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Aurum Webinar: Indian Defence Offset Program


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This is the presentation from the Aurum Webinar held on 21st December on the Indian Defence Offset Program - Challenges and Opportunities. Speakers include Amit Cowshish from Dua Associates, and V Sunder and Vikram Bihani from Aurum Equity Partners LLP.

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Aurum Webinar: Indian Defence Offset Program

  1. 1. Indian Defense Offset Program Challenges & Opportuni9es December 2016 1
  2. 2. •  This document is presented solely for the internal use of the recipient to whom it is marked by Aurum Equity Partners LLP (Aurum) and cannot be published or disclosed in part or in whole to any third party without the specific wri@en consent of Aurum. This document is incomplete without reference to, and should be viewed solely in conjuncEon with the verbal briefing, as may have been provided, by Aurum. •  This document shall be subject to the terms of any Non Disclosure Agreement that may have been entered into between Aurum and the recipient to whom it is marked. •  In preparing this document Aurum has relied upon and assumed, without independent verificaEon, the accuracy and completeness of all informaEon available from published and public sources and/or provided to it for the purposes of this document. Accordingly, neither Aurum nor any of its partners, employees, affiliates, agents or advisors make any representaEon as to the accuracy, completeness, reasonableness or sufficiency of any of the informaEon contained in this document, and none of them shall be liable for any loss or damage (direct or indirect) suffered as a result of reliance upon any informaEon contained in this document, or any omission of any informaEon from this document and any such liability is expressly disclaimed. •  Aurum has developed this document and all concepts, structures, recommendaEons and analyses are proprietary to Aurum and cannot be used without the express wri@en consent of Aurum. •  This document has been prepared for preliminary discussion purposes only without prejudice and should not be construed as an offer or invitaEon to purchase or sell any securiEes, businesses, or assets of any enEty referred to in this document. Disclaimer 2
  3. 3. Vikram Bihani Partner Experience: Vikram is an experienced investment banker with over 18 years and over 50 transacEons under his belt. Exper9se: •  Vikram excels at fostering and developing relaEonships to enable clients to make informed decisions through trusted advice in a complex internal and external environment. •  Deep rooted passion in fostering the start-up eocsystem, ability to connect with growth oriented entrepreneurs through their life cycle from capital raises, acquisiEons and exits. •  Director and Investment Commi@ee Member of Triveda Capital, a US$ 500 million real estate fund •  Director, Investor and Mentor of Tricog Health Services Pvt Ltd, a predicEve healthcare analyEcs firm, funded by some of India’s leading venture capital funds •  He is a member, and been a past president of the Entrepreneurs’ OrganizaEon Bangalore, the Bangalore chapter of a 11,000 + member global organizaEon comprising some of leading entrepreneurs across the world. Work Experience: Past: •  Co-Founder and Director of Mosaic Capital Services Pvt Ltd •  Ambit Corporate Finance Pte Ltd 3 Speaker Profiles …
  4. 4. Strategic Business Advisor – Aerospace and Defense, Automo9ve and General Engineering V Sunder Experience: He has, over 25 years, held several posiEons including being the CEO of Joint Ventures, Head Corporate Planning, Head Compliance, Legal and Company Secretary and Group CFO of a large and diverse Indian mulEnaEonal. He has served on the boards of many companies including Listed companies in India and abroad. Exper9se : •  He is an Industry veteran and an InsEtuEon Builder. •  He has over 25 years of rich experience in areas of Banking, Financial Services, Manufacturing, Design and Engineering Service •  He has been closely involved in establishing and expanding many ventures across the Globe in diverse fields like Engineering, AutomoEve, Defense, Aerospace, Engineering Design Services, Biotechnology, Homeland Security and Trading AcEviEes. •  Apart from his experience in establishing and growing businesses organically, he has led acquisiEons of businesses across the Globe and integraEng them with the exisEng Indian Ventures. •  His team building and natural leadership skills have enabled him to idenEfy, lead and mentor many young business leaders throughout his professional career. •  He is a Fellow Member of The InsEtute Of Company Secretaries of India. •  He is a long-standing member of the WPO (World Presidents OrganizaEon)-A premier Global Leadership OrganizaEon. Work Experience: Past President & Group CFO - DynamaEc Technologies Ltd Current Co-founder & MD of Ma Foi ConnecEng Dots Advisory (P) Ltd. 4 Speaker Profiles …
