Milco faces declining revenues due to cuts in defense spending by governments. To sustain profits, Milco must develop new markets or products. Two opportunities are expanding into emerging markets for existing products and developing new aerospace equipment. MRO IT systems and services show growth potential and increasing profits. However, military facility construction loses money and its market is stagnant, so Milco should consider selling this business unit. Overall, Milco needs diversification through new markets and products to maintain its position as defense spending declines.
1. BUSINESS CASE CHALLENGE
‘THE MAVERICK’SEASON 3
Team Name: Smart Spiders
Pravin Bokil
Ankit Rote
Srabana Chaudhuri
K. J. Somaiya Institute of Management Studies & Research
2. Executive Summary
The global aerospace defense sector is expected to witness continued decline in revenues
as a result of cuts in defense spending by the governments of various nations, attributed to slowdown
in the economy and the end of prolonged wars in Middle East and other regions. Therefore, the US
government, which has been rigorously involved in such activities in those regions is cutting down their
defense spending since 2011 with 1 % cut in the same year followed by drastic defense spending cuts
of 6% and 5 % in 2012, 2013 respectively. Such cutback by the US government would adversely
impact revenues and profit margins of companies actively participating in the defense and aerospace
industry. Therefore, these companies would have to strive for sustaining their bottom lines in the least
and maintaining market share.
Milco, one of the market leaders in product categories like Military flight simulators(MFS),
Military Flight Simulator Services, MRO IT services and a struggling player in Military Facilities
Construction segment will face similar problems . Being active in the US defense sector only, it
augments Milco’s problems to which there are two possible solutions .Milco would either have to move
into new emerging markets with existing products or develop new aerospace defense equipment on
the whole.
Emerging economies like China , India, Russia are investing huge in modernizing their
national security and defense due to threats and unrest in South East Asian, Middle Eastern region
and these can be considered as prospective markets for future growth of Milco. However, the US
market is still the largest spender in aerospace and defense products and services with a lion share of
41% of the global defense spending.
Apart from the defense sector, the new market for existing product as well as
diversification through new product development in an inevitable move to maintain the market position
for the company like Milco.
3. Income Statement for Milco
Forecasted Income Statement from the year 2015 to 2019 (In Million USD)
Year
2014
(Actual) 2015 2016 2017 2018 2019
Total Revenue $2,005.000 $2,077.680 $2,167.380 $2,244.260 $2,343.400 $2,457.400
Total COGS $1,050.000 $1,091.450 $1,134.550 $1,184.260 $1,235.750 $1,296.000
EBITDA $955.000 $986.230 $1,032.830 $1,060.000 $1,107.650 $1,161.400
Gross Operating Margin 47.63% 47.47% 47.65% 47.23% 47.27% 47.26%
SG&A Expenses(20% of revenues) $401.00 $415.54 $433.48 $448.85 $468.68 $491.48
Net Operating Income $554.000 $570.694 $599.354 $611.148 $638.970 $669.920
Net Operating Margin 27.63% 27.47% 27.65% 27.23% 27.27% 27.26%
Total Depreciation & Amortization $101.00 $106.40 $115.58 $119.36 $123.41 $135.56
EBIT $453.000 $464.294 $483.774 $491.788 $515.560 $534.360
Interest Expenses $76.500 $80.758 $86.230 $91.030 $96.097 $102.891
Profit Before Tax $376.500 $383.536 $397.544 $400.758 $419.463 $431.469
Tax $112.95 $115.06 $119.26 $120.23 $125.84 $129.44
Profit After Tax $263.550 $268.475 $278.280 $280.531 $293.624 $302.029
Profit margin 13.14% 12.92% 12.84% 12.50% 12.53% 12.29%
4. Financial Performance Analysis
Overall
1. Net profit will increase by 3% every year, although the gross profit margin increasing with little higher of 4%
2. Growth in net profit is not enough to meet the expected return on investment of share holders, which would lead
to fall in share prices and eventually the market cap
3. Milco is investing in assets by borrowing money through long term debt as it is not able to generate enough
profits to reinvest in the business
4. One of the major factor behind reduction in net profit margin is increase in interest expenses, having a steep
rise of around 33% in 5 years period with average increase 6% every year
5. Investment in assets inevitably increases the depreciation expenses, which increases by around 35% in the
span of 5 years as against 3% increase in net profits, dampening the Return on Assets (RoA)
6. Interest Coverage Ratio(ICR) will decrease from 5.9 to 5.2 in next 5 years and Debt Service Coverage
Ratio(DSCR) would see a dip from 31% to 28%. Operating the company in the same manner would have
serious repercussions on the credit rating of the company
7. Overall profit margin will go on declining over the period of time if the company does not diversify by investing in
new products to improve its product portfolio as well as new market development
Product-wise
1. Military Facility construction has the negative return of $4 Million in the year 2014, which is eroding the bottom
line of the company
2. Profit margins for Military Flight Simulator will go on reducing as the COGS is increasing at the rate more than
the revenue growth of the product
3. EBIT for MRO IT Systems would increase at higher rate of 8% every year along with the market growth.
Investing in this category to increase the market share would reap good benefits in the long term
4. EBIT for MFS Instruction would remain constant in absolute terms, due to which it will not be a cash cow for the
company for longer period
5. MRO IT System services has a good growth prospective with increasing EBIT at an average of 