue for local suppliers.
Some major programmes could add up to about $25 billion (Rs 1,58,961 crore) in the next few years. Bids for some programmes are in already in place. For instance, L&T has participated in two artillery (155 mm Howitzer) programmes – towed guns and self-propelled tracked guns. Tests on competing systems have been carried out and the results are expected in 12 to 18 months. Two other large bids in place are for landing platform docks and anti-submarine warfare crafts. Currently, the company is executing orders for missile & rocket launchers, missile canisters & sub-assemblies, avionics, fire-control systems, radars & military bridges.
Kotwal says, “Recently, we received an order valued at about Rs 1,400 crore for offshore patrol vessels. We also expect an order for a naval floating dock soon. Our order book covering defence equipment and systems through the past few years has been in the range of $500-800 million (Rs 3,179 crore to Rs 5,086.7 crore). But today’s numbers do not reflect a stable business environment. Through the next two years, we expect the order book to cross $1 billion (Rs 6,358 crore) and be substantially higher in the following few years.â€
An expert said the potential was huge, given every $1 billion of equipment order led to $5-7 billion (Rs 31,792 crore to Rs 44,509 crore) worth of support-related (services, spares, etc) orders through the lifespan of the equipment.
Through the past year, the government has announced several other regulatory changes, which will result in accelerated investments. For starters, it has increased the foreign direct investment (FDI) cap to 49 per cent, which could include portfolio and private equity investments of up to 25 per cent. This is expected to fuel joint ventures and partnerships.
Shyam Shentar, chief executive and managing director of O3Capital, says: “We see different opportunities emerging after key regulatory changes in the sector. While we expect revenue potential of $75 billion (Rs 476,883 crore) through offset contracts signed by the government, we also see Indian companies looking to acquire capabilities. So, a lot more acquisitions will happen in this segment. Private investments in the sector should also improve, as defence is a capital-intensive sector.â€
Experts expect the deal sizes to be large, between $100 million (Rs 635.8 crore) and $1 billion (Rs 6,358 crore). Through the past year, two big joint ventures have already been recorded -while Tata Advanced Systems entered into a partnership with Airbus in 2014 to manufacture Airbus C295 medium transport aircraft in India, Thales entered into a joint venture with Bharat Electronics to manufacture entire radar systems in India. In 2013, L&T entered into a partnership with Pratt & Whitney to set up a facility for maintenance, repair and overhaul and manufacture of aircraft engine components. Earlier this year, Cyient acquired Rangsons Electronics in an all-cash deal. Rangsons, an electronics system design and manufacturing company, is a qualified supplier to major defence and aerospace OEMs.
The Defence Acquisition Council, the apex body for capital expenditure, has approved projects worth Rs 178,036 crore ($28 billion) to kick-start the programme to modernise armed forces, says Citi. Given the sector is capital-intensive, Indian companies planning to supply to global OEMs need cash to invest in world-class manufacturing capabilities and technological know-how. The new FDI policy is expected to result in higher investment in the sector, through investments and joint ventures.
Khullar of Equirus says: “Indian companies have been actively sourcing know-how from their counterparts and are better placed today than in the past. But, we will find it difficult to make high-technology products in many areas, which foreign players have learnt through the past 50 years, by making huge investments. It will take some time before Indian companies start figuring in the bigger league. But the building blocks are falling in place.â€
AIRCRAFT Opportunity size ::
– Analysts expect over $50-bn (Rs 3,17,922 cr) orders for aircraft and aero engines. Spending to rise faster than defence budget as Soviet-era equipment to be replaced Projects: $4 bn (Rs 25,434 cr) on Tejas, India’s first local combat aircraft$10.4-bn (Rs 66,128 cr) jet fighter deal with Dassault Rafale
– $1.2-bn (Rs 7,630 cr) orders to Airbus for refuelling tankers
– Indian firms in the segment: Tata Advanced Systems and HAL
ARTILLERY Opportunity size ::
– Army has not purchased artillery guns for three decades before 2014. Military modernisation programme pegged at $8 bn (Rs 50,868 cr)Projects: Local Dhanush howitzer undergoing field trials.$200-mn (Rs 1,271.7 cr) order placed;
– $2.5-bn (Rs 15,896 cr) tender launched for 100 guns to be imported and 712 to be made in India
– Indian firms in the segment: Mahindra & Mahindra, L&T, and Bharat Electronics
WARSHIPS & SUBMARINES Opportunity size ::
Navy has got a budget of $18 bn (Rs 1,14,452 cr) for fleet acquisition in 2014. Procurements to be largely local. Navy has pending orders of $18 bn (Rs 1,14,452 cr) with Mazagon dockyard Projects: $8-bn (Rs 50,868 cr) order for 15 submarines made in India yet to be signed Indian firms: L&T & Pipavav
