Russia-Ukraine Crisis and the Impact on the Aerospace and Defence Industry


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Frost & Sullivan Market Insight: Russia-Ukraine Crisis and the Impact on the Aerospace and Defence Industry

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Russia-Ukraine Crisis and the Impact on the Aerospace and Defence Industry

  1. 1. March 2014 Russia-Ukraine Crisis and the Impact on the Aerospace and Defence Industry Plus Ça Change, Plus C’est La Même Chose
  2. 2. 2 The political, foreign policy, and economic impact of this latest foray into the political affairs of a neighbour will be a potentially significant moment in the recent history of Russia's relationships with its neighbours and with the West, as was the 2008 war with Georgia. That said, such a geopolitical shock is unlikely to come as a huge surprise to any business investing in the region. Despite the initial negative stock market reaction to the spiralling crisis, many investors have chosen to bide their time before deciding whether to jettison investments in the region and markets rallied after the first day of panic wiped 11% from the Moscow Interbank Currency Exchange (Micex). At this stage, economic sanctions look unlikely and hence the economic and financial impact of the crisis appears to be so far limited. Whatever happens with foreign investment in Russia and Ukraine, foreign investment in the Aerospace and Defence (A&D) industry, including in the civil security market, is unlikely to be hugely impacted. European and Russian trade is growing ever more interdependent and sanctions would harm both economies; Russia has around 50% of its foreign trade with Europe. This is not regarded as a preferred option at this stage. Even if it were, export sanctions against Russia would not have a significant impact for A&D companies because of the limited, non-strategic reliance on imports in Russia and the fact that local production with foreign companies is done in country on a joint venture basis. In fact, in the defence market, Russia recently set in motion an initiative to ban defence imports entirely in segments where a viable Russian alternative is available. Since embargoes remain highly unlikely at this stage, it is not expected that foreign companies will be banned from doing business in Russia which means joint ventures are unlikely to be affected. The Russian defence and security sectors do have some considerable cooperation with Western companies on sizeable contracts, generally on a case-by-case basis. As things currently stand, ongoing programmes will not be affected in either sector. Likewise, in commercial aerospace, even though Russian airlines still operate on a majority of Western-built aircraft and new Russian aircraft programmes rely predominantly on Western parts, it is not expected that these supply-chain partnerships will be abandoned. Foreign investment in these markets in Ukraine is negligible, even as the country attempts to re-define its socio-political and socio-economic allegiances, trying recently to be aligned better with the West and particularly with Europe. Even Ukrainian military forces, following increased cooperation with the North Atlantic Treaty Organisation (NATO) in the last decade, only have minimal amounts of Western equipment, mainly just a handful of High Mobility Multipurpose Wheeled Vehicles (HMMWV) gifted by the United States (US). Cooperation in commercial aerospace is largely through Antonov aircraft programmes, which are mainly focussed on the Russian market anyway.
  3. 3. 3 Ukraine’s military and economic reliance on Russia is so vast that Moscow can exert an incredible amount of pressure on the country. In the A&D industry, Ukraine is likewise tied to Russia. Unless this situation ends in a wholesale volte face, with the Ukraine shifting it’s orientation entirely from Russia to the West, which would no doubt involves years of civil strife to achieve, there is unlikely to be any growing Ukrainian partnerships with Western A&D capabilities in the short term. Ukraine has, for the past few years, placed rapprochement with the European Union (EU) at the top of its foreign policy agenda, but achieving close economic ties is going to require a long struggle against the tide of history. The highest level of cooperation, in defence and security, is between Russian and European companies, a result of increasingly intertwined economic relations in general. German, Italian, and French A&D companies, in particular, have significant partnerships with Russian counterparts. However, the current crisis is expected to have a short-lived, if any, impact on their balance sheets. It is highly unlikely that major European companies will be unable to ride out this crisis, and, even if forced to abandon current joint ventures, they will easily rekindle business once the situation normalises. In the commercial aerospace sector, it is mainly US companies with the greatest presence. Again, any negative impact would only result in short-term losses. Among the Europeans, Italian A&D investment in Russia is notable. Iveco agreed joint production of around 1,775 Light Mobility Vehicles (LMV), a contract valued around $1.0B if completed to plan, and Finmeccanica, through Augusta-Westland have a joint venture with Russian Helicopters to produce the AW139 in Russia. Elettronica S.p.A. was also chosen by Rosoboronexport to provide electronics and radio systems for the Russian Antonov