L&T's Naik: Rooting for public-private JVs

In the September of 2004, a member of the top brass of Larsen & Toubro (L&T) shot off a letter to the shipping secretary, proposing a joint venture with Hindustan Shipyard Ltd (HSL). HSL is a sick public sector undertaking based in Visakhapatnam on the east coast, one of just two shipyards in the country with a capacity to build big ships (the other is Cochin Shipyard Ltd). The proposed scheme envisages the formation of an associate company of HSL, in which the engineering and construction giant would pick up a majority stake, and into which HSL would transfer its assets (minus its past liabilities) as its portion of equity. L&T is particularly keen to foray into shipbuilding, keeping in mind the global demand, three-fourths of which is currently being met by South Korea, Japan and China. The way L&T sees it, the government would continue to be the owner of HSL (as well as of its past dues and liabilities), even as its infusion of cash and utilisation of HSL assets via the joint venture would go some way in initiating a turnaround at the loss-making PSU (L&T is willing to pump in upwards of Rs 200 crore as equity and for further investments).

The response, from the Joint Secretary, Shipping, was quick, praising the company for its splendid idea. He requested L&T to go ahead, to broadly outline the shape of the proposed association and to communicate it to the Chairman & MD of HSL. By early 2005, the L&T top brass was making a presentation to the shipping secretary in his chambers, where were also present, amongst others, representatives of the Ministry of Finance and the Planning Commission. A decision was taken to value the worth of HSL assets, as a step forward. The valuation took place by March-April. What happened after that is unclear, but as things stand today, the JV is as much a gleam in the eyes of A.M. Naik, CMD, L&T, as it was 15 months ago.

AN EYE ON THE PUBLIC SECTOR L&T sees huge potential for partnerships with state-owned units
PSU PROPOSAL
HINDUSTAN SHIPYARD LTD: To form a 60:40 JV as an associate company of HSL, with the majority being held by L&T, and the assets of HSL transferred into the JV for building mega-size ships. L&T would bring in cash, upwards of Rs 200 crore as its contribution (including equity and investments) MAZAGON DOCK LTD: To form a JV with L&T holding a majority stake, which will jointly implement the Scorpene submarine project (L&T will make three and MDL three; currently, MDL has the mandate for all six). The JV could go on to make indigenous submarines, after the necessary technology absorption from Scorpene HINDUSTAN AERONAUTICS: To jointly implement-via a JV-the 30 per cent offset deals that will accrue courtesy A-I and IA's orders for aircraft from Boeing and Airbus. In the longer run, the JV could go on to implement future offset deals that will arise in the defence sector (on orders for field guns, tanks, avionics, etc.) NUCLEAR POWER CORP OF INDIA-BHEL: For building turnkey nuclear power stations, L&T sees a three-way JV between BHEL, NPCIL and L&T as an option, with BHEL building the power island and L&T-NPCil the nuclear island
Note: Whilst the proposals for HSL and Mazagon Dock have been made to the government, those for HAL and NPCIL-BHEL-L&T haven't yet been

Sitting in his office in C Block, at L&T's sprawling works in Powai, deep in suburban Mumbai, Naik is still hopeful the L&T-HSL venture will see the light of day. "For decades the Indian shipbuilding industry has not been able to exploit the international boom," says Naik. "HSL is an ailing PSU but has the potential to become a successful shipbuilder with suitable support. Since we are already into heavy fabrication, shipbuilding is a good fit for us."

The L&T-HSL JV isn't the only proposal Naik has in mind with the public sector. He's also keen to forge such equity partnerships in the big-ticket areas of avionics, nuclear power and defence. For instance, he wants to get a finger in the lush pie of offset deals, via a JV with Hindustan Aeronautics Ltd (HAL), another defence PSU. The 30 per cent offset deals on the orders of planes from Boeing and Airbus to Air-India and Indian Airlines-offsets broadly entail that components worth 30 per cent of an overseas order's value will have to be supplied to the firm executing the order- are estimated to be worth around Rs 7,000 crore over eight years. Defence experts point out that in the years ahead, there will be offsets worth thousands of crores in the defence sector, arising from orders for field guns, tanks, fighter planes and the like. L&T feels a JV on the lines of L&T-HAL would be best placed to be a programme manager, which in turn will go about identifying vendors for individual components, under ministerial supervision.

