Privatization of Australian Submarine Corporation


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My study in 2008 for an Australian client regarding the possibilities for privatization of Australian Submarine Corporation (ASC Pty.)

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Privatization of Australian Submarine Corporation

  1. 1. JAMES HASIK w w w . j a m e s h a s i k . c o m ! ! Date! 13 May 2008 ! To! [Redacted] ! Subject! Options for the Privatisation of ASC Attached please find my analysis of the Commonwealth’s options for the sale of ASC, and brief summary below. The Commonwealth’s objectives rather center on the maintenance or en- hancement of a submarine yard in Australia, but also include the fostering of competitive surface warship construction. At some point in the future, the government will turn to ASC either to build new submarines to print, to par- ticipate considerably with a foreign designer in engineering the specifically Australian requirements, or to launch a design effort largely on its own. With that in mind, there there are basically four options for ASC’s privatisation: public offering, trade sale to institutions, trade sale to a defense contractor or shipbuilder, or no sale at all. Each option for control brings considerably different effects in ownership, interest, domicile, and industry structure. Prospective buyers can be expected to value ASC for its current contracts, its potential cash flows, and their ability to leverage its skills, technologies, and costs globally. Current contracts represent real money that can be val- ued rather quickly. Cost synergies may prove considerably more elusive. That said, should the two most discussed strategic buyers, General Dynam- ics and ThyssenKrupp, bid for ASC, they will present the Commonwealth with stories of capabilities in costs, technologies & skills, and access to markets. These two owners of shipbuilders, however, have a mixed track record in these regards in past mergers. The strategic benefits of a strategic sale depend unpredictably on the pos- sibility of a range of technological, operational, and geopolitical develop- ments. What is most notable, though, is that the government’s latitude in developing future submarines to deal with security challenges could benefit from retaining the maximal choice over which companies to retain for what part of the submarine design. The government, then, should carefully con- sider its own strategic interests before selling ASC to a strategically moti-
  2. 2. vated buyer. In the end, the best course may lie in selling ASC to a reliably interested Australian institution. The purely financial stake of the narrowly interested could actually provide considerable strategic benefit to the Commonwealth. If I can be of any further help, do not hesitate to call. Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •!
  3. 3. Section One | The Commonwealth’s Objectives The Commonwealth government's objectives center on the maintenance or enhancement of a submarine yard in Australia, but also include the foster- ing of competitive surface warship construction. The Commonwealth government's objectives may include, in increasing scope of ambition, maintaining in Australia a yard and workforce capable of undertaking five tasks: Maintaining and modifying the Collins-class submarines. Almost without question, the yard at issue will continue to be ASC. This is not merely because the present government has given assurances that the ships will be built in Adelaide.1 Rather, it is more fundamentally because developing yet another facility for this purpose from scratch would be almost bizarre. In the first instance, training a staff and capitalizing a facility for through-life support did substantially moti- vate the decision to build the ships in Australia. As a federal parliamentary report put it in Sep- tember 2001, Deciding to build the submarines in Australia was the most important single act in the history of the program. It was done because it was thought to be the best means of providing efficient and effective support throughout the submarines' service lives. It was also to provide a basis for im- proving them over time to meet the demands of changing strategic circumstances.2 Maintaining this capacity is foremost a matter of financial commitment by the government; if the money is available, there should be enough skilled shipbuilders in Australia to accept the work, despite the short-term difficulties that Incat and Austal are experiencing staffing their commercial construction programs. Repairing and modifying a future class of submarines, presumably the replacement for the Collins class. Given Australia's distance from the nearest overseas submarine repair yard (in Guam), the quite arguable interest in maintaining the strategic latitude to make decisions about how the ships will be maintained, and the size of the submarine flotilla, it is almost incon- ceivable that a future government would choose not to fund ASC’s continuance as a repair yard for the Collinses and their replacements. Competing against other Australian shipyards in the construction of surface vessels, af- ter the completion of the Hobart-class air warfare destroyers. Australian naval shipbuilding and conversion might be expected to take a bit of a holiday in the next decade, after the con- struction of the Hobart-class destroyers, the completion of the Canberra-class helicopter carri- ers, and the upgrading of the Adelaide-class frigates. All the same, as noted below in section Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 1 of 28 1 Cameron Stewart, ‘Defense to Reach New Depths,’ The Australian, 19 April 2008 2 Derek Woolner, Getting in Early: Lessons of the Collins Submarine Program for Improved Oversight of Defence Procurement, Parliamentary Research Paper 3 2001–02, 18 September 2001. Accessible at
  4. 4. three, there may be a few more projects pending. ASC's competitiveness for these projects will depend in part upon its performance in building the Hobarts, for its reputation with the Collinses is mixed. Moreover, as evidenced by Northrop Grumman’s struggles with everything but the Virginia-class, success in submarines is not a strong indicator of success in surface combat- ants. Building a future class of submarines with overseas assistance in design and engineer- ing. While the main gate decision is not expected until 2011, Collins herself will reach her twen- tieth year of service in 2016; construction for the replacement of the class should begin some- time thereafter. As outlined below in section three, unless the government and ASC attempt to build bespoke submarines to a domestic and wholly new design, an overseas partner will be needed to provide the design and engineering details needed for a new class of ships. ASC does not maintain the engineering staff necessary for this task today—and well it should not, given the cost. Building that capacity domestically would be difficult to justify for the replacement of a class of six ships. Building a future class of submarines from an original Australian design. Australia’s sub- marine requirements may prove unique in the world, in that the Royal Australian Navy (RAN) needs vessels with considerably greater range and endurance than is available in any European or Japanese designs, but probably without the nuclear propulsion of which the American, British, French fleets avail themselves.3 Indeed, the Collinses themselves stand alone in this regard amongst diesel-electric submarines worldwide. The story of their gestation is well-known for its developmental troubles, in that the design from which it was adapted was much smaller, shorter-ranged, and possessed of a combat system intended for a wholly different marine envi- ronment—the shallow and narrow Baltic. The experience may lead a future government to de- cide to attempt a clean-sheet design, albeit with significant material and engineering input from suppliers worldwide. There is a residual objective: Raising money for the Treasury. A price of $700 million has been suggested as a target, though “the global credit crunch will narrow the field of interested buyers” and possibly cut this figure.4 Because all the major parties agree that privatisation is preferred, but because there also appears to be no urgency to launching the transaction, the sale is expected to be delayed. Still, as described in section three below, the form of the sale and the objectives of both the government and the prospective buyers will strongly influence the ultimate sale price. Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 2 of 28 3 Cameron Stewart, ‘Defense to Reach New Depths,’ The Australian, 19 April 2008 4 John Kerin, ‘Sale of $700m ASC stake stalls,’ The Australian Financial Review, 28 April 2008
  5. 5. Section Two | Options for Privatisation There are basically four options for ASC’s privatisation: an initial public of- fering (IPO), a trade sale to institutions, trade sale to a defense contractor or shipbuilder, or no sale at all. Each option for control brings a different set of effects in ownership, interest, domicile, and industry structure. Over time, the Howard and Rudd Governments, and the management of ASC, have succes- sively entertained these four options for the disposition of the company. Four broad factors de- termined by the form of the privatisation will substantially determine how ASC behaves in the future, and what actions future governments may need to undertake to safeguard its own inter- ests: Ownership may be diffuse or concentrated. An IPO almost necessarily distributes shares widely amongst the public (even if largely within Australia), leading to diffuse ownership and generally financial control over management’s performance. Relative failure will be reflected in poor returns to shareholders, which may eventually lead to a shareholder revolt, but which more generally lead to takeover offers from companies with presumably better management. Trade sales lead to relatively concentrated ownership. In some continental European countries (notably France), privatisation candidates considered strategic have often been sold to reliable and politically well-connected owners who can be trusted with the safeguarding of the state’s interest. This noyau dur concept limits the potential for foreign takeovers,5 though the same could be achieved with a law limiting foreign ownership to less than a controlling or even influ- encing stake. While concentrated ownership can lead to quick action to correct managerial problems, it also can decrease transparency and limit the "functioning of the market for corpo- rate control.”6 Concentrated ownership often provides more critical and demanding superiors to shipyard managers than merely the largely self-selected corporate board, but end results are not guaranteed. Northrop Grumman's acquisition of Litton Industries' Ingalls and Avondale yards (2000) and Newport News Shipbuilding & Drydock (2001) did not remarkably improve perform- ance at any of the yards for quite some time, and arguably not at all. The owner’s interest may be financial or strategic. To be sure, almost all owners are inter- ested in the financial performance of commercial assets. In the analysis of mergers and acquisi- tions, however, practitioners distinguish financial buyers from strategic ones. Financial buyers are wholly interested in the value of an asset as a stand-alone entity, even while seeking to un- lock additional value through improving operations, cutting costs, or other changes. Strategic Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 3 of 28 5 David Parker, Privatisation in the European Union: Theory and Policy Perspectives (Rout- ledge, 1998), p. 37 6 Ladan Mahoobi, Privatising State-owned Enterprises: An Overview of Policies and Practices (OECD Publishing, 2003), p. 113. See also Vivien A. Schmidt, 'Privatisation in France,' p. 65, in Ali Farazmand ed., Privatization or Public Enterprise Reform: International Case Studies with Implications for Public Management (Greenwood, 2000)