  5. 5. Air Marshal M Matheswaran Strategic Consultancy - Defense & Aerospace Business Experience: Air Marshal M Matheswaran is the former Deputy Chief of Integrated Defence Staff (‘DCIDS’), responsible for Policy, PerspecEve Plans and Force Development. He reEred ager 39 years of service with the IAF. Commissioned as a fighter pilot in 1975, he has extensive experience in important projects such as the LCA and Kaveri. He was Senior Advisor to CMD, HAL at Bangalore from May 2014 to May 2015. He was "President, Aerospace Business" of Reliance Defence from 01 Nov 2015 to 31 July 2016 at Mumbai, helping the industry major to set up its Aerospace VerEcal. He is acEve in academic work and presents papers in internaEonal conferences. He is a member of the ExecuEve Council, the governing body of IDSA (InsEtute of Defence Studies and Analysis), New Delhi - an autonomous think tank under MOD. He is acEve with various other think-tanks and insEtuEons such as ISA, USI, CAPS, ORF, and IISS. Currently he is Strategic Advisor & Consultant for Defence & Aerospace to Cyient, Reliance Defence, FICCI and Doctoral Faculty, PhD program, Naval War College, Goa amongst others. 5
  6. 6. Amit Cowshish Partner, Dua Associates Experience: Amit is a former Financial Advisor (AcquisiEon) and Member Defence Procurement Board, MoD. During his career with the Indian Defence Accounts Service, spanning 35 years, he worked in various capaciEes in the Defence Accounts Department and on deputaEon with the CVC and the MoD. •  While serving with the MoD he was associated with financial and contractual ma@ers related to procurement of goods and services for the Indian Navy, Coast Guard, Special Forces and the Army Ordnance; he also handled defence plans and budget from 2005 to 2011 •  As Financial Advisor (AcquisiEon), he handled all financial ma@ers related to capital procurements for the services and the Coast Guard •  He has chaired the commi@ee that reviewed and draged the Defence Procurement Manual, 2009 and its supplement of 2010 •  He was co-chair of the forum set up to review the progress of all procurement cases under the Foreign Military Sales (FMS) programme of the US Government and was a member of the IndoRussian working group on procurement related issues •  He is a DisEnguished Fellow at the InsEtute for Defence Studies and Analyses and a Senior VisiEng Fellow at the Delhi Policy Group •  Presently, he is also a member of the commi@ee set up by the Ministry of Defence to recommend seong up of a defence procurement organisaEon 6 Speaker Profiles
  7. 7. 7 S. No. Sec9on Page 1. Indian Defense Industry Overview 8 2. Indian Defense Offset Program 11 3. Indian Defense Offset Opportunity 20 4. Limited impact of the Offset program 23 5. Key Measures Required 28 6. Annexures 34 Index
  8. 8. 8 Indian Defense Industry Overview 1SECTION
  9. 9. 9 India accounts for ~2% of the global defense spend… Source: Ministry of Defence, Govt. of India, SIPRI * Figures may not be compa@ble with each other due to differences in classifica@on *Others include OFs, DGQA, RR, NCC, MF, ECHS, etc §  India is the 6th largest country in terms of defense spending, with the enEre defence sector, including defence pensions, accounEng for 2.4% of India’s GDP in 2016-17 §  India’s Defence budget for 2016-17: INR 2,491 bn (1.65% of GDP in 16-17) §  Majority of the defense budget is allocated for revenue expenditure (65% for the year 2016-17) and the Army receives the largest allocaEon §  Outlay on capital expenditure as per budget esEmates has decreased in 2016-17 budget for accommodaEng increases in pay (7thCPC recommendaEons) and pension (OROP) 596 215 87 66 55 51 51 41 0.0% 4.0% 8.0% 12.0% 16.0% - 200 400 600 USA China Saudi Arabia Russia UK India France Japan Military Expenditure by Country Military Expenditure in 2015 (USD bn) % of GDP 113 125 134 152 163 80 78 95 95 86 193 203 229 247 249 0 50 100 150 200 250 300 2012-13 2013-14 2014-15 2015-16 2016-17 Indian Defence Budget (INR ‘000 cr) Revenue Expenditure Capital Expenditure Total 52% 16% 21% 5% 5% Breakup of 2016-17 Defense Budget Army Navy Air Force DRDO Others*