Whilst L&T is keen to jointly work with MDL to develop submarines, the feeling within MDL is that the PSU is quite capable of handling the job on its own-and that a JV at this stage could well delay the Scorpene submarine project further

In the defence sector, too, Naik is keen to forge a JV with Mazagon Dock Ltd (MDL), which he feels will eventually help the Navy achieve its goal of owning indigenous submarines by 2030. Based on the defence requirements of the Navy, the government decided that six Scorpene submarines would be ordered via MDL. L&T has proposed that the L&T-MDL joint venture could facilitate the sharing of the order. The cost of the six-submarine project was originally estimated at Rs 8,600 crore, but experts say that time overruns-the first Scorpene submarine was supposed to be commissioned by 2010, but will only be ready two years later-could take the project cost up to Rs 12,000 crore. L&T is also keen to forge a three-way partnership with Bharat Heavy Electricals and the Nuclear Power Corporation of India Ltd (NPCIL) for building turnkey nuclear power stations.

Such partnerships will doubtless lead to creation of value for L&T shareholders-nuclear reactor fabrication, for instance, is a high-margin business-but Naik prefers to underscore a larger benefit of such associations. "I am a strong advocate of public-private partnerships for making India powerful... L&T is committed to the national endeavour... you must remember we built India's first nuclear reactor," he says. Naik adds that the entry of the private sector will hasten the process of technology absorption and making India self-reliant-for instance, in the Scorpene submarine deal, the government's goal is to first build 12 submarines with varying degrees of help from Scorpene and the next 12 should be totally indigenous, assuming MDL can absorb the relevant technology and design capabilities. The country's record at technology absorption in defence has been abysmal, with technology transfer agreements proving a misnomer, and most PSUs and the ordnance factories still resorting largely to the CKD/SKD route of manufacture. That explains in a large part why 70 per cent of the India's defence needs are met through imports.

Since the 60s, L&T has been partnering with institutes like NPCIL in the area of nuclear power, in space research with Isro and in defence with DRDO. JVs with PSUs in these sectors could be one way to take those partnerships forward

The areas of defence, nuclear and aerospace account for 10 per cent of L&T's revenues and operating margins, at 15-20 per cent, are two times L&T's standalone margins (according to Motilal Oswal Securities). Yet it's difficult to be sceptical about Naik's nationalistic sentiments when you take a glance at L&T's achievements in the areas of defence, nuclear and aerospace. This is a company that fabricates rockets and satellites for the missions of the Indian Space Research Organisation (ISRO). It's the sole supplier of reactors for nuclear power plants and is also a key player in development of core missile systems (like Prithvi, Agni, Akash, Trishul and Nag) for the defence ministry.

With such credentials you would think L&T is ideally placed to leverage the domain expertise of the PSU universe along with its own expertise in engineering & design, programme management, procurement and quality control, thereby resulting in a win-win-win situation for all: The nation becomes more self-reliant, public sector technology skills get upgraded and L&T shareholders also benefit. Why then aren't the PSUs playing ball? Consider L&T's proposal for a JV with HAL to manage the forthcoming offset contracts of Boeing and Airbus. Aviation sources point out that recent offsets have never been fully honoured, with many of the agreements degenerating into counter-trade and barter (instead of aircraft wings or seats, or wiring harnesses being supplied, it's been usually commodities like tea that are exported, and that too the entire value of the offset is invariably never exploited). That's where L&T thinks it can make a difference-by forming a programme management venture with HAL, the JV can select the various vendors under the eagle eye of a central ministerial monitoring committee, ensuring that the full value of the offset deals is realised. "L&T may not earn much, but what's important is that manufacturing technology levels will rise across the entire aviation ancillary industries," says Naik.

HAL Chairman Ashok Baweja: Not decided yet

Sources at HAL confirm that several players from the private sector-not just L&T-have approached it for a partnership to handle the commercial aviation offset deals. HAL has yet to decide whom to partner, or whether to partner anyone at all

From HAL's point of view, though, the moot question is: Does it really need L&T? A spokesperson, on the condition of anonymity, points out that several private sector players have proposed JVs to handle the offset deals and "we will decide whom to partner or whether we could execute on our own". He counters that when IA bought two planes from Boeing in 1994, HAL along with other players benefited from the offset clause to the tune of Rs 95-110 crore, with HAL supplying components like emergency auxiliary doors, undercarriage uplock boxes and CAD/CAM software. HAL's upshot is that it has worked with Indian private sector partners in the past-like Infosys, TCS, Satyam, ITC Infotech and L&T- but exclusive partnerships might not be the answer. For instance, when building the Sukhoi aircraft, HAL outsourced 30 per cent of the work to various private sector players.