  6. 6. buyers hope to develop value by utilizing the purchased asset in conjunction with others they already own, or plan to own. In this sense, a pension fund would likely be considered a financial buyer, but a defense contractor or shipyard owner would almost certainly be considered a stra- tegic buyer. The difference is important to the government in that a strategic buyer can be ex- pected to hold a higher reservation price for any given asset, but to attain that price, will gener- ally plan to affect greater changes than a financial buyer. Thus, if the government chooses to sell to a company that already owns one or more shipyards, the acquirer may attempt to integrate their operations to some degree. The track record for find- ing interyard efficiencies in shipbuilding is mixed at best. As shown in section four, General Dy- namics was relatively successful in the 1990s cutting costs and improving processes at its two shipbuilding acquisitions, the Bath Iron Work (BIW) and the National Steel & Shipbuilding Com- pany (NASSCO). Northrop Grumman has, as noted, relatively struggled at its integration task. BAE Systems Ship Repair was also assembled through acquisition, now and undertakes just over 50 percent of all privately-provided military ship repair in the US with its four yards in Nor- folk, San Diego, San Francisco, and Honolulu. However, the company's predecessor, United States Marine Repair, was formed not so much as a vehicle for finding greater efficiencies be- tween yards, as one for bidding on the much larger "Multi-Ship, Multi-Option" (MSMO) repair contracts that the Navy began releasing for tender about five years ago. Still, if a strategic acquirer owns other yards, then some integration may be undertaken to im- prove returns either at ASC or the other yard. That is, a strategic owner could rationally act in a way that would lessen the capabilities of ASC as long as that action would improve the returns from other assets by more than an offsetting degree. The result may be beneficial to the owner, and even globally Pareto-efficient, but it could very well not be beneficial to the Commonwealth. An example of this may be found in Kockums' purchase by HDW (and the subsequent incorpo- ration of the whole enterprise into ThyssenKrupp Marine Systems). As explained below in sec- tion four, the Defence Ministry in Stockholm has not been happy with ThyssenKrupps' steward- ship of Sweden's sole large naval construction yard. The acquirer may be domiciled domestically or overseas. All things being equal, the gov- ernment might express no concern over overseas ownership of ASC. However, the government may very well insist, as Finance Minister Lindsay Tanner has suggested, that the chairman, chief executive, and a majority of members of the board of directors be Australian.7 If so, then any strategic acquirer other than Austal will effectively face a managerial buffer between its in- terests and those of the Commonwealth government. The approach would be broadly similar to that of a Proxy Agreement or a Voting Trust Agreement used in the United States for managing "Foreign Ownership, Control, or Influence" (FOCI) of military contractors.8 Buffering control would be, of course, the intent, but it would also dull the point of a strategic acquisition. The ac- Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 4 of 28 7 John Kerin, 'Sale of $700 million ASC stake stalls,' Australian Financial Review, 28 April 2008. 8 The agreements are almost identical in effect; the difference is that under the Voting Trust Agreement, the foreign owner transfers legal title in the company to trustees approved by De- fense Security Service. See National Industrial Security Program Operating Manual, 28 Febru- ary 2008, paragraph 2–303.
  7. 7. quirer would be limited in its ability use the assets of ASC in conjunction with those elsewhere in the world, and with the freedom to transfer value from ASC to an overseas facility. The issue of who is allowed to participate, and to what degree, is clearly strategic. In July 2001, Defence Minister Peter Reith announced that the selection of a contractor to upgrade the Col- linses’ combat systems would be postponed, because "a comprehensive arrangement with the US Navy on submarine issues is in Australia’s best strategic interests". In other words, a compe- tition between Raytheon and STN Atlas would not be reasonable if the US Navy was not going to choose a combat system from a German company, regardless of its quality.9 Raytheon's AN/ BYG-1 v8 combat system was eventually chosen for the ships.10 The other American company with a considerable interest in Australian shipbuilding today is General Dynamics (GD). GD has suggested purchasing up to 40 percent of ASC,11 a move that might be a logical outgrowth of the ‘capability partner agreement’ that it has had with ASC since 2002.12 GD also has a rather close relationship with Austal in their half of the US Navy’s Littoral Combat Ship (LCS) program. In 2005 and 2006, Austal chairman John Rothwell told the federal government that his firm was planning to make a joint bid for ASC with GD,13 a move which would presumably bring both the overseas strategic interest and the domestic domicile that the government seems to prefer. General Dynamics, however, is not the only capability partner that might assist with the con- struction of the replacements for the Collinses. If the design for the replacement submarines is not a wholly new and uniquely Australian creation, or a boat with only American and Australian combat systems, then the underlying design may come from overseas. ThyssenKrupp’s candi- dacy for the role of designer may suffer slightly from the contentious relationship that ASC and the Howard Government had with Kockums, but ThyssenKrupp’s Type 212A submarines are amongst the best-regarded worldwide, and the company has a long history of export success. Navantia and its S-80 fuel cell submarines are another possibility, particularly if the collaboration on the Air Warfare Destroyers goes well. Mitsubishi Heavy Industries is now building the rather Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 5 of 28 9 The Hon. Peter Reid, Media release: Submarine Combat System, 9 July 2001. 10 Australia’s Collins Class Subs, Submariners On Track for Upgrades, Defense Industry Daily, 15 November 2005. 11 Senator Robert Hill in the Australian Parliament, 11 January 2002, accessible at 12 See ‘Electric Boat Corporation signs as capability partner to Australian Submarine Corpora- tion,’ press release by the Hon. Robert Hill, Minister for Defence, 3 October 2002. GD’s subsidi- ary Electric Boat is assisting ASC in the Collins-class submarine program, and its subsidiary the Bath Iron Works is assisting ASC in the Hobart-class destroyer program. 13 ‘Austal in ring for defence firm,’ The West Australian, 31 May 2005; ‘Austal still keen on sub- marines,’ Australian Financial Review, 16 June 2005; ‘Austal cautions on sale of submarine builder,’ HR Monthly, August 2006
  8. 8. admired Soryu-class submarines with Kockums-built Stirling engines,14 though the Japanese government would need to consent to arms exports for this to matter. DCNS and Navantia’s col- laboration over the Scorpene submarine and its MESMA closed-cycle steam engine (see sec- tion four) are yet another possibility.15 The table below summarizes these effects of each of the four options on the ownership of ASC, its owners’ interest in it, the domicile of its corporate control, and the structure of the industry: SELECTED ECONOMIC EFFECTS OF EACH OPTION FOR PRIVATISATION Method of sale Ownership Interest Domicile Structure No sale concentrated captive domestic no change Public offering diffuse financial domestic no change Sale to institution concentrated financial domestic no change Sale to shipbuilder concentrated strategic depends depends Unaddressed at this point in the narrative is the future structure of the shipbuilding industry in Australia. Selling ASC to a company that does not own a shipyard, or not selling it at all, will leave the industry’s structure largely unchanged. Selling ASC to a shipbuilder is another matter. That is— The acquisition itself may lead to concentration in the industry, or no short-term change. This rather depends on who does the acquiring. If the acquirer only owns shipyards overseas, the mix of assets, technology, skills, and managerial acumen available to ASC may change. While the fundamental structure of the industry will not change immediately, ASC’s competitive- ness could increase in the long run, thus increasing competition within the industry domestically. If the acquirer owns a shipyard in Australia, the concentration in the industry may change, but this effectively depends on the degree of competition today between the acquirer and ASC. The table below summarizes the situation for three potential acquirers—ThyssenKrupp, General Dy- namics, and Austal—plus Tenix (BAE Systems) as a control case: Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 6 of 28 14 ‘First Improved Oyashio-class boat takes to the water,’ Jane's Navy International, 6 December 2007 15 Richard Scott, Spain’s S-80A submarine comes up to the surface, Jane's Navy International, December 2007
  9. 9. SELECTED ECONOMIC EFFECTS OF PRIVATISATION THROUGH SEVERAL POTENTIAL STRATEGIC BUYERS Shipbuilding buyer Ownership Interest Domicile Structure BAE-Tenix concentrated strategic UK concentrated ThyssenKrupp concentrated strategic Germany no change General Dynamics concentrated strategic US no change Austal concentrated strategic domestic some change Austal + GD concentrated strategic US & domestic some change The government would almost certainly reject a bid by Tenix or BAE Systems (assuming that BAE Systems’ proposed acquisition of Tenix Defence is approved) because it would sharply concentrate both shipbuilding market share and assets in one firm. An acquisition by Austal (or a combination of firms including Austal) would superficially concentrate the industry, but the an- ticompetitive effect may be slight. ASC builds submarines and steel-hulled destroyers; Austal (Australian Aluminum Ships) builds aluminum-hulled car ferries, patrol boats, and (now) small frigates like the LCS. Without significant overlap between the firms, the combined entity would not gain pricing power, either against Incat in aluminum ferries and small warships, or against Tenix in large steel warships. Section Three | Valuing ASC Prospective buyers will value ASC for its current contracts, its potential cash flows, and their ability to leverage its skills, technologies, and costs globally. ASC may be attractive to financial or strategic buyers, in rough order of decreasing tangible- ness, for four reasons. Financial and strategic buyers will value ASC's expected cash flow from existing pro- jects. These mainly comprise the long-term contract (through December 2018, with an option through December 2028) for the maintenance of the Collins-class submarines, and the more recent contract for the construction of the three Hobart-class Air Warfare Destroyers (AWDs), which will run through at least the middle of 2017. While modeling and valuing these operations is a nontrivial exercise, the through-life support contract is not difficult to grasp conceptually and to value. However, as Austal CEO John Rothwell told Business Review Weekly last December, "it would be easy to put a valuation on ASC if it was doing nothing other than servicing subma- rines. The complexity”, he noted, “will be AWD... With an $8 billion contract, you wouldn't want it to go too far wrong." Further, prospective buyers should be somewhat sanguine about the pros- Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 7 of 28