  10. 10. 10 ..but is the largest importer of arms in the world Source: SIPRI, Dhirendra Singh CommiGee Report 2015, Ministry of Defense 14.0% 7.0% 4.7% 4.6% 3.6% 3.4% 3.3% 2.9% 2.9% 2.6% 0.0% 5.0% 10.0% 15.0% India Saudi Arabia China UAE Australia Turkey Pakistan Vietnam US South Korea Top 10 Arms Importer, 2011-15 (% of Global Share) §  Due to lack of indigenously designed weapons, India has to primarily rely on imports for meeEng its defence capital acquisiEon requirements §  Russia is the biggest supplier of arms to India, though US imports in India have started growing off late §  Going forward, India’s capex spend is expected to go up as ~50% of the country’s defence equipments are obsolete 70% 14% 5% 12% Top Suppliers of Arms to India (2011-15) Russia US Israel Others 382 292 262 - 100 200 300 400 500 FY14 FY15 FY16 Procurement from Foreign Vendors by Indian Armed Forces (INR bn) India should accelerate its efforts to manufacture in India, which will lead to increased self-reliance in arms procurement, and save precious foreign exchange – hence the focus on “Offset Program”
  11. 11. 11 Indian Defense Offset Program 2SECTION
  12. 12. 12 Defense Offsets Source: McKinsey, Public Sources What are Defense offsets? §  CompensaEon arrangements required by the government as a condiEon of the purchase of goods and services from non-domesEc suppliers §  Offsets can take either of two forms: direct offsets (agreements which are directly related to the defense products being sold) and indirect offsets §  Governments typically give offset packages a significant weightage when evaluaEng compeEng bids from various foreign suppliers §  Offset obligaEons are mostly fulfilled through award of “credits”. Credits may be earned using a “mulEplier,” or an incenEve that reflects the country’s desire to direct funding or services toward parEcular sectors or iniEaEves. Benefits of Offset programs §  Governments count on the local investments and technology transfer that offsets generate to jusEfy the capital expenditures required for their defense upgrades §  For global defence companies, offsets help them tap difficult to access markets through their industrial relaEonships with local partners (for joint producEon or development) Risks in Offset Agreements §  Offsets can pose legal and reputaEonal risks for the contractors which act improperly in fulfilling their offset obligaEons §  Another risk over the long term is increased compeEEon from companies that have gained key capabiliEes through offsets
  13. 13. 13 Indian Defense Offset Policy Source: Ministry of Defence * No revision in 2013 but changes in 2012 were incorporated in 2013 §  The Defence Offset policy, was formally announced for the first Eme in 2005. Over the period 2005-2016, the Defence Offset Guidelines have been revised mulEple Emes based on feedback from various stakeholders. §  Defence Offsets Management Wing (DOMW) under the Department of Defence ProducEon is responsible for formulaEon of Defence Offset Guidelines Revisions in Defense Offset Guidelines over the years Current Defense Offset Guidelines (as per DPP 2016) §  The current DPP 2016 lays down various categories of procurement processes namely, in priority, Buy Indian – IDDM (Indigenously Designed, Developed & Manufactured), Buy Indian, Buy & Make (Indian), Buy & Make (Global) and Buy Global* §  The Offset clause is applicable for ‘Buy (Global)’ or ‘Buy and Make’ categories of procurements where the indicaEve cost of acquisiEon is INR 2,000 crores or more §  30% of the es9mated cost of the acquisi9on in ‘Buy (Global)’ category acquisi9ons and 30% of the foreign exchange component in ‘Buy and Make’ category acquisi9ons will be the required value of the offset obliga9ons §  The offset condiEon forms a part of the RFP and subsequently of the main contract. A separate offset contract is executed simultaneously with the main contract. 2005 2006 2008 2011 2012 2013 2016 *Details of categories of procurement under DPP 2016 provided in Annexure I
  14. 14. 14 Defense Offset Ecosystem Source: DPP 2013 Indian Offset Partner (IOP) Foreign OEM/ Vendor Regulators Avenues for Discharge of Offset Obliga9ons §  Direct Purchase/ Exports §  FDI §  Investment in kind- TOT §  Investment in kind- Others §  Government InsEtuEons §  DRDO §  Ministry of Defense §  DIPP §  Defense PSUs §  Ordnance Factories §  DRDO §  Private Players Tier I sub- vendor Discharge of Offset Obliga9ons §  Vendor Responsibility §  Period for discharge §  Performance bond §  Mandatory Offsets §  Offset credits for TOT §  Offset Banking §  MulEpliers §  ValuaEon of Offsets Management of Offsets §  Acquisi9on Wing - Responsible for technical and commercial evaluaEon of offset proposals §  DOMW - FormulaEon of Defence Offset Guidelines and all ma@ers relaEng to post contract management Requirement from IOP §  Include Indian enterprises and insEtuEons and establishments engaged in manufacture of eligible products and/or provision of eligible services, including DRDO §  IOP shall comply with the guidelines/ licensing requirements sEpulated by DIPP §  The OEM/vendor/Tier-I sub-vendor is free to select IOP for implemenEng the offset obligaEon, provided the IOP has not been barred by MOD
