‘We have to build capability to utilise offset credits'

The Hinduja group declared its intention of being a serious player in the promising Defence equipment business when it signed an MoU last month with a well-known German company, Krauss-Maffei Wegmann, to collaborate in the development of advanced Defence systems. A new company, Ashok Leyland Defence Systems Ltd., has been created with flagship, Ashok Leyland, holding 26 per cent equity in it. Spearheading the group's foray into the Defence equipment business is Dr V. Sumantran, Executive Vice-Chairman, Hinduja Automotive, and Chairman, Ashok Leyland Defence Systems. In this interview with Business Line, Dr Sumantran sets out the rationale for the foray into the Defence and aerospace businesses.

Excerpts:

Q. Could you elaborate on your strategy for the Defence business?

We've had a good Defence business for sometime. But we felt that running a Defence-oriented activity within a large automotive company was not giving it the right amount of focus.

The pressures of a 3,000-4,000 unit specialised vehicles business was getting lost in a 1,00,000 units a year commercial vehicles company. What we've done is to carve this business aside.

We have effectively a greater than 50 per cent foreign ownership technically, because Hinduja Automotive is London-based. So we decided to create a 26 per cent Ashok Leyland-owned Indian company that will make it fully eligible to participate in Indian Defence tenders and qualify for offset obligations.

Q. So who owns the balance 74 per cent?

Indian residents of the Hinduja family. It has the elements of ALL's legacy and remains an Indian company. Now, we are getting into a much broader range of products rather than limit ourselves to logistics vehicles. To get into contention for these orders, we needed to fulfil the FDI limit norms, which we now do with the new company.

Q. How did you zero in on your partner for the Defence business, Krauss-Maffei Wegmann (KMW)?

We talked to several partners and zeroed in on this prestigious German company, KMW. They are the Porsche of the Defence business. Very, very high-end products, high performance, but not very high volumes.

The NATO's main battle tank, the Leopard 2, is a KMW product. I had a ride in it and all I can is that it is staggering. It's a tank that drives like a sports car, no exaggeration.

They have other products like artillery, they have the Dingo which is an armoured personnel carrier, protected from mines, rocket propelled grenades… it can run over dunes at 80 km/hr. We are now developing a number of new products with them. The new company will expand its product range. Initially, we'll use some of the ALL facilities on loan but, eventually, we'll set up our own limited volume production for the specialised vehicles, including armoured vehicles. We've already started with some of the prototypes building at our plant near Sriperumbudur.

Q. Will ALL's existing Defence business move into the new company?

Not all of it. We've got a good stable product in Stallion, which will continue in ALL, but several new programmes will move into the new company.

Q. The success of the venture hinges on your ability to get Defence tenders and you'll be head on with Heavy Vehicles Factory and other Ordnance Factories…

More and more the government is saying that there will be a role for the private sector for two reasons.

One, to mobilise wider capital and, two, to spread the work through a broader enterprise and, hopefully, leverage some of the private sector's focus on economics.

Two, we have to make a start and build capability to utilise the offset credit. Today, huge credits are being accumulated and the common refrain from the European and American players is that we can't even spend the money if we want to.

That is not a good situation for India and it is enterprises like us that have to step in and make profitable use of the offset obligations. It is inevitable that in India over a period of time, we have to develop our own equivalents of a KMW or Rockwell. The players with an advantage of building that business would be players with some degree of incumbency in manufacturing large systems.

For us, as a group we've decided we will not go into cars. That is high volume, very different dynamics but for the kind of industry that we are, we have to constantly find new frontiers and this is a logical one for us to get into. Particularly over the next 10 years we can build a company that to my mind can exploit the low-cost advantage that India has. The advantage cannot be limited to cars alone.

Now, we are in serious discussions to enter the aerospace sector. We've taken longer to reach this conclusion compared to some of the other bigger groups but we were busy with many other things. Now we have a team in place to do two things. The organic project we're already building. We are now doing design and engineering for some sub-systems in India. We've acquired a small group that does design and engineering services for an European aerospace manufacturer. We've converted one of our test facilities in Defiance, Detroit to address aerospace testing. We've got some pretty good clients as well.

We are talking to a couple of global players about stepping into some form of aircraft assembly. This is a big step for us.

Q. Will this be military or civil aerospace products?

Both. Many of these will have civil and military applications. For instance, if you take helicopters, it will have both civil and military use.

Q. So, will you produce only fixed wing aircraft or helicopters as well?

Both are under consideration. The partners we are talking to we cannot disclose for some time but they are well known European and US companies.

Q. Will you go for multiple partners or just one?

Hopefully we'll end up with at least one. One initiative and one partner, if all things start to align and we decide to do both and its feasible, it may be two separate partners, obviously non-conflicting.

Q. All this will be done under the banner of Ashok Leyland Defence Services?

Initially we'll look at how we'll incubate this but the scale that we are thinking of, it will deserve to become a separate company. So there will be a separate aerospace company.

Q. And ALL will hold equity in it?

ALL will hold equity in it along with parts of the group. So we'll distribute the shareholding between ALL and the group.