  10. 10. pects for wringing large savings out of the operation. As ASC CEO John Tunny put it late last year in the same article, "we're not being privatised for someone to come and fix us. We must always remember that submarines go to deep-dive depth. We can't lose sight of that at any time. It sits at the heart of our commercial sustainability."16 Financial and strategic buyers will value ASC's potential cash flow from future projects in Australia. Assuming that the Commonwealth government will want ASC to compete not just for a life-cycle maintenance contract for the Hobarts, but for further surface ship construction con- tracts as well, there may be a good deal available: ✦ Replacement of the Success. Project SEA 1654 is already planned to replace the support ship HMAS Success with a new vessel, much as HMAS Sirius replaced HMAS Westralia in 2006. The Sirius, however, was built by Hyundai in South Korea as the merchant tanker De- los, and was obtained just after builder's trials from its original owner, the Greek shipping line Tsakos Energy Navigation. This suggests strongly that the RAN may purchase its next cargo and refueling ship from a commercial yard, possibly again in an off-the-shelf manner, if the price is again right. ✦ Replacement of the remaining Kanimbla-class landing ship is an outside possibility, but this will more likely be accomplished with a contract for a with a commercially-derived and foreign-built roll-on, roll-off (ro-ro) ship. ✦ Early replacement of the ANZACs. With the retirement of the last of the Perth- (Charles F. Adams-) class destroyer in 2000, and the limited availability of the Adelaide- (Oliver Hazard Perry-) class frigates during the ongoing FFG Upgrade program, the ANZAC-class frigates have experienced heavier than expected usage, particular in support of the war effort in the Middle East. Replacement of the ANZACs may need to begin earlier than expected, though the first ship (HMAS Anzac herself) will not reach her twentieth year of service until 2016. ✦ Replacement of the Adelaides. The aforementioned FFG Upgrade program has not gone well, and the oldest ship of the class still serving, HMAS Sydney, is already 25 years old. Further, their systems require relatively large crews at a time when the RAN is short of sail- ors. With the debut of the AWDs and their Aegis systems, a new class of relatively auto- mated ships designed for littoral warfare may be a useful replacement for the four remaining FFGs. ✦ Replacement of the Balikpapan-class heavy landing craft. While several of the class played important roles in East Timor for both INTERFET (1999) and Operation Astute (2006), the ships' nine-knot top speed initially led the RAN to charter Incat 045 as HMAS Jervis Bay for the recurring run to Dili. It is reasonable to wonder whether these ships would be well-replaced with vessels that were either larger, faster, or both. ✦ Through-life support of the Hobart-class destroyers. By the time the Hobarts are ready for even their first pier-side maintenance period, ASC will have amassed years of experi- Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 8 of 28 16 Jeffrey Hutton, First Line of Defence, Business Review Weekly, 6 December 2007, p. 46.
  11. 11. ence in the care and feeding of the six Collins-class ships. While the capitalization of the yard and the tasks of the workers differ somewhat in the maintenance of submarines and destroyers, the collective experience in forecasting and managing work packages will be very useful. The RAN may also come to prefer ASC’s central location in Adelaide if the ships are to be based at both Fleet Base East and Fleet Base West. ✦ Replacement of the Collins-class submarines. This project is virtually guaranteed to ASC, its preliminary engineering work will begin in the next few years, and the prospect of a unique and indigenous Australian design promises any buyer a great deal of revenue. The preceding list encompasses only projects for the RAN, but no buyer should completely ig- nores the possibility of exporting ships from Australia. The Collinses have been described as an orphaned design, in that they are the unusual example of relatively large and long-ranged, but conventionally-powered submarines. As explained in section five, a number of possible techno- logical and geopolitical developments could make a submarine built to Australian specifications a more attractive purchase in several other countries. Strategic buyers may value the corporate citizenship of owning an Australian defence contractor. The intangible value that defense contractors accord to corporate citizenship has been recognized through several waves of merger activity.17 This was presumably much of Thales' motivation in acquiring Australian Defence Industries, and of EADS’s ongoing campaign of purchasing small-but-notable defense contractors in the United States. It is also a strategy whose payoff is difficult to adjudge: determining just how much of a premium to pay for local presence is at best an art. Strategic buyers may value the technologies, skills, and costs that could be leveraged and shared between yards. The trouble is that these are difficult to attain. Interyard efficiencies are hard to effect in general, but they are particularly unlikely to be found between yards in Aus- tralia and in the US, or between yards in Australia and in Germany or Sweden. The next section shows how this has been the case for the two most frequently mentioned potential strategic buyers, General Dynamics and ThyssenKrupp. Section Four | What Strategic Buyers Offer The two most discussed strategic buyers, General Dynamics and Thys- senKrupp, will offer the Commonwealth capabilities in costs, technologies & skills, and access to markets. Each, however, has a mixed track record in these regards in past mergers. Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 9 of 28 17 Stephen M. Waters and Joel T. Waters, ‘Pricing Your Deal for Optimum Value,’ in Milton L. Rock, Robert H. Rock, and Martin Sikora, eds., The Mergers & Acquisitions Handbook (McGraw-Hill, 1994), p. 195
  12. 12. General Dynamics Marine Systems. Shipbuilding has been one of GD’s businesses from the beginning: the company itself was formed in 1952 through the combination of the Electric Boat Company (EB), Canadair, and several other businesses. As the general decrease in US military spending in the early 1990s triggered a wave of defense industry consolidation, GD’s strategy was to focus on its oligopolistic positions in nuclear submarines and armored vehicles while di- vesting nearly all other businesses. In 1992 and 1993, GD sold off Cessna Aircraft to Textron, its missiles division to Hughes, its electronics operations to the Carlyle Group, Applied Remote Technology to Raytheon, its electronics manufacturing unit to Elbit and Computer Crossroads, and its Fort Worth fighter aircraft factory to Lockheed. It is important to note that all these transactions closed before Deputy Defense Secretary Wil- liam Perry’s famous ‘Last Supper’ meeting with the captains of the US defence industry, in which he explained the need for drastic consolidation. GD was thus an early and vigorous seller of assets, exiting all businesses which management believed that the company could not domi- nate. It was also handsomely rewarded by the equities markets for its initiative. Throughout cal- endar year 1993, GD produced total returns to shareholders (in equity appreciation and pre- sumably reinvested dividends) of 53 percent. This far exceeded the return of investments that year—and until the beginning of the war in Afghanistan, for that matter—in any other large US defense contractor. In 1995, GD reversed tack, and began largely acquiring businesses. Its first target was the Bath Iron Works (BIW), a warship builder on the Kennebec River in Maine which had been founded in 1884.18 BIW was particularly valued for its role in the Arleigh Burke-class Aegis destroyer pro- gram: the yard was competing with Ingalls shipbuidling for the rights to build the larger share of what would eventually become a 62-ship program. Quite apart from the more costly weapons systems, the ship construction portion of this program alone would eventually total over $18 bil- lion. GD paid $300 million (US) for BIW up front, and invested another roughly $200 million in the business between 1996 and 2000. Up until this point, BIW was highly leveraged and techno- logically falling behind Ingalls, its primary rival.19 To compensate, GD invested $200 million in the yard between 1997 and 2000, including upgrades to materials procurement and manage- ment systems, materials handling equipment, metal fabrication processes; and the construction of a land-level launching system.9 In 1998, GD picked up its sixth target, National Steel and Shipbuilding (NASSCO), a cargo ship builder in San Diego with mostly military business. GD paid $415 million up front for the yard, Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 10 of 28 18 Hereafter, we occasionally refer to BIW and NASSCO as yards, because each is a single site operation. We cannot quite describe EB as a yard, because the company actually has two ship- yards: the primary and older site on the Connecticut River in Groton, Connecticut, and a second site at the old Quonset Point Naval Air Station in adjoining Rhode Island, which fabricates sec- tions of submarines for assembly at Groton. 19 FAS website: last accessed 6 August 2007
  13. 13. and invested another $135 million starting in 2001.20 That year, NASSCO won the contract from the US Navy to build the dry cargo & ammunition ships of the Lewis & Clark-class. If the class runs to its expected twelve units, the contract will have a potential total value of $3.7 billion.21 The higher price reflected the improved state of defense spending in 1998, and the lower level of investment required was partly a result of the lower level complexity involved in building cargo ships. Today, EB, BIW, and NASSCO form the ship construction and repair units of General Dynamics Marine Systems (GDMS), one of the largest naval contractors in the world.22 In aggregate, the effect upon GD’s financial performance and the technical performance of the acquired entities has been largely positive. Some analysts estimate that today BIW alone is worth $1 billion, and it is regarded as a higher-quality (if somewhat more expensive builder) than Ingalls. Marine Sys- tems overall is showing little revenue growth, but remains a stable producer of cash flows for GD. The group currently has about thirty months of backlog on its order books.23 Profitability has improved since 2003-05 when cost over-runs on Jones Act tankers being built at NASSCO dragged margins as low as five percent, and NASSCO itself is generally thought to have only recently become profitable as a stand-alone entity.24 Contract awards for the Lewis & Clark-class have been gradual: the third ship was only delivered in June 2007, and the option for the tenth ship was only exercised in July 2007.25 One might say, then, that while shipbuilding has been a good investment for GD, it has not been one of uniform success. In considering GD’s relative success as a gauge of how well a trade Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 11 of 28 20 ‘San Diego-based NASSCO's history to date,’ San Diego Chronicle, 29 November 2005. 21 Infobase and Capital IQ databases, last accessed 8/6/07. 22 There is a fourth unit, American Overseas Marine Corporation, which manages some of the chartered ships of US Military Sealift Command 23 CIBC World Markets report on General Dynamics, 26 July 2007 24 A.G. Edwards report on General Dynamics, 14 September 2006. The Jones Act, more for- mally the Merchant Marine Act of 1920, is a cabotage law that prohibits the carriage of goods and passengers between US ports by ships flagged, built, crewed, or even largely repaired out- side the United States. Certain exemptions apply for Guam, American Samoa, the Marianas Is- lands, and the US Virgin Islands, which are territories, not states. The effect on shipbuilding has been to maintain repair and construction capacity in the United States, but also to subsidize the cost-inefficiency of many of those yards. The effect has been more pronounced in construction than in repair. Since the bulk of the cruise line industry is undertaken with foreign-flagged, built, and crewed ships: the ships make convenient stops in Bermuda and the Bahamas to avoid cabotage infringements. While cruise liners are almost never built in North America, they often must be repaired and overhauled there, and thus US yards compete for this business with Ca- nadian and Bahamian ones. 25 General Dynamics’ website (, last accessed 6 August 2007