  15. 15. 15 Avenues for discharge of offset obliga9ons Source: DPP 2013 • Direct purchase of, or execuEng export orders for, eligible products manufactured by, or services provided by Indian enterprises, i.e. Defence Public Sector Undertakings, Ordnance Factory Board and private and public sector Indian enterprises. Direct Purchase/ Exports • Foreign Direct Investment in joint ventures with Indian enterprises (equity investment) for the manufacture and/or maintenance of eligible products and provision of eligible services FDI • Investment in ‘kind’ in terms of transfer of technology (TOT) to Indian enterprises for the manufacture and/or maintenance of eligible products and provision of eligible services • This could be through joint ventures or through the non-equity route for co-producEon, co-development and producEon or licensed producEon of eligible products and eligible services Investment in kind- TOT • Investment in ‘kind’ in Indian enterprises in terms of provision of equipment through the non-equity route for the manufacture and/or maintenance of eligible products and provision of eligible services (excluding TOT, civil infrastructure and second hand equipment) Investment in kind- Others • Provision of equipment and/or TOT to Government insEtuEons and establishments engaged in the manufacture and/or maintenance of eligible products and provision of eligible services, including DRDO Government ins9tu9ons • Technology AcquisiEon by the Defence Research and Development OrganizaEon in areas of high technology DRDO §  Mandatory Offsets: Ø  A minimum 70 percent of the offset obligaEon must be discharged by any one or a combinaEon of Direct Purchase/ Exports, FDI, “Investment in Kind- TOT” or “Investment in Kind-Others” Ø  Where the discharge of offset obligaEons is proposed in terms of “Investment in Kind-Others”, the vendor is required to buyback a minimum 40% of the eligible product and/or service (by value) within the permissible period for discharge of offset obligaEons §  Offset Credits for ToT: Where the discharge of offset obligaEons is proposed in terms of “Investment in Kind- TOT”, the offset credit for TOT shall be 10% of the value of buyback during the period of the offset contract, to the extent of value addiEon in India
  16. 16. 16 Discharge of Offset Obliga9ons (1/2) Source: DPP 2013 Vendor Responsibility §  The Vendor of the equipment under the main procurement contract responsible for the fulfilment of offset obligaEons §  The Vendor can allow his Tier-1 sub-vendors under the main procurement contract to discharge offset obligaEons, to the extent of their work share (by value), on behalf of the main vendor §  But, overall responsibility and liability for the full discharge of offset obligaEons conEnue to remain with the main vendor Period for Offset Discharge §  Offset obligaEons are to be discharged within a Eme frame that can extend beyond the period of the main procurement contract by a maximum period of two years §  The period of the main contract includes the period of warranty of the equipment being procured under the main contract Performance Bond §  When the period for discharge of offset obligaEons exceeds the period of the main procurement contract, the vendor is required to furnish an addiEonal Performance Bond to DOMW in the form of a Bank Guarantee covering the full value of the un-discharged offset obligaEons §  This Performance Bond shall be reduced annually, unEl full exEncEon, based on the pro rata value of the discharged offset obligaEon accepted by the DOMW. The addiEonal Performance Bond shall be submi@ed six months prior to expiry of the main Performance-cum-Warranty Bond
  17. 17. 17 Discharge of Offset Obliga9ons (2/2) Source: DPP 2013 Offset Banking §  Banking of offset credits is permissible in respect of offsets sEpulated under Direct Purchase/ Exports, FDI, “Investment in Kind- TOT” or “Investment in Kind-Others” §  Pre-approved banked offset credits can be considered for discharge of offset obligaEons subject to a maximum of 50% of the total offset obligaEon under each procurement contract §  Banked offset credits remain valid for a period of 7 years from the date of acceptance by DOMW §  Banked offset credits are not transferable except between the main vendor and his Tier-1 sub- vendors within the same procurement contract* Mul9pliers^ §  In the discharge of offset obligaEons under Direct Purchase/ Exports, FDI, “Investment in Kind- TOT” or “Investment in Kind-Others”- a mulEplier of 1.50 is permi@ed where Micro, Small and Medium Enterprises (MSME) are IOPs §  In the discharge of offset obligaEons under technology acquisiEon by DRDO, a mulEplier up to 3 is permi@ed Date of Discharge and Valua9on of Offsets §  the date of discharge of offset obligaEons under Direct Purchase/ Exports is reckoned as the date of invoice or the date of final payment whichever is later. In case of equity investment under any of the other five methods), the date of compleEon of the transacEon, based on documentary evidence, is reckoned as the date of discharge of offset obligaEon. §  The value of the offset components for which offset credits are sought have to be supported by documentary evidence. Only transacEons undertaken ager signing of the offset contract are reckoned for discharging offset obligaEons (excluding Offset Banking) *The main vendor is required to submit a list of such Tier-1 sub- vendors along with the technical and commercial offset proposals ^ Details of mulEpliers provided in Annexure II
