M&M, Pipavav deal positive if it materialises: KPMG

Menaka:I know the Pipavav has denied it as we have already put it out and I know that this is only rumored. I am not asking you to comment on any financials or anything like this but can you give us a qualitative comment on what a company like M&M would see in a company like Pipavav and whether this is a green field route or a acquisition route best?

A: We are all very clear about how the defence sectors are opening up. We have a new minister, there is a lot of talk about make in India and not to forget the recent Delhi elections, all these add up to a situation where the government is going to be making long term changes. The defence minister Mr Parrikar has already been speaking about revising the entire defence procurement procedure, the DPP as we call it. So, these are the things which are creating a lot of buzz in the market. Lot of conversations were already happening right from the last 7-8 months when the BJP government first came up with this 26, 49 and 74 and 100 percent FDI thing. FDI is the biggest elephant in the room, if this gets sorted out we’ll see many more deals.

Coming specifically about Mahindras, they have very strong presence on the and systems and in aviation also they made some acquisitions in Australia which they are planning to now bring to India and I guess Naval is the one which was a missing link. So, it makes a sense for them, it sort of completes the portfolio.Senthil: At this price-because it is a company which has a huge amount of debt?

A: Yes, that is true because we are all funding for the next 20 years because most of these orders, they are huge orders expected for submarines about Rs 50,000 crore, that is almost about USD 8 billion and plus on top of that their ships, rivets , corvettes, minesweepers, they are lots of things coming up. Navy as you know traditionally has been sort of a laggard with the—the people allege that it has got a step motherly treatment, the budget allocations are low and that lead to some of those unfortunate incidents. Even the first ever resignation by a sitting naval chief so, a lot of correction overdue and that is where qualitatively we see a lot of opportunities for people like Mahindras.

Menaka: Whether M&M should approach this space which is the maritime or the warships space so to speak or the naval space as you call it through an acquisition or whether it should do it in a Greenfield way that is one? Secondly can Pipavav Defences skills and abilities in building warships be extended to some of the other naval contracts that may come up in the years to come as Defence opens up and therefore does it make Pipavav that much more of a compelling buy?

A: If I take our first question yes an acquisition always make sense this is a same thing in aerospace as well. Because it is just so difficult to first acquire land, then your dry docks when all the manufacturing facilities will fabricate the parts of the ship and then assemble it in the dry dock then do the testing. It is just too difficult to do that it is going to take a long time. Secondly, certifications, clearances, approvals there is too much to ask for. The acquisition route given the fact that this new government is pro-reformed and they have been talking about FDI reform, spending up the defence acquisition proposals, time is at a premium and that is why probably an acquisition will make more sense.

Coming back to Pipavav, there have fantastic facility who so ever have visited that has corroborated that. That gives them a lot of flexibility to bring in other kinds of ships also. The current shipyards like Mazgaon, Hindustan Shipyard in Cochin, Garden Reach in Kolkata, Cochin Shipyard all of them are flush with the orders and may be there is demand more than supply there is a great play available for the private sector. So, I see a great future for Pipavav.

Menaka: Is there any other play in this space in the naval space that might appeal to M&M or any other acquirer besides Pipavav? So does Pipavav have competition?

A: It is very difficult to set up something fresh.

Menaka: Not Greenfield I mean Brownfield. Is there any other acquisition available any other company that does the kind of work that Pipavav does that could also make for an interesting target?

A: There are not too many.

Menaka: Can you give us the list of all the deals that are likely to happen in the next one year?

A: The speed at which the orders are being cleared, almost USD 19-20 billion worth of programs are already being approved by the previous defense minister Arun Jaitley and now the current one over a last just 7-8 months. It is not that these are new proposals these proposals have been in the files for the last several years. Things are moving at the same time one has to also take a balance view.

Like in this year most of the defense acquisition funds have gone for previous committed liabilities. These are previous programs and the previous years so there is not much left on this year. Hopefully next year the economy kicks in we will have more and more funds left for the finance minister to hand over to the defense minister. That is when we see more programs coming up. However, to give numbers and names it is very difficult but no fighter jets we have the Medium Multi-Role Combat Aircraft (MMRCA) deal. On helicopters, the light utility helicopters, advanced light helicopters, the combat helicopters, UAVs, on missiles, the tank modernisations, on the ships, submarine it is huge list.

Varinder: Is there any precedence in terms of any benchmark in a naval kind of a deal, locally or globally which we can compare if at all this deal happens going ahead?

A: I doubt so because commercial is very different from Military. Military is all program based, project based, tender based, so it all depends on the size of the tender, the duration, the competition they will face, the amount of indigenization and hence leading to the margins and based on the margins we work backwards on a DCF basis and work out the valuations, so as far as my knowledge goes I don’t think- as against commercial ship building unit we can do a multiplier here in case of defence ship building.

Menaka: You sort of laid out a long list of potential orders or maybe at least previous orders that are finally getting fulfilled or budgets that are getting spent etc. That makes this space such an active vibrant space finally. How do we gauge which companies are best positioned o benefit from this? Who will be the best in class in defence? Where some of these deals will take place either in terms of the specific skills sets or spaces like Naval or otherwise how does one understand the kind of activity that will take place over the next couple of years here?

A: Unfortunately I can’t take very specific names here but the names are all well known. There are about four or five very large companies. These are the established manufacturing companies in India who have been in the defence space for almost 30-40 years. They are also supplying to the public sector. Hindustan Aeronautics Limited (HAL), Bharat Electronics Limited (BEL), Indian Space Research Organisation (ISRO) on the space program as well so, as long as the foreign direct investment (FDI) remains at 49 percent or below, these ones would be the first ones who will be approached by the global players and lot of conversations are happening as we speak.

Now if the FDI reforms happen and we take it to 51 or 74 percent as KPMG has been pushing for 74 percent, if that happens then we will see a lot of opportunities opening up for the other large Indian corporates who are also equally keen and behind the scenes let me just divulge a secret, they are all under pressure from the Indian government to now take risks, come out of their disinterest and punt on the defence sector. So, I guess that it will be a very wider pool.

One last point is about the offsets. The current way the defence offsets are designed, once a Boeing or Airbus or a Lockheed locks in its offset partners, at the time they were bidding, say 5 -6 years back, you don’t have the flexibility to change the offset partner. Now, lot of people allege that there is a vested interest there but if the global players are allowed to change their offset partners and the suppliers, like in any other field, we can see many more opportunities opening up for companies who are hitherto not involved in defence.