  14. 14. sale of the ASC might go, we can make three observations addressing GD’s potential efficiency as an owner of multiple shipbuilding divisions: ✦ GD’s shipyard acquisitions have helped rationalize costs, unlocking considerable value for its shareholders, and improving the economics of shipbuilding for the US Navy. From almost the outset, GD’s acquisitions had a clearly beneficial effect upon BIW and NASSCO’s performance to cost and schedule requirements. There is also some indica- tion that GD’s stewardship of EB was helpful in the process. Facing a sharply declining order volume for submarines, GD hired Booz Allen & Hamilton to restructure EB in 1993. In late 1995, it hired the same firm — and the same officer-in-charge — to restructure BIW. At the time, as Booz’s marketing literature now asserts, BIW was struggling to overcome crippling disadvantages in production costs, technology capabilities and market positioning. Its wage rates were higher than average, its building methods were antiquated and its reputation as a premier contractor had sharply declin- ed—putting BIW in a competitively disadvantaged position. Unchecked, rising costs seemed likely to sink BIW, especially in the face of DoD demands for more stringent cost controls. Our research uncovered a range of opinions as to the extent of the synergies amongst these three units.26 Most people interviewed believed that the opportunities for cost sharing amongst the yards was none to slight. Today, EB, BIW and NASSCO work largely inde- pendently of one another because the ships they build are rather different products. The first unit builds and modifies atomic-powered submarines, the second currently builds only guided-missile destroyers of a single class, and the third currently builds only military cargo ships of a single class.27 The various yards—BIW (in Maine), NASSCO (in California), and EB (in Connecticut and Rhode Island)—largely do not supply each other with inputs, partly because EB’s nuclear-powered, submersible products are subject to a much more extensive and costly oversight and quality control regime. These are not costs that NASSCO would care to share with its oil-fired cargo ships. Some back office processes—payroll, accounts receivable, benefits administration—can clearly be combined, but some or all could also be outsourced to a specialist provider. For Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 12 of 28 26 Interviews with Myles Walton, CIBC World Markets, 3 August 2007; Mark Jordan, A.G. Ed- wards, 3 August 2007; Dick Rumpf, former US Assistant Secretary of the Navy for Research, Engineering, and Systems, 8 August 2007; and a number of naval officers with experience in shipbuilding who spoke on condition of anonymity. 27 EB builds, in a monopolistic consortium with Northrop Grumman’s Newport News division, the Virginia-class attack submarines. It also modified the ballistic missile submarines Ohio, Michi- gan, Florida, and Georgia to a cruise missile configuration. This fills 22 of the 24 Trident missile launchers with 154 Tomahawk missiles tubes, and fills the other two with swimmer lockout and equipment chambers for SEAL commandos. Work has been split between EB’s yard in Groton, Connecticut and that of its project partner, Todd Pacific Shipyards on Puget Sound. Otherwise, it is remarkable that GD’s three yards build from the keel only three classes of ships.
  15. 15. example, in 1991, GD outsourced its information systems management to Computer Sci- ences Corporation (CSC). In 1996, BIW was brought into this contract as well, and in 2005, GD’s group-wide contract with CSC was extended for another seven years. GD or GDMS’s corporate oversight of this contract from its headquarters in Fairfax, Virginia may add some value to its utilization at EB, BIW, and NASSCO, but it is not obvious how extensive this is. Companies like CSC, after all, specialize in lowering costs by sharing services between dif- ferent, unrelated companies, and not just those in the same industry. ✦ GD’s shipyard acquisitions have provided better access to superior technologies and skills, though it is unclear how much would have been accomplished without the mergers. Of course, it was GD that insisted that BIW automate its processes, beginning with the outsourcing contract with CSC. GD further insisted that BIW install an enterprise resource planning (ERP) system and integrated product data environment (IPDE) for mate- rials management, and the company deserves credit for this decision. Depending on the de- gree of customization available in the system, common ownership may or may not have helpful to the several yards. If acceptable ERP and IPDE packages were available with modules designed for shipbuilders, and if a volume discount was not enticing, then the benefits of buying them together are not obvious. If, on the other hand, the package se- lected required heavy on-site customization for the shipbuilding industry, then common own- ership of the yards may have been economical, spreading the costs across the operations of the three divisions. Divergent processes in the construction of submarines, destroyers, and auxiliaries may have limited the extent of those economies in information technology. However, even though the products are different, they are all steel-hulled warships, and there are some clear examples of sharing of non-recurring costs amongst the units. In 1996, GD brought its modeling and simulation (M&S) systems for ship design from EB to BIW, which had theretofore had rela- tively little automation in its design shops. These tools were then made available to NASSCO as well when it was acquired. GD also brought new computerized waterjet and laser metal cutting machines to BIW and NASSCO that significantly reduced wastage of ex- pensive HY-80 and HY-100 steel plate. Electric Boat also had built, with funding from the Program Executive Office for Submarines, a large manufacturing site at Quonset Point, Rhode Island with a unique, high-speed, robotic laser cutting system automated though CAD/CAM. One senior Navy Department official termed it a "beautiful" piece of machinery that would shut itself down if something seemed wrong. BIW and NASSCO have subse- quently tapped into that system, as a brand new tool for their manufacturing operations. As alluded above, EB is necessarily possessed of a high degree of quality control, as its monopsonistic submarine-buying customer demands. The Navy Department’s P90, P290, and SUBSAFE programs add both quality and cost to the product. While GD has been keen to avoid transferring all the costs to BIW and NASSCO, it has lent some of the people famil- iar with them to BIW in particular. Their exact role in the production of destroyers in not known, but one can assume that they are well qualified and very familiar with what common processes have been developed for use at both divisions. These temporary transfers of staff and their skills are said to have helped smoothed out gaps in production requirements dur- Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 13 of 28
  16. 16. ing periods of lumpy demand from the US Navy. Modular and lean manufacturing tech- niques developed at one yard have also shared amongst the rest. Again, though, it is not clear that the technologically advanced tools could not have been efficiently licensed from EB or some other developer by an otherwise independent BIW or NASSCO. While there are only very limited sources of engineers familiar with the construc- tion of nuclear-powered submarines (or submarines of any type), modular and lean manu- facturing techniques are available from a variety of marine engineering consultants. ✦ GD’s shipyard acquisitions have so far provided only a hint of opportunities for better access to global marketing channels. Regarding export markets, in the course of our re- search, we heard the assertion that BIW’s association with the GD brand has raised the re- spectability of its products worldwide. While we consider this plausible, we have not been able to check brand awareness with naval buyers worldwide. We do observe, however, that it has practically meant nothing to BIW or GD on the export market: no GD shipbuilding divi- sion has exported a new construction ship in decades. This is partly because GD’s yards (like many US yards) are not cost-efficient, but it is also because the warship designs that the US Navy has heretofore preferred have not been very marketable worldwide. It is possible that some of the widely rumored international interest in GDMS’s entry in the Littoral Combat Ship (LCS) competition, the Independence-class, will lead to a stream of exports. However, even if this happens, it will mean nothing for BIW as a shipyard: while the division is helping manage the program, the actual ships are being built at Austal’s facility on Mobile Bay in Alabama. At that stage, even BIW’s program management may be of ques- tionable value: if the GD-Austal LCSs really are as modular as advertised, overseas buyers may very well customize the ships with their own preferences for weapons, and may even request that they be constructed at Austal’s longer-established yard in Henderson, Western Australia. Regarding the domestic market, it is possible that BIW's association with GD helps garner congressional support in states other than Maine for its shipbuilding programs (and we as- sume that this might apply to NASSCO outside California as well). With more time, this could be tested by examining the voting record of legislators like US Senators Joe Lieber- man (Independent) and Chris Dodd (Democrat) of Connecticut.28 Strong supporters of sub- marine construction (and naturally, EB), Lieberman and Dodd might be inclined to support Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 14 of 28 28 We know of no academic work investigating alliances between legislators representing con- stituencies with factories from different branches of the same military contractor. In the US’s congressional system, however, committee seats are critical for securing funding in excess of that requested by government departments and agencies. The only work of which we are aware on this subject found that US universities which were represented by senators or congressmen on the Senate or House Appropriations Committees experience returns to their lobbying activi- ties of $11–17 for each dollar spent; those without such representation have essentially zero returns. See John M. de Figueiredo & Brian S. Silverman, Academic Earmarks and the Returns to Lobbying, National Bureau of Economic Research, Working Paper #9064, July 2002. Notably, Lieberman sits on the Senate Appropriations Committee, though not its Defense Subcommittee.