  18. 18. 18 Recent Amendments in Defense Offset Policy (1/2) Key Issue Recent Amendment in Offset Policy Unrealis9c offset offers and inflexibility for suppliers §  Time lag between submission of offset offers, finalizaEon and implementaEon of the offset contracts §  Suppliers face difficulEes in providing upfront specific descripEon of products, work share, yearly discharge schedule and supporEng documents to establish eligibility of IOPs §  Pre-Contract Stage: Vendors now have the opEon, to submit detailed offset proposals at a later stage. The vendor can finalize its IOPs and offset product details either at the Eme of seeking offset credits or 1 year prior to the intended offset discharge through the IOP §  Post-Contract Stage: Enabling provisions have also been provided at the post-contract stage for change in IOP/ offset component and re-phasing within the performance period, and a provision has been introduced allowing addressing of supplier's requests to change the IOP or their offset component as per requirement during the period of the contract Exchange rate varia9on during course of offset discharge §  Exchange Rate VariaEon (ERV) has been made applicable for Rupee contracts with Indian vendors based on RFPs issued under all categories of capital acquisiEons where there is an import content. §  However, ERV clause will not be applicable to contracts where the delivery period is less than 1 year and the rate of exchange is within the band of +/- 2.5% 1 2
  19. 19. 19 Recent Amendments in Defense Offset Policy (2/2) Key Issue Recent Amendment in Offset Policy Non-availability of Services as an eligible avenue for offset discharge 'Services' (kept in abeyance since May 2013) were reinstated, in December 2015, as an eligible avenue for offset discharge: §  Maintenance, repair and overhaul; upgradaEon/life extension; and research and development services (from government recognized R & D faciliEes) have been reinstated. §  Engineering, design and tesEng; and sogware development services, have been reinstated with capping at 20% of the total offset obligaEon and prescribing of a random audit §  Quality assurance; and training services sEll conEnue to be under abeyance. High offset trigger for Indian companies par9cipa9ng in 'Buy (Global)' Tenders §  Indian vendors parEcipaEng in 'Buy (Global)' category procurements, were required to discharge offset obligaEon on the foreign exchange component of the contract, if the indigenous content (by value) in the product was less than 50%. §  This threshold has now been reduced to 30%. Offset obligaEons will not be a@racted if the indigenous content in the product is 30% or more. If it is less than 30%, then the offset obligaEons are to be fulfilled to the tune of 30% less the indigenous content percentage. 3 4
  20. 20. 20 Indian Defense Offset Opportunity 3SECTION
  21. 21. 21 Current Status of the Offset Program Source: Ministry of Defence Number of Contracts Offset Value (USD mn) % of Total Air Force 16 3,904 79% Navy 6 886 18% Army 3 180 4% TOTAL 25 4,970 100% Offset Contracts signed by MoD 9ll October 2014 §  First offset contract was signed in 2007 §  As per Ministry of Defense, it has overall signed 29 offset contracts worth USD 6.13 bn Ell May 06, 2016 which have to be discharged Ell 2022 §  Offset obligaEons to be discharged in respect of defence contracts signed was USD ~2.23 bn by 31st December 2015 §  Vendors have reported discharge claims worth USD~ 1.78 bn* through their quarterly reports 46% 16% 34% 4% Offset Breakup- By Geography (Till October 2014) USA Russia Europe Israel *Subject to audit 40% 33% 27% Offset Breakup- By Sector (Till October 2014) Defense PSUs Large Industries SMEs