An-140 regional commercial aircraft programme. French companies like Thales and Safran also have considerable partnerships with Russian organisations. Safran and Uralvagonzavod Joint Stock Company (UVZ) signed a Memorandum of Understanding (MoU) in 2012 for a long-term strategic partnership to locally produce Sagem’s optronic equipment and other high-tech products produced by Sagem Defense Securite for UVZ armoured vehicles and artillery systems. Thales, for example, is working closely with Gazprom in Russia and was also recently contracted to provide security to a Lukoil Mid-East Ltd. facility, a subsidiary of Russia’s Lukoil, in the West Qurna 2 oilfield southwest of Basra in Iraq. Airbus Group (previously in the guise of European Aeronautic Defense and Space Company - EADS) have investments in Irkut, part of Russia’s United Aircraft Corporation (UAC), and UAC held shares in EADS at one stage, though those were sold in the last few years. Turkey has increased cooperation with Russia of late too, having launched satellite programmes in Kazakhstan through a US-Russian joint venture as well as agreeing to procure civil helicopters for use in the Turkish fire service. In
  4. 4. 4 addition, Turkey explored air-defence systems cooperation with Russia for a ground-based missile defence programme. As of now, Turkey remains the only NATO country with which Russia has major defence-industrial cooperation. The British division of Finmeccanica’s Selex S.p.A., Selex Electronic System Ltd., also signed two agreements with Russia for the coproduction of aviation radio equipment. As for Germany, probably the most significant investment is from Rheinmetall who recently developed a military training services facility in Russia. Siemens and Bosch have investments in the Russian security market too. Outside of Europe, several US companies have trade with Russia equivalents. In the aerospace sector there are partnerships between US and Russian organisations on space programmes. For example, Rosoboronexport recently, in partnership with a US company, launched a Turkish satellite. It is the commercial aviation market that has the greatest amount of cooperation between US and Russian companies. Boeing, United Technology Corporation (UTC), Rockwell Collins, and Honeywell, for example, all have offices in Russia (and Ukraine, for that matter, given Antonov’s base). Boeing has a 50-50 joint venture in Russia under Ural Boeing Manufacturing (UBM) producing parts for the Boeing 787 aircraft. As for UTC, Pratt & Whitney supplies aircraft engines for the Russian MS21 aircraft programme. Both Rockwell Collins and Honeywell provide systems and components for Russian aircraft. Also, Canadian company Bombardier Inc. remains in negotiations with Rostech and Ilyushin for the final assembly and sale of its turboprop aircraft in Russia, despite the current situation. In the security sector, major companies like IBM, Cisco, as well as Honeywell’ security business, have presence in Russia. Some Indian companies have recently created partnerships with Russian firms and Israel also has defence-industry ties with Russia. A recent example of Russian-Indian cooperation, in addition to the years of exports from Russia to India, is the exploration of a joint venture for the production of missiles for ground artillery systems. Frost & Sullivan consultants based in Israel understand that the Israeli government is rethinking its defence-industry cooperation with Russia. Exports to Russia from Israel have long been scrutinised to ensure no strategic capabilities are transferred and additional caution is being taken now until more clarity is gained on how the current situation will unfold. Again, contracts are on a case-by-case basis, with no indication that ongoing partnerships will be cancelled at this time. As such, neither India nor Israel is likely to be hugely financially impacted by this situation. Exhibit 1: Examples of key Russian industry partnerships with Foreign Original Equipment Manufacturers (OEMs)
  5. 5. 5 (Source: Frost & Sullivan, Rapidly Emerging Markets, 2013) Foreign companies with partnerships in Russia, if derailed by economic sanctions, may only mean a short-term hiatus. Of course there will be short- term financial losses to the companies involved and contract losses would have a considerable impact to this year's balance sheet at least, but we are not seeing the prospect of deep international defence-industrial partnerships unravelling. In fact, it is very unlikely that any financial turmoil created will lead to a long-term reduction in the level of opportunity for foreign Aerospace, Defence, and Security companies operating in Russia itself or operating globally in partnership with Russian organisations. As a final note, this situation will increase the threat perceptions of former- Soviet nations on Russia’s periphery and other neighbouring countries. Frost & Sullivan’s defence research considers threat perception as a key driver of military spending and it is a critical parameter in defence market forecasts. The trend of increased defence spending noted in the last few years in countries like Poland, Estonia, Lithuania, and Latvia, for example, will continue to be underpinned by this factor. The current situation will do nothing to allay fears in those countries and cooperation with NATO will be high on their foreign policy agenda. Ukraine itself though will remain reliant on Moscow more so than the West for a long time yet.