  17. 17. the work of their colleagues Susan Collins (Republican) and Olympia Snowe (Republican) of Maine in their bid to ensure that BIW obtain a portion of the future Zumwalt-class destroyer program. However, a few years ago, Connecticut found itself very close to opposing Maine in an argument concerning nuclear submarines. The government-owned and -operated Portsmouth Naval Shipyard lies in Maine (astride the city of Portsmouth, New Hampshire), and has competed directly with EB for submarine repair work. When the Defense Depart- ment attempted during the 2005 Base Realignment and Closure (BRAC) process to shutter both the yard in Portsmouth and the submarine base in Groton (which lies next to EB), the entire New England delegation closed ranks to oppose the closings—and successfully. However, had the Defense Department chosen to seek the shutdown of only one of those bases, Maine and Connecticut’s cooperation would not likely have been forthcoming. Thus, political alignments based on corporate parents are not always easy to predict. ThyssenKrupp Marine Systems. The aggregation of ThyssenKrupp Marine Systems (TKMS), most notably with the acquisition of Howaldtswerke Deutsche Werft (HDW) in 2004, has had interlinked political and corporate rationales. A succession of German governments, both Social Democrat and Christian Democrat, has been seeking European amalgamation of shipbuilding assets as a matter of policy, with an aim of securing for Germany a degree of global leadership in manufacturing surface vessels and conventional submarines.29 TKMS’ acquisition of HDW fulfilled these objectives. First, it returned HDW from the foreign ownership of US-based Bank One. Second, it also facilitated the previously existing cooperation between HDW and two com- panies of TKMS: Blohm und Voss (B+V) and Nordseewerke. HDW and Nordseewerke had been the primary members of the German Submarine Consortium for many years. B+V is the well- regarded designer and builder of the MEKO series of modular corvettes and frigates, the design of which forms the basis of the ANZAC-class. Formal acquisition was meant to remove transac- tion costs, and strengthen the companies’ financial position through synergies and cash pooling. This, it was thought, would in turn create a firm German base for the expected European naval shipbuilding consolidation.30 Marine Systems operates independently of other ThyssenKrupp entities, even of other divisions within the ThyssenKrupp Technologies group in which it resides, because the other Technolo- gies segments (Plant Technology and Mechanical Engineering) have very different products. On the corporate level, ThyssenKrupp appears to exert little influence over TKMS because the latter is not part of its core steel portfolio; rather, ThyssenKrupp acts almost as a German holding company for the mostly national shipbuilding assets TKMS comprises. It could be said that TK was simply the company that the German government supported to acquire HDW in order to return HDW to German ownership. Today, ThyssenKrupp’s continued ownership of Marine Sys- tems could be called largely a favor to the government, which prevents the acquisition of the German shipyards by a foreign buyer. European Union financial regulations generally do not permit the prevention of foreign takeovers without the invocation of Article 296 of the Treaty of Rome. While the subtleties of intra-union politics often call for less obvious measures in Europe, the Commonwealth government is bound by no such niceties. Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 15 of 28 29 “ThyssenKrupp and EADS to Buy Sonar Maker”. Associated Press, 30 December 2005. 30 ThyssenKrupp Technologies, presentation at analysts’ and investors’ meeting, London, 18 May 2005.
  18. 18. Now, following the framework from earlier in this section, we can make three similar observa- tions addressing TK’s potential efficiency as an owner of multiple shipbuilding divisions: ✦ ThyssenKrupp’s acquisitions have not clearly rationalized costs between its various yards. While the mergers have been (mostly) politically popular, assessing their financial effects has been more difficult. ThyssenKrupp does not separate Marine Systems’ financial figures from those of its ThyssenKrupp Technologies parent. Only scattered data points are available. One equities analyst reported that “ThyssenKrupp managers describe the [TKMS] as highly profitable by group standards. The shipyards are benefiting from the global boom in shipbuilding as well as from strong demand for submarines as they are the technological leaders in submarine construction, including craft driven by fuel cells.”31 In May 2006, Credit Suisse estimated that the integration of HDW with B+V would yield over €100 million in cost savings.32 While we have been unable to verify these estimates, we can outline their potential sources of savings. As noted above, the mergers eliminated some transaction costs associated with running a long-standing consortium. In Germany in par- ticular, they eliminated some physical costs as well. Before the HDW acquisition, HDW, B+V, and Nordseewerke had some capability to produce multiple types of ships. Since the acqui- sition, TKMS has gradually restructured the shipyards to make each focused on one particu- lar product.33 This model reduces costs in several ways, and if only by eliminating some of the shipping costs between two sites (HDW and Nordseewerke) cooperating to manufacture a submarine. As with GDMS, manufacturing synergies amongst the various TKMS shipyards are less significant as the products lines are quite different. In Sweden, the cost savings seem particularly difficult to identify. In interviews late last year, several Swedish Defence Ministry officials asserted that Kockums was a cost-effective yard before its acquisition by HDW, and that it has not benefited from foreign ownership in this regard, especially in submarine design and production. Regarding surface ships, they ar- gued that there was more opportunity to reduce costs, but that it was still unclear that Kockums had benefited. Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 16 of 28 31 Metzler report on ThyssenKrupp AG, 30 May 2006 32 Credit Suisse report on ThyssenKrupp AG, 18 April 2006 33 Interview with Rochus Brauneiser, Kepler Equities, 6 August 2007
  19. 19. ✦ ThyssenKrupp’s acquisitions have brought new technology into TKMS, but they have not clearly provided better access to technology or skills to the acquired yards. HDW’s acquisition of Kockums had a sound strategic rationale. Air-independent propulsion (AIP) systems offer a shorter-ranged but less costly, weighty, and technically challenging alternative to nuclear propulsion. Kockums was the first yard to install a practical AIP system in an ocean-going submarine, placing a Stirling cycle engine (fired by diesel fuel and liquid oxygen) in HMS Näcken during her refurbishment in 1989. Since then, all Swedish and Aus- tralian submarines have been built with Stirling cycle engines to supplement their diesels, as they provide virtually silent operation, albeit at rather low speeds. Two refurbished but ex- cess ships, the Västergötland and the Halsingland, have sold to the Singaporean Navy; Kockums is currently refitting them with Stirling cycle engines.34 Across the Baltic, the two yards of the old German Submarine Consortium had pursued quite different approaches to AIP capabilities. HDW had concentrated on fuel cell develop- ment, installing its first set of cells in the U-31, a U-212A series ship, in 2003. Fuel cells are now standard equipment on 208-, 212-, and 214 series submarines. Nordseewerke devel- oped in parallel a closed-cycle diesel (CCD) engine—a particularly economical approach, in that it can take its air from the snorkel, so that only a single engine is required on the sub- marine. The CCD is being offered as a relatively simple—but greatly enhancing—retrofit to submarines already in service. CCDs have been available for decades, but engineering reli- ability and safety into them is not necessarily a simple matter. In the 1950s, the Soviet Navy procured about thirty Project 615-class submarines, but the crews nicknamed them cigarette lighters, for their annoying tendency to develop uncontrollable fuel fires fed by liquid oxygen. DCNS has also developed an AIP option for submarines, termed the MESMA—Module d'Energie Sous-Marine Autonome. The MESMA is a closed cycle steam engine, adapted from the steam plant used in French nuclear submarines, which burns ethanol and liquid oxygen. MESMA plants have been ordered by the Pakistani Navy for retrofitting in its three Agosta 90B ships, the Khalid, Saad, and Hamzaa. No other sales, domestic or export, have been announced. It is thus notable that TKMS today has global leadership in three of the four prominent AIP technologies, and the two best-selling ones at that. That describes the benefits to TKMS of the merger (and presumably value paid to Kockums’ shareholders), but Kockums’ fate since the acquisition is less clear. There are strong indica- tions of specialization by TKMS’s yards in Germany, there is much less evidence of this across the Baltic. Kockums appears to have shifted its work largely to through-life support, working on the upgrade program for the Visby-class stealth corvettes, the retrofits of the two submarines destined for Singapore, and its assumption of responsibility for the fortified na- val repair yard on the island of Muskö. Kockums’ future may be relatively secure, but the scope of its future work remains to be seen. The Swedish government did recently resolve to fund the development of a future class of AIP submarines, but simultaneously decided to Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 17 of 28 34 For reviews of AIP technologies, see Don Walsh, ‘The AIP Alternative,’ Seapower, December 1999; and Edward C. Whitman, ‘AIP Technology Creates a New Undersea Threat,’ Undersea Warfare, Fall 2001
  20. 20. push off the design of replacements for the Visby-class corvettes, the primary combat power of its surface fleet. Still, Kockums’ Stirling cycle AIP system is said to be particularly efficient and reliable, and it is now in its third-generation of technological development. Within the Swedish Defence Ministry, some officials have privately expressed the belief that Kockums sales have been limited because it competes with other technology in the ThyssenKrupp Marine Systems portfolio, notably the fuel cell propulsion system from the German-built Type 212A subma- rines, and that TKMS has done little to invest in new technological development at the facil- ity in Sweden. Indeed, there may be some frustration locally that Swedish taxpayers have funded development that is now available at no cost to others.35 Still, Kockums has sold Stir- ling engines recently to the Japanese Navy for its new Soryu-class submarines, so it is clear that the new parent company has not removed the product from the international market. ✦ ThyssenKrupp’s acquisitions have not provided significant market access for its ac- quired companies. HDW’s initial acquisition of Kockums clearly eliminated a competitor. At the time, this was easily digested in Sweden, as Kockums had been relatively unsuccessful as a submarine exporter. Between 1998 and 2007, global deliveries of ocean-going, non- nuclear submarines totaled 44 ships, but Kockums itself managed only three deliveries, all to the Swedish Navy.36 Participation in the Collins-class program would raise that market share to nine ships, but otherwise, Kockums had landed at best one export customer for new submarines, and one of its AIP system. The acrimonious nature of the program did not, of course, improve the global marketability of Kockums’ ships. In this light, if building parts of submarines for German assembly yards seemed a less glorious future, it was at least a rela- tively secure one. Whether the acquisition by TKMS helped Kockums secure its Stirling engine contract for the Soryu-class is difficult to say, but the sale has contributed to a surge in exports that have considerably improved the division’s finances.37 As indicated in the table below, the sale has greatly increased Kockums’ output without greatly increasing its headcount, and raised its performance within the companies of the Säkerhets och Försvarsföretagen (SoFF), the Swedish Security and Defense Industries Association. The SoFF accounts for about 95 per- cent of the Swedish defense industry, so the comparison is nearly complete. Kockums AB 2003 2004 2005 2006 2007 Sales (MM SKr) Exports (MM SKr) 1,503 1,228 1,074 1,194 1,576 289 344 278 653 757 Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 18 of 28 35 Conversations with Swedish Defence Ministry Officials, in Stockholm, August 2007. 36 Research in August 2007 by CRA International. 37 Data from Säkerhets och Försvarsföretagen (SoFF), the Swedish Security & Defense Indus- tries Association.