  22. 22. 22 Es9mated Defense Offset Opportunity (FY17- FY22) Par9culars FY17- FY22 Remarks Indian Defence Spend (USD bn) 412 Defense budget to become 2.25% of India’s GDP Capex Spend as % of Defence Spend 49% Capex to Opex mix expected to improve in next 5 years from the current level EsEmated Capex Spend (USD bn) 201 EsEmated New Armament Spend (USD bn) 171 New Armament Spend esEmated at 85% of overall capex spend Imports as % of New Armament Spend 55% Import part of capex spend is expected to reduce over next 5 years with India’s focus on indigenizaEon “Make in India” Imported Equipment Spend (USD bn) 94^ Offset as % of Imports 30% Addressable Offset Opportunity (USD bn) 28 Average Offset Opportunity per year (USD bn)* 5.6 Source: FICCI Exchange Rate: USD 1= INR 67 * Timing uncertain for these offsets ^ As per DPP 2016, only acquisi@on contracts >INR 2000 crore (USD ~300 mn) eligible for offsets Based on simplis9c assump9ons, it is es9mated that USD ~6 bn in addi9onal offset opportuni9es will be generated for Indian players during the period FY17-FY22; however a more realis9c expecta9on based on current experience makes us believe that the Es9mated Capex Spend will not cross USD 100 bn over the next 5 years
  23. 23. 23 Limited Impact of the Offset Program 4SECTION
  24. 24. 24 There has been growth in A&D Exports since 2007…… Source: Interna@onal Trade Centre *ITC (HS) Codes are broad-based and inclusive of few non-defence items also Does not include services, inland and coastal security 83 96 80 61 200 69 379 1,614 1,313 1,998 2,664 2,039 4,805 4,448 - 1,000 2,000 3,000 4,000 5,000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 India Exports of A&D Equipment (USD mn)* Total ITC- 93 ITC- 8906 ITC- 88 ITC- 8710 ITC HS Code Category Descrip9on 8710 Tanks and other armoured fighEng vehicles 88 Aircrag, spacecrag, and parts thereof 8906 Vessels, incl. warships and lifeboats 93 Arms and ammuniEon; parts and accessories thereof §  Items eligible for offset discharge broadly fall under 4 categories under ITC HS classificaEon- 93, 8906, 88 and 8720 §  Growth in exports of A&D equipment from India has coincided with the promulga9on of offset policy since 2005 §  Exports under ITC HS Code 88, which cater to ‘aircrag, spacecrag and parts’, account for 85% share of exports in 2015 §  However, majority of exports under this category consEtutes of civilian aircrags and related components sent abroad for MRO
  25. 25. 25 but mostly aircrar parts are being exported…. Source: Interna@onal Trade Centre Country-wise Exports to Countries with Offset Liabili9es under ITC HS Codes 8802 and 8803 in 2015 Country Exports under ITC HS 8802 Exports under ITC HS 8803 USD mn USD mn USA 101 374 UK 6 216 France 2 130 Russia - 95 Israel - 55 Switzerland - 25 Italy - 11 Others 2,329 326 Total 2,438 1,299 §  Value of exports under the two heads, 8802 and 8803, accounted for ~84% of the total A&D exports in 2015 §  Category 8802 refers to “powered aircrags including helicopters, aeroplanes, spacecrag incl. satellites and spacecrag launch vehicles” while 8803 refer to “parts of aircrag and spacecrag “ §  Majority of exports to the countries having offset discharge liabili9es are in the category 8803, implying mostly parts and components are being exported to these countries by Indian suppliers §  Substan9al rise in exports under category 8803 to countries with offset liability from 2007 onwards, further reinforces that offsets have resulted in substan9al increase in Indian exports of aircrar parts to these countries 50 37 42 46 204 621 476 1,004 910 1,066 902 844 906 - 200 400 600 800 1,000 1,200 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 India Exports under ITC HS Code 8803 (USD mn) USA UK France Russia Israel Switzerland Italy Total
  26. 26. 26 …and there is negligible FDI from Offsets so far Source: DIPP, Ministry of Defense §  As per DIPP, India has received FDI worth only USD ~5 mn in Defense Industries from Apr-2000 to Sep-2016. §  This lack of interest can be a@ributed majorly to 26% limit on FDI in Defence Industries which was in place Ell August 2014. However, there is not a single inflow which was brought in by companies having offset liability with MoD §  The Government has liberalized FDI policy provisions in defence sector vide. Press Note.5 (2016 Series) on 24th June, 2016 §  As per the new FDI policy, foreign investment upto 49% is permi@ed under automaEc route and beyond 49% through Government approval route wherever it is likely to result in access to modern technology or for other reasons to be recorded §  Since opening of defence sector for FDI, 36 FDI/ JV proposals have been approved for manufacture of various licensable defence items Ell date. Ager the noEficaEon of revised FDI policy in June 2016, 6 proposals have been received by the FIPB Ell date. 56,080 24,250 22,050 21,169 15,793 5 - 20,000 40,000 60,000 Services ConstrucEon IT Sogware & Hardware Telecom Automobile Defence Cumula9ve FDI Inflows (USD mn) in India from April 2000- September 2016 There has been negligible FDI which has come into India on account of Offsets. Impact of increase in FDI cap to 100% on the discharge of offset obliga9ons remain to be seen.
  27. 27. 27 Historical Reasons for Limited Impact of Offset Program §  Rigidity of the Offset Policy combined with a weak governance structure where there is no strategic direcEon and no major power given to the DOMW is a major hindrance §  Lack of a mulE-Eer ecosystem like in the automoEve sector has reduced the scope for outsourcing by global majors §  ExisEng supply chain is dominated by small players developed by the PSUs who had a monopoly in this market; small players suffer from lack of capital, technology and process capabiliEes to service global majors §  Lack of paEent capital to support the long gestaEon periods – a significant feature of this sector; financial sources of capital such as private equity and venture capital do not enter at an early stage due to long gestaEon period of projects §  Lack of coordinated efforts amongst mechanical engineering, electronics, design and the informaEon technology sectors so as to offer a complete soluEon to customers; a coordinated approach can enable building of enEre pla}orms which will, apart from adding value, build volume in this sector §  Lack of Industrial clusters like in automoEve and other sectors; globally, large scale industrial growth has happened when they have adopted a 'cluster approach’ §  Non availability of raw material sources within the country and conEnued reliance on imports
  28. 28. 28 Opportunity Ahead 5SECTION
  29. 29. 29 Opportuni9es Ahead … Source: SIPRI, Indian Budget Documents, FICCI §  As per a report by FICCI, a combinaEon of factors such as offsets, outsourcing, defense capital expenditure spends, etc could drive the defense spend from $6 billion in FY 14 to an esEmated $41 billion by FY 22 as below:
  30. 30. 30 Opportuni9es Ahead … Source: KPMG Report 2015 §  Expenditure on capital equipment by all segments of the armed forces to gather steam; it is expected that capital expenditure will rise to 50% of defense expenditure as against 35% currently and revenue expenditure will decline correspondingly; some high Ecket items of immediate priority are listed below: Air > USD 30 billion Naval > USD 22 billion Land > USD 16 billion Rafale, Avro Replacement Program, Pilatus Trainer Aircrag, Light UElity Helicopter, Sukhoi Fighter Jet, Tejas LCA, Kamov Helicopters Soldier as a System Program, Infantry Combat Vehicle, M777 Ultra Light Howitzers, Light Armored MulEpurpose Vehicle, Thermal Imaging Sights for T-72 tanks Submarines (Project 75I), Indigenous Aircrag Carrier (INS – Vishal), MulE Role Frigates (Project 17A), Landing Pla}orm Docks, Corve@es (Warships – Project 28A)
  31. 31. 31 Opportuni9es Ahead … §  A strong eco-system is being created for aerospace & defense in India: §  Large business groups such as Tata’s, Aditya Birla, Reliance, L&T, etc are using their core competencies to enter the defense industry challenging the large bureaucraEc PSUs §  Companies such as M&M & Bharat Forge that have been in auto components are looking to move up the value chain in aerospace & defense and this trend is find favor with mid sized auto component companies who are using capabiliEes such as Quality (QS-ISO cerEficaEon, Product CapabiliEes (small car manufacturing in India), availability of skilled manpower and proximity to key markets as a foundaEon for moving into the aerospace & defense sector; §  Emergence of clusters dedicated to aerospace & defense as shown below.
  32. 32. 32 Opportuni9es Ahead … §  Other factors contribuEng to large anEcipated growth ahead include: §  LiberalizaEon of the offset norms and procurement processes of PSUs driven by the Government's 'Make In India' iniEaEve has enthused larger private sector players to enter this sector §  Large global companies such as Thyssen Krupp seong up warehouses in India, easing the supply of criEcal raw material §  Skill development iniEaEves have started building human resource capacity §  The global socio-poliEcal climate, especially with China and Pakistan; Donald Trump’s elecEon to the Presidency of USA and his equaEon with PuEn of Russia could be a benefit to India as well as we import 70% of our arms from Russia §  India’s current fiscal posiEon with Public Debt to GDP raEo seen as comfortable, could spur defense spending on capital expenditure
  33. 33. 33 Thank You Contact Persons: Sanjay Bansal Founder & Managing Partner Aurum Equity Partners LLP Tel: +91 124 4424477 Mob: +91 98110 10810 Email: Vikram Bihani Partner Aurum Equity Partners LLP Tel: +91 80 67205598 Mob: +91 9886409387 Email:
  34. 34. 34 Annexures 6SECTION
  35. 35. 35 6A Annexure I: Impact of Recent Events
  36. 36. 36 Rafale Deal with France Source: Public Sources Rafale Deal Par9culars Value Contract Size (INR bn) 590 Offset Clause of Rafale Deal 50% Offset Opportunity (INR bn) 295 Offset Discharge Period (years) 7 Annual Offset Opportunity (INR bn) 42 USD~630 mn of annual offset opportunity available to Indian Defense industry from the Rafale deal over next 7 years §  India signed Euro 7.87 billion (Rs 59,000 crore) agreement with France for purchase of 36 Rafale fighter on September 23, 2016 §  The offset clause of Rafale deal is a 50% investment commitment from the French industry in India §  The offsets will be carried out by French company Dassault and its vendors- Safran, Thales and MBDA, all part of the Rafale project §  As per the contract, Dassault is in charge of meeEng the offset obligaEons and has to share details of all its partners and planned work within one year of signing the contract §  ~74% of the 50% offset value should be exported from India §  Reliance Defence has already formed a JV with Dassault Systems “Dassault Reliance Aerospace” for execuEon of offset obligaEons Ø  Dassault expected to make aerostructures, engine parts and electronics at the Reliance facility in Nagpur Ø  Aim to make 50% of Rafale parts in India §  Besides the investment commitment, there is a 6% technology sharing component as well Ø  France likely to help India revive the unsuccessful Kaveri engine project for indigenous Tejas aircrag, and Ø  Transfer advanced technology to DRDO
  37. 37. 37 Increase in contract cost threshold in DPP 2016 Source: ASSOCHAM India, DPP 2016 As per DPP 2016 §  The offset clause would be applicable for ‘Buy (Global)’ or ‘Buy and Make’ categories of procurements where the indicaEve cost of acquisiEon is Rs. 2000 Crores or more, as on the date of accord of AoN. §  However, DAC may consider parEal or full waiver of offset clause. §  In case of a waiver for a parEcular acquisiEon case, eligible/selected Indian vendors need to be exempted from the corresponding IC sEpulaEons Likely Posi9ve Impact §  Management and monitoring by the MoD will become more efficient as the number of programmes decreases §  PosiEve from foreign OEMs perspecEve looking to invest in Indian defense opportuniEes Likely Nega9ve Impact §  Increase in threshold will reduce the number of projects eligible for offsets and hence quantum of offsets flowing into the country §  Detrimental to the Make in India narraEve which promotes development of local industry and ploughing back of capital into the country
  38. 38. 38 6B Annexure II: Categories under DPP 2016
  39. 39. 39 Categories of Procurement under DPP 2016 Source: DPP- 2016 In decreasing order of priority the procurement of defence equipment, under DPP 2016 are categorized as follows: • ‘Buy (Indian-IDDM)’ category refers to the procurement of products from an Indian vendor meeEng one of the two condiEons: products that have been indigenously designed, developed and manufactured with a minimum of 40% Indigenous Content (IC) on cost basis of the total contract value; or, products having 60% IC on cost basis of the total contract value, which may not have been designed and developed indigenously Buy (Indian- IDDM) • ‘Buy (Indian)’ category refers to procurement of products having a minimum of 40% IC on cost basis of the total contract value, from an Indian vendor Buy (Indian) • ‘Buy & Make (Indian)’ category refers to an iniEal procurement of equipment in Fully Formed (FF) state in quanEEes as considered necessary, from an Indian vendor engaged in a Ee-up with a foreign OEM, followed by indigenous producEon in a phased manner involving ToT of criEcal technologies as per specified range, depth and scope from the foreign OEM. Under this category of procurement, a minimum of 50% IC is required on cost basis of the ‘Make’ porEon of the contract. Buy and Make (Indian) • ‘Buy & Make’ category refers to an iniEal procurement of equipment in Fully Formed (FF) state from a foreign vendor, in quanEEes as considered necessary, followed by indigenous producEon through an Indian ProducEon Agency (PA), in a phased manner involving ToT of criEcal technologies as per specified range, depth and scope, to the PA Buy and Make • ‘Buy (Global)’ categorizaEon refers to outright purchase of equipment from foreign or Indian vendors. In case of foreign vendors, Government to Government route may be adopted, for equipment meeEng strategic/long term requirements. Buy (Global)
  40. 40. 40 6C Annexure III: Mul9pliers
  41. 41. 41 Annexure II: Mul9pliers Source: DPP- 2013 Defini9on of Micro, Small and Medium Enterprises §  In the case of enterprises engaged in manufacture of goods: Ø  A micro enterprise is that where investment in plant and machinery does not exceed INR 2.5 million; Ø  A small enterprise is that where investment in plant and machinery is more than INR 2.5 million but does not exceed INR 50 million; and Ø  A medium enterprise is that where investment in plant and machinery is more than INR 50 million but does not exceed INR 100 million §  In the case of enterprises engaged in providing services: Ø  A micro enterprise is that where investment in equipment does not exceed INR 1 million; Ø  A small enterprise is that where investment in equipment is more than INR 1 million but does not exceed INR 20 million; and Ø  A medium enterprise is that where investment in equipment is more than INR 20 million but does not exceed INR 50 million Mul9plier for Technology Acquisi9on by DRDO §  MulEplier of 2.0 is applicable when the technology is offered for use by Indian Armed Forces only but without any restricEon on the numbers that can be produced §  MulEplier of 2.5 is applicable when the technology is offered for use only in Indian Market but for both military and civil applicaEons and without any restricEon on the numbers that can be produced §  MulEplier of 3.0 is applicable when the technology is offered without any restricEon and with full and unfe@ered rights, including right to export
  42. 42. 42 6D Annexure IV: Abbrevia9ons
  43. 43. 43 Abbrevia9ons bn Billion MF Military Farms CPC Central Pay Commission mn Million DGQA Directorate General Quality Assurance MOD Ministry of Defence DIPP Department Of Industrial Policy & PromoEon NCC NaEonal Cadet Corps DOMW Defence Offsets Management Wing OEM Original Equipment Manufacturer DPP Defence Procurement Procedure OF Ordnance Factory DRDO Defence Research and Development OrganisaEon OROP One Rank One Pension ECHS Ex-Servicemen Contributory Health Scheme PA ProducEon Agency FDI Foreign Direct Investment RFP Request for Proposal FF Fully Formed RR Rashtriya Rifles GDP Gross DomesEc Product SIPRI Stockholm InternaEonal Peace Research InsEtute IC Indigenous Content TOT Transfer of Technology IDDM Indigenously Designed Developed and Manufactured UK The United Kingdom INR Indian Rupee USA United States of America IOP Indian Offset Partner USD United States Dollar