Q. What will be the likely capitalisation of this venture?

Difficult to say because what the scale of the business is and to what level we structure it, has not been finalised. It also depends on how much work share we will end up with; how much work will be done in India and how much overseas and how much will be done through perhaps a third partner.

Q. Are you open to offering equity to your technology supplier?

Yes, definitely.

Q. Do you see scope for this business in India or do you plan to look at other markets too?

If you look at the MMRCA order, all the global manufacturers are salivating. Where do you get an order for 126 aircraft and expensive, top-line ones at that?

Plus maybe 560 helicopters… nobody in the world can see the line of sight to such an order for the next five years. Add to this the 20 Boeing C-17 transporters, AWACS, military heavy-lift helicopters, medium range transport aircraft… and all this is only military. There is civil too.

Q. Do you see serious competition from the established multinationals in this business?

The way the aerospace business has evolved, it is globally characterised by two interesting dynamics. If you look at the F22 programme piloted by Boeing, tremendous amount of work for that is done by General Dynamics and Lockheed Martin.

Here are three competitors sharing work. Take the F53 fighter fronted by Lockheed Martin, there is work done by Boeing, Raytheon and United Technologies. If you take Europe, Bombardier makes tail pieces for Airbus. Take 787, between Mitsubishi, Fuji and Kawasaki, they build 40 per cent of the 787. So, the way the aerospace sector works is: one, there is a distributed work model. People work on pieces of the work. They are all major sub-contractors in large programmes. It is not uncommon for the participating contributors to a programme to also be competitors. It is sharing of risks and rewards and leveraging assets too.

Q. But why will a Lockheed Martin or a Boeing choose a new company set-up in India to even share a part of the work?

The only reason we are doing this is that until now the aerospace business remained a preserve of the public sector. This is the first time that the doors are being opened for the private sector. So nobody has a head-start. We are all running off the starting blocks more or less at the same time.

Q. But why will they even want to pick up a private sector player from India?

We are coming back to the offsets. They were a mechanism for the Indian government to nurture domestic industry.

Q. So, you see the offsets as a prime pivot?

Yes. God willing, if the strategy works right, then 20 years from now in India, there will be equivalents of a General Dynamics and a British Aerospace.

Q. So, it's a long-term business…

Yes it is.

Q. How capital-intensive is the business?

In many ways, I would say that the capital intensity in aerospace has slightly different dynamics. It is not so intimidating to an automaker. Even if you take the light combat aircraft programme, the kind of capital expenditures are not that intimidating to an automaker.

The big difference is, in the auto industry, we put a huge amount of the capex into the plant. In aerospace, the plant is not expensive. What is expensive is product development, validation, testing… If the investment on the product side is mitigated, then the investment in the plant itself can be managed by an automotive company.

Q. Then it;s critical you get a partner with a developed product, but he's going to demand his pound of flesh…

It's normal dynamics; every partner must get what they want and a fair share in return for their contributions.

Q. The plans to enter aerospace, taken in association with your plans for the Defence business with KMW, are you taking on more than you can digest?

One is you have to learn to groom skills and talent. They are very different businesses. For Defiance we got a very senior IT professional to come in as CEO. For Albonair we got two MDs from Germany, one of whom is the original patent holder for the technology. For our John Deere JV, we have a CEO from India who has spent his career in the construction equipment business.

Yes, we have got a lot of balls in the air but if we have to grow, we need to step up the level of our game. A lot of it is people; if we get the right people, we are fine.

For aerospace, we have some very senior people working with us. One of them is the former Deputy Programme Director for the LCA. It's not easy but, on the other hand, I'm not discouraged. Today its not difficult getting people; if they buy your story, they throw in their lot with you.

Q. When do you see your plans coming to fruition?

In aerospace, for anything we do, the time scales are multiplied by two, compared to the auto industry. For instance, for this LCV venture, we had the deal with Carlos Ghosn towards the end of 2007. We have been working on the project and it is the fastest anybody has done a brand new engine and new product. With that speed, it still took us 3 years to be here. In aerospace, it will take at least twice that time. And the discussions leading to the formation of the company, definition of the projects, products, etc., will take time. I think by the second half of this year, say June/July, we will be in a position to specifically announce what we will be doing. We would have tied up our partner by then and also identified the first set of products.

Q. What is the scope of the KMW MoU?

It covers armoured vehicles, tracked vehicles, wheeled vehicles, artillery and special purpose applications such as bridge laying equipment.

Q. So you will pay only a technology fee to them for each of these?

No, some of these we may end up producing together for not only the Indian market but for other markets. In some others, it will be oriented predominantly towards the Indian market. That will determine the structure.

Q. So, you are not offering them an equity stake to start with?

We have decided we'll wait and see how each of these projects shapes up. At that stage, we are flexible to do whatever makes sense.

Q. Personally, you'll be piloting these new businesses…

All of the new ventures, whether it is Nissan or John Deere, I will be shepherding on behalf of the group. At the apex, Sesh and I look at what we want to do, Sesh spends a lot on the core growth strategy while I spend a lot of time on the new initiatives.

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