Rear Admiral Ajit Tewari, Chairman & Managing Director, HSL, agrees that strategic partnerships with the private sector "might bring in efficiencies and competencies to HSL". However, he adds a crucial caveat: "Decisions on such partnerships can only be taken by the government which is the owner of the PSU''

L&T's view is that public-private partnerships via contracts or build-operate-and-transfer agreements are all fine, but the concept of a public-private joint venture-run with the management and technical expertise of the private sector, with funds from the private sector along with the PSUs' domain expertise built over the past five decades-is long overdue. Naik gives the example of the joint venture he's proposed with Mazagon Dock. "We will bring our design and development skills to the table and MDL has the capacity and the domain knowledge. Between us, we have the resources to create an alternative Indian submarine programme," says Naik. L&T's proposal is that an L&T-MDL joint venture will help advance the commissioning date of the first submarine from 2012 to 2010, which was as per the original schedule. The hastening of the project could prove crucial because the Navy is set to decommission its existing range, come 2010. If MDL is able to deliver the first Scorpene sub only by 2012, the Navy may have to hold on to the old lot or invest in leasing fresh submarines.

Naik says roping in L&T will have two benefits: One, the submarines will be delivered on schedule (but only if he gets the order in the next three months), and two, technological absorption will be faster, which will eventually enable indigenous manufacture. Rear Admiral R.M. Bhatia, Chairman & MD, MDL, isn't convinced: "It's a complex exercise that involves foreign partners. As the contract has already been awarded, creating a joint venture might (further) delay the project," says Bhatia, even as he doesn't rule out MDL's ability to absorb design and development skills and eventually attempt to make submarines indigenously.

The recent creation of ONGC Mittal Energy is a classic public-private JV, which will help address India's energy security problems. Will the defence aerospace and nuclear sectors be the next arenas for such alliances?

Will MDL be able to meet the Navy's deadline of 24 submarines (12 of them totally indigenous) by 2030, on its own? That's not an easy question to answer. If tentative optimism does exist in some quarters within MDL, it's because MDL isn't a sick company. HSL, on the other hand, though, is a stretcher case and badly in need of a healing touch. Today shipbuilding accounts for just around a third of its business, with the rest coming from ship repair. Accumulated losses and a negative net worth have prompted the shipping ministry to work on a restructuring package for HSL (which is still awaiting approval). But Rear Admiral Ajit Tewari, Chairman & Managing Director, HSL, agrees that "a strategic partnership with the private sector might help bring in efficiencies and competencies to HSL". But he also talks about "a public-public partnership which can be useful for bringing in new technologies and investments". The problem for HSL, though, is not a choice between a public-public or a private partnership; it lies elsewhere. As Tewari explains: "Decisions on such partnerships can only be taken by the government, which is the owner of the PSU.''

If L&T is able to move ahead with its public-private partnership model, the concept of "co-investment" may work out as a feasible alternative to disinvestment, at least in the shorter run

That could well be the nub of the problem-the reluctance of either the government or the PSU to take a decision on partnering with the private sector. The problem could also be historic, what with the public sector staunchly resisting the entry of private players into areas it considered its fiefdom in the seventies and eighties. Perhaps that monopolistic mindset still prevails, although the flip side is that there are few Indian companies in the private sector that have the technological depth to be able to address the country's defence, nuclear and aerospace needs. Contrary to popular perception, the public sector is not all dross--of the 250-odd central PSUs, a third are loss-making. The government on its part has proposed a policy to grant autonomy to navratnas and mini-ratnas for acquisitions and joint ventures. Another silver lining is the creation of ONGC Mittal Energy Ltd (OMEL), a JV between the Indian oil giant and Lakshmi Mittal, which recently acquired oil blocks in Nigeria. Such JVs will help address the crucial energy security problem. Like ONGC, there are other immensely viable PSUs operating in crucial sectors that could benefit from private sector associations-BEML, BEL, Coal India, Cochin Refineries, Hudco, NHPC, NMDC, NTPC, NJPC, NPCIL...the list is long, and you can be fairly sure it's not just L&T that will relish the opportunity to unleash the value locked in such PSUs.

-additional reporting by Venkatesha Babu and E. Kumar Sharma