  21. 21. Kockums AB 2003 2004 2005 2006 2007 Staff Sales (MM SKr)/Staff % of all SoFF sales % of all SoFF exports % of all SoFF staff Overall SoFF sales/staff 1,209 1,154 1,077 1,060 1,070 1.24 1.06 1.00 1.13 1.47 4.6% 3.7% 3.2% 3.5% 4.1% 2.0% 2.2% 1.7% 3.6% 3.6% 5.5% 5.6% 5.0% 5.0% 4.9% 1.47 1.60 1.58 1.62 1.74 However, since many of the TKMS’s shipyards already had significant export markets before the amalgamation, the marketing advantage of the various mergers may seem relatively lim- ited. Purchasing Hellenic Shipyards may have helped the German yards gain a foothold in Greece, but this is a relatively small market for naval vessels. Still, Kockums’ products have recently garnered an excellent reputation in mock combat with the US Navy. Collins-class submarines are said to have repeatedly bested American Los Angeles-class submarines in exercises off Australia and Hawaii. HMS Götland was leased— with her Swedish crew—by the US Navy for a year of training, and for many months, completely eluded detection. Ret- rospectively, then, HDW’s purchase seems a very shrewd move, piling into one company the most competitive submarine designs in the world, and eventually establishing TKMS as the clear leader in submarine exports worldwide. That said, it is not the benefits to the com- panies which we are seeking here to evaluate. Rather— In summary, ThyssenKrupp’s acquisitions have provided few benefits to the Swedish government, though General Dynamics acquisitions were at least initially helpful to the US government. GD’s initial acquisitions of BIW and NASSCO were probably opportunistic purchases of undervalued assets. As a shipbuilder, GD may have understood better than BIW’s previous private equity owners what needed to be done to unlock the cash flows available from a long-term half-share of a 62-ship building program. While BIW may have been in extremis, NASSCO was at least in serious difficulty with its cost-overruns building Jones Act tankers. The returns available from the acquisition of the more sophisticated destroyer-builder were thus con- siderably greater than those available in the acquisition of a cargo ship metal-bender, even one with a relatively protected market. GD has clearly improved performance at both yards, and the US Navy is reasonably happy with GDMS’s efficiency.38 However, it is reasonable to ask whether this guidance could only have been supplied by a defense contractor, or specifically a shipyard. It seems conceivable that, say, an aircraft manufacturer could have provided the necessary decision-making, but to paraphrase Norman Augustine, the entry into shipbuilding by non-shipbuilding military contractors has a re- cord relatively unblemished by success. Lockheed had previously exited the shipbuilding busi- ness in 1987 (after concluding that it could not win a role in the Arleigh Burke program). In its Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 19 of 28 38 Conversation with senior Navy Department official, at the Pentagon, September 2007.
  22. 22. recent attempt at reentry, Lockheed Martin has made a hash of its LCS program, and during at- tempted conversions, destroyed a series of 110-foot Coast Guard cutters in conjunction with Northrop Grumman and the smaller Gulf Coast shipbuilders Bender and Bollinger. Boeing's last foray into shipbuilding, the Pegasus-class patrol hydrofoil-missile (PHM) program of the late 1970s, produced a series of unreliable little ships of which the US Navy eagerly disposed. Northrop Grumman's acquisition of three yards has not greatly improved their management. However, if GD’s acquisitions made sound financial sense from the viewpoint of the 1990s, they may have made sense for another firm as well. Furthermore, GD and GDMS’s continued own- ership of the yards appears less clearly essential today. The yards remain relatively separately managed and marketed, with only some sharing of technology and systems amongst them. The political advantage to common ownership may have some value, but evidence is circumstantial and situational. The assembly of TKMS has brought clear benefits to the German submarine industry. HDW and Nordseewerke, while pursuing different paths in some areas of technological development, were otherwise cooperating closely in the development and production of U-212 and U-214 series submarines. Adding Kockums to the group eliminated what could have been its most serious competition, and brought in-house leadership in three of the four leading approaches to AIP. As noted, though, TKMS has almost no managerial interaction with TK. It is possible that the ownership and structure of TKMS may change in the next three to five years, because many of TK’s investors are pushing for it to concentrate on steel manufacturing, which is recovering after a difficult decade in the 1990s. The TKMS segment definitely produces steady cash flow, and could be used to acquire additional shipbuilding capabilities should the European market con- solidate. Alternatively, it could produce a handsome return if sold, or even be cost-effectively spun off to shareholders. Given the slow pace of naval developments in Europe, and the Ger- man government’s encouragement of TK’s safeguarding national interests, no decision appears likely in the near term. Regarding the potential sale of ASC, the assembly of GDMS and of TKMS suggest that there are ✦ Some synergies to the ownership of naval shipyards by firms experienced in running other naval shipyards. GD's acquisition of BIW and NASSCO helped improve operations initially, if only because those yards were rather poorly managed at the time. GD's continued ownership may be beneficial, at least in contrast to Northrop Grumman's embarrassing lack of stewardship over its Gulf Coast yards. TK's shipyard acquisitions were probably useful for customers (and the German government in particular), by reducing costs and enhancing TKMS’s technological leadership in AIP submarines. The effect on other stakeholders, such as the Swedish government is less clear. ✦ Rather fewer synergies to the common ownership of naval shipyards and other mili- tary contractors. Ownership by GD has not helped any of GDMS’s three shipbuilding divi- sions export ships, and its domestic political benefits are hard to measure. Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 20 of 28
  23. 23. ✦ Few, if any, benefits, to the ownership of naval shipyards by unrelated industrial con- glomerates. ThyssenKrupp has, by all accounts, rather little involvement with ThyssenK- rupp Marine Systems, and we can find no other positive examples of beneficial forward inte- gration by a steel supplier into shipbuilding. If the Commonwealth government is keen to privatize ASC through a trade sale, one could then argue that another shipyard would be a logical strategic buyer. However, the applicability of that conclusion depend strongly on ASC's future business prospects. If they lay—aside from the Hobart-class destroyer program—primarily in ship repair, then there is little reason to believe that either a shipyard on the other side of the world, or an unrelated military contractor in Austra- lia or anywhere else, could do much to improve upon ASC’s operations. For practical evidence, we observe that military ship repair in the US, the world’s largest naval market by far, is largely a stand-alone business. Even BAE Systems Ship Repair, the largest ship repair firm in the US, is operated quite independently of the rest of BAE Systems’ activities in North America—and of BAE Systems’ shipbuilding and repair operations in the UK. Indeed, in the US, BAE Systems’ presence in ship repair is largely an artifact of the Carlyle Group's decision in 2002 to lump the former United States Marine Repair (USMR) and United Defense (UD) into a single entity; when BAE bought UD to expand its armored vehicles and armaments business, it got USMR in the bargain. UD ran USMR with very light oversight, and when BAE acquired the combined entity, it immediately separated the two sides operationally and organizationally. However, if ASC’s ambitions lay in ship construction—and particularly of submarines—then it is possible that GD would be preferred to most other defense contractors. The existing Memoran- dum of Understanding between the Australian and US Defense Departments concerning sub- marine technological development, and EB's role as ASC’s ‘capabilities partner’ in ship design, point to both political and commercial advantages. These do exist together, after all, outside the relatively rarified world of German defense contracting. Some efforts in this direction may al- ready have been considered. One report holds that some officers of the Royal Australian Navy were told in the late 1990s that the US Navy had encouraged GD to purchase a stake in ASC— and to transfer enough technology to the firm—to enable it to export submarines to Taiwan.39 An export license, however, was not forthcoming from then-Prime Minister Paul Keating’s govern- ment, so the issue became moot.40 Since Prime Minister Rudd’s interest in maintaining good relations with mainland China is, if anything, only greatly than John Howards’, this idea seems unlikely. The trouble is that export prospects otherwise are relatively low, for there is no cus- Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 21 of 28 39 ‘Intelligence,’ Far Eastern Economic Review, 6 September 2001. 40 Peter Chen, [Taiwanese] Central News Agency, 7 November 1997, via the US Foreign Broad- cast Information Service. Since this time, the sale of conventional submarines has been repeat- edly raised, but the high cost of developing a fresh design at a US company—whether Northrop Grumman or General Dynamics—accustomed to only building large, nuclear-powered subma- rines has more than dampened enthusiasm in Taiwan. Taiwanese reticence over the idea has not improved its chances, already not high, of its approval in Washington. See Gavin Phipps, ‘Former DoD official pours cold water on Taiwan's submarine deal with US,’ Jane’s Defence In- dustry, 30 April 2008.
  24. 24. tomer in the Far East, save Japan or South Korea, with a greater need for submarines than Tai- wan. On the other hand, equity participation by GD in ASC could actually hamper the procurement effort for the successors to the Collins-class. It is true that neither GD nor Northrop Grumman builds conventionally-powered submarines, and that US shipyards do not export submarines. Both of these limitations sit firmly in place because the US Navy has, since the late 1960s, in- sisted on only nuclear propulsion, and on not sharing its technological developments abroad, even with allies. That said, GD’s Capability Partnering Agreement with ASC and the US Navy’s lease of the Götland from the Swedish government indicate that some change may be under- way. The US Navy’s overall budget is unlikely to grow significantly in the next decade, but meet- ing its shipbuilding plan for surface vessels requires savings in other areas. To date, the Navy’s leadership has focused on reducing manpower costs by increasing the automation of shipboard systems to reduce crew sizes. This has, in part, led to the design of the engine room on Lock- heed Martin’s LCS prototype, USS Freedom, a space that one Navy engineering officer de- scribed as “not just unmanned, but unmannable”—so cramped and dangerous that significant combat damage there could be unsurvivable. Restrained enthusiasm for reducing manning, or simply budgetary failures elsewhere in the Navy’s enterprise, could just conceivably lead the service to again consider submarines with both conventional diesel and air-independent propulsion systems. US submarines might be- come available for export, particularly if the Navy came to believe that US submarine technology was not across-the-board superior to anything else available. At that point, potential suppliers to a future ASC building program might seriously consider how much technology they cared to make available to a company partly-owned by GD. While this eventuality may seem remote, it need not come to pass to scare off potential suppliers. If ThyssenKrupp, Navantia, or DCNS be- lieved that it could happen, any of these companies might think twice. Section Five | Future Developments The strategic benefits of a strategic sale depend unpredictably on the pos- sibility of a range of technological and operational developments. Geopoli- tically, they vary particularly with the possible continued expansion of the Chinese fleet, but not overwhelmingly. Tied up in this question of who will help build the next Australian submarines is the question of how much help will be requested. All things being equal, demand for relatively larger subma- rines favors local development of the design for the successors to the Collinses. Submarines are particularly useful around the world as asymmetric weapons: plans for Russian exports to countries like Iran and Venezuela are predicated on the assumption that neither navy would seek a fleet-on-fleet engagement with the United States, but could use a difficult-to-detect weapon to complicate the United States’ planning. Outside a handful of countries, enthusiasm for sending submarines far abroad is slight, so most exported ships are designed for littoral op- Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 22 of 28
  25. 25. erations only. Thus, if the Australian government concludes that its next class of submarines must be capable of operations far into the Pacific and Indian Oceans, it will seek ships larger than other conventionally-powered ones—just as the Collinses are. The government could then direct ASC to work with a capability partner to scale up an existing design, but this experience with Kockums was troubled and strongly remembered throughout Australia. A clean-sheet ap- proach might be preferred, if not technologically, at least politically. Since technological progress is difficult to predict, its strategic impact will be even more unpredictable. Submarines, of course, fit operationally into the broader context of the whole of the RAN’s fleet, so developments affecting the utility of different arms of the fleet could relatively affect the value of different types of submarines. As a blue water navy, the RAN has a wide range of objectives, including securing Australia's seacoasts, suppressing piracy, hunting terror- ists, protecting offshore assets, defending friendly countries, rescuing failed states, and gener- ally maintaining the freedom of navigation. These political objectives require ships capable of undertaking a wide variety of missions, including hunting submarines, hunting mines, defending against air attack, attacking targets ashore, landing troops, destroying surface craft, and board- ing and seizing vessels. They also, naturally, fit into the scheme of capabilities offered by the Australian Army, the Royal Australian Air Force (RAAF), and allied forces as well.The ability to undertake any these missions may relatively increase or decrease with a range of technological developments: ✦ Progress with unmanned submersibles may lead to demand for larger submarines that could carry more drones for coastal reconnaissance, hydrographic survey, and intelligence- gathering missions that would not directly endanger the host ship. Unmanned submersibles, however, will likely remain a technology relatively decoupled from that of manned subma- rines, in that the two systems will operate together through standard interfaces. If procure- ment is thus modular, with navies making procurement decisions regarding unmanned craft separate from those regarding the ships, ✦ Progress with target discrimination could increase the value of over-the-horizon weap- onry against mobile and relocatable targets. Targeting terrorists from afar has so far been largely an American and Israeli undertaking, but the RAF’s recent acquisition of jet-powered MQ-9 Reaper aircraft, “fitted for-but-not-with” Hellfire missiles, suggests that Britain may soon be increasingly joining the fray. American aircraft have not always been equally avail- able for supporting both American and allied troops, so some other members of the Coalition in Afghanistan are seeking their own capabilities. ✦ Progress with unmanned aircraft, whether big ones for land basing, small ones for frig- ates and corvettes, or something in between for carriers, may play a role. Weaponization of Northrop Grumman’s RQ-4A Global Hawk is possible, and the RAAF appears to consider this its most likely candidate for supplementing the long-range reconnaissance capabilities of its AP-3 Orions. This could provide an intriguing option for overwatch of deployed Austra- lian Army forces. It is possible that some other, future unmanned aircraft could replace some of the RAAF’s strike capacity less expensively than manned aircraft. It is also possible that heightened demand for unmanned reconnaissance and strike capability could drain funds that would otherwise be available to the Navy in general of the submarine flotilla in particu- Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 23 of 28
  26. 26. lar, as any capital investment must come at the expense of some other foregone expendi- ture. ✦ Further progress with (non-nuclear) air-independent propulsion could make subma- rines an even more attractive investment for Australia than they are today. Greater endur- ance means longer time on station, performing missions with less risk of detection. That ex- pands the envelope of potential uses for the submarines. The effects of some of these developments point to some useful strategic choices. If the gov- ernment were anticipating great progress in AIP, keeping a line open to the best AIP designer (probably ThyssenKrupp) would be very important a priori. If the government expected that much of the military utility of its future submarines would be tied up in that of unmanned sub- mersibles, then the choice of submarine capability partner might not be as restricting. The trou- ble, though, is that the Commonwealth government cannot be confident about likely future tech- nological trajectories. Operational experience often guides military investment decisions in ways that cannot be easily foreseen. The USAF’s beneficial experience with the Predator reconnaissance drone over Bosnia and Kosovo in the 1990s led to the weaponization of the aircraft in time for the in- vasion of Afghanistan in 2003, and its excellent operational results over Iraq through the present day. Naval experience is probably harder to come by, in that few large battles have recently been fought at sea, but the nature of the RAN’s fleet points to a few possibilities: ✦ Future operational success with HMA Ships Canberra and Adelaide may lead to enthu- siasm for a third ship, or the expansion of the capabilities of the class. The Australian ships are not designed for intensive combat operations, as they are being built without anti-aircraft defenses or any plans for the embarkation of fighter aircraft. The same cannot be said, how- ever, for the Spanish ship on which the design is based: she is designed to carry both Har- rier jets and close-in missile defenses. There is no fundamental reason that the Australian government could not call upon the RAN to expand their repertoire of the ships tasks to- wards the expectations of the Spanish government at some point in the future. The issue is simply one of political will and financial resources. Canberra and Adelaide could find them- selves, albeit not by original intent, as eventual something of replacements for the storied carrier Melbourne. ✦ Potential American operational success with the Ohio-class cruise missile subma- rines could raise Australian interest in a smaller version of this capability. As noted in section Four (see the footnote), between November 2002 and this past February, four of the US Navy's Ohio-class ballistic missile submarines were converted into cruise missile subma- rines. On each ship, twenty-two of the twenty-four single Trident missile tubes were con- verted to house as many as seven missiles that fit the Navy’s standard submarine vertical launch canister for conventional weapons. In their maximal configuration, each tube con- tains seven Tomahawk missiles, so each ship could carry as many as 154 land-attack mis- siles. The remaining two tubes were converted into lockout chambers for SEAL commandos, and the ships now have bunk space for an embarked company of sixty-six. Should the gov- ernment look admiringly on some future employment of one or more of these ships, the suc- Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 24 of 28
  27. 27. cessor to the Collinses could be designed with space for land-attack weapons that would make the ships a partial replacement for the RAAF’s F-111s' strike capability, and a stealthy complement to the RAN's amphibious assault capability. It is again difficult to say how these possibilities would affect the soundness of any selection of a buyer by the government. Positive experience with the new helicopter carriers could relatively dampen enthusiasm for more and larger submarines, but only in the overall competition for fi- nancial resources. American operational success with the modified ships of the Ohio-class would probably raise enthusiasm for more, larger, and longer-ranged submarines, and thus likely also for ships built to an indigenous Australian design. Geopolitically, the rise of China’s military capabilities and its long-term strategic intent are the great uncertainties. The United States, the rest of NATO (and its extended Partnership for Peace family), and Australia today provide a fascinating set of comparisons in strategic out- look and its supporting military procurement. European governments almost all agree that there is little direct military threat to Europe today—only Poland and Finland seem greatly concerned with territorial defence to the east. The most pressing security problems, it is generally agreed, will be found abroad. That said, only a handful of European countries are truly reshaping their military forces for the expeditionary operations that will enable them to influence political devel- opments far from home. Chief amongst them may be Denmark: the Navy is trading in its missile boats meant for sinking ships in the Baltic for ‘command and support ships’ designed for a wide range of expeditionary operations abroad. To its credit, the Australian Defence Force required considerably less reshaping after the Cold War largely because it had for some time been focused on small-scale, regional security prob- lems. Today, though, Chinese military capabilities are rising, and China’s strategic intent is the subject of great debate. More pointedly, the Chinese Navy is today building a large submarine fleet, and more Chinese warships moving further into the Pacific will mean more monitoring by Australian and American submarines. This is nothing new for the RAN's submarine flotilla, but it does indicate the importance of the perceived Chinese threat to Australian naval plans.41 In the United States, counterinsurgency requirements are ostensibly paramount, but great sums of money are still fueling procurements for systems meant for the big war against what the Pen- tagon calls a “near peer competitor”—almost certainly China. In the alternative, of course, China makes nice with Taiwan (however this is achieved), and settles down to a comfortable position of growing-but-valued influence in the civilized world. If military procurement decisions were taken purely for national interest, this would lead to a radically different force structure in the United States, one rather more akin to the small-war plans of the more forward-thinking Euro- peans, perhaps a Danish model writ large. All manner of naval vessels, from submarine to aircraft carriers, have a role to play in both the big-war and small-war scenarios, but in differing balances and with differing qualities. European diesel submarines are generally smaller and shorter-ranged because they are not too likely to Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 25 of 28 41 See Brendan Nicholson, Secret spy missions forced to the surface, The Age, 8 September 2006
  28. 28. be tasked to destroy enemy shipping at great distance. European aircraft carriers, whether in Britain, France, or Spain, are getting larger from class-to-class because the focus of military at- tention has shifted to the projection of power far from home. In Australia, general agreement over a rising potential threat from China could lead to greater demand for longer-ranged subma- rines; a general consensus that problems like those of East Timor will more occupying could lead to less demand, but not strictly. The distances in the Pacific are such that long range will bring benefits in almost any operation. The general observation, then, is that the demand for an indigenously designed class of submarines would be enhanced by the perception of a threat from China, but not overwhelmingly. Section Six | Recommended Course The government should carefully consider its own strategic interests be- fore selling ASC to a strategically motivated buyer. Having addressed how future developments may affect the outcomes of the government’s choice, it is not reasonable to ask what combination of attributes the government should be well advised to consider in light of the objectives assumed in section one and the framework of con- siderations of ownership, interest, domicile, and industry structure discussed in section two: Concentrated ownership may be slightly preferable. Concentrated ownership seems to be the government’s preference, though only in a derivative fashion, because Mr. Rudd’s ministers have generally continued the Howard Government’s noncommittal talk of seeking an overseas strategic investor (which would necessarily bring relatively concentrated ownership). The advan- tage lies with the closer external control that a strategic buyer brings, in comparison to that of the diffuse ownership of the public equity markets. Closer control can be useful for closer super- vision: booting out underperforming-but-entrenched management can be difficult without a clear chain of command. An existing defence contractor, shipbuilder, or institution would hopefully provide. Arguably, this would help with meeting all of the objectives laid out in section one (e.g., maintaining and modifying the Collins-class submarines, building a future class of submarine), but the evidence is not overwhelming. A more financial interest by the investor will do more to preserve options for the Com- monwealth. That is, the government’s aforementioned preference for a strategic investor should not be assumed to the exclusion of other objectives. Since maximizing price is not ex- pected to be the sole objective of privatisation, potential strategic investors can be expected to tout the benefits they would bring to the ASC and the Commonwealth. The first trouble with this preference is that the benefits of these positions are somewhat lacking in evidence. As illus- trated in section four, the government should look quite closely at these claims, and compare them to each potential acquirer’s track record in acquiring other shipbuilders and repairers. The second trouble is that choosing a strategic investor now, before any significant work has been accomplished in designing or even specifying he next class of Australian submarines (whether built to a primarily local or foreign design), could limit the government’s options for securing the best design of the ships. The most meaningful strategic investors are those with existing subma- Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 26 of 28
  29. 29. rine activities (GDMS, TKMS, DCNS, Navantia), and any one of these would necessarily com- pete with the rest. Choosing an investor is not quite choosing a design, but it will give any capa- bility partner pause before proceeding. More-or-less domestic domicile is a reasonable condition, but not a panacea. The gov- ernment has floated the idea that overseas buyers should not be allowed to own more than 49 percent of ASC. That begs the question, though, of what should happen to the other 51 percent (or more). To provide a meaningful counterweight to overseas control, the remainder of the company would need to be entrusted to a noyau dur of one or more Australian entities. The combination of Austal and GD may seem particularly appealing, in that it marries in an Austra- lian joint venture one of the world’s most capable submarine builders with one of the world’s most capable high-speed multihull builders. The management of the venture would be guided by the experience of the two firms in their already mutually agreeable alliance in the US LCS program. However, this arranged courtship may be ignoring the recent falling-out that Austal and GD have had in the bidding for the US Army and Navy’s Joint High Speed Vessel (JHSV) pro- gram. Incat and its American partner Bollinger are bidding an aluminum catamaran, Austal is bidding an aluminum catamaran, but General Dynamics has set its Bath Iron Works to bid a steel-hulled monohull ro-ro ferry with design assistance from Rolls Royce. Moreover, the ballyhooed combination does not fully address the underlying reason for the insis- tence on majority Australian control. After all, the Howard Government did not object to the takeover of Australian Defence Industries by the French firm Thales, and raised no initial objec- tions to the purchase of Tenix Defence by the British firm BAE Systems. Thus, unless Finance Minister Tanner’s recommendation is to represent a fundamental break with previous policy, the condition of Australian control is assumedly predicated upon a matter endemic to ASC and the submarine flotilla. This is most likely the question of intellectual property. The Collinses contain rather advanced and proprietary gear, including Swedish Stirling engines (from Kockums), French sonars (from Thales), and American combat systems (from Raytheon, as noted above). The original designer was Kockums AB, now a subsidiary of a German submarine builder, but the current capability partner to ASC is the aforementioned General Dynamics. Outright acquisi- tion of ASC by any of Thales, Raytheon, GD, ThyssenKrupp, or DCNS could cause consterna- tion amongst more than one of the others, potentially negatively affecting ASC’s ability to con- tract with major suppliers for the follow-on to the Collinses. Austal’s participation in the man- agement may or may be enough to placate overseas shipbuilders’ concerns for the security of their intellectual property. Competition is easy to preserve in the industry. The scenarios laid out in the preceding paragraph overlook, of course, the option of allowing Tenix (or BAE Systems) to bid for ASC. Keeping the ownership of ASC separate from that of Tenix ensures that two different shipbuild- ers will be building large surface warships in Australia through at least 2013, and will be ready after that point to bid to build the replacements for the Adelaide and ANZAC-class frigates. As- serting the goodness of this separation is not a throwaway statement. If long-term demand for Australian-built military ships were to dip below the minimum efficient scale of any two produc- ers, the Commonwealth government might consider merger to monopoly to be within its inter- ests. As the local monopsonistic buyer, it would retain considerable control over pricing and per- formance at ASC. This is rather the path taken in the United Kingdom, which has a larger navy Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 27 of 28
  30. 30. and more sustained demand for domestically-built military ships. All the same, at the moment, there is no compelling case for allowing BAE Systems to bid. The trouble, then, is that strategic interest by investors may be hard to reconcile to the strategic interests of the Commonwealth. It is possible that the government is asking too much in seeking an investor which would seek to benefit strategically from partial ownership of ASC, but not benefit too much. As outlined above, some of the government’s objectives are easy to meet. Competition in Australian naval shipbuilding can be maintained simply by exclud- ing BAE Systems (or Tenix) from the bidding. An Australian domicile can be ensured simply in stipulating the terms of sale. As noted in the table on the preceding page, the government’s preferences line up with the weight of our analysis. The goal of recruiting a strategic investor, however, may conflict with the interest of retaining a controlling Australian interest, and may possibly limit the choices available to the designer of the next class of submarines a few years hence. However, the government’s apparent preference for concentrated ownership still has at least two important benefits: hostile bids for ASC can be fended off without resorting to heavy-handed government action, and management can be more readily seen off if necessary. Thus, privatizing ASC through a trade sale to a financially- interested institution may be the safe approach which retains latitude for ASC in seeking a ca- pability partner, ensures a healthy degree of domestic control over the asset, but also entrusts the company to a responsible party with an stake in guaranteeing its financial health and per- formance. Options for the Privatisation of ASC! 13 May 2008 ! ! JAMES HASIK •! page 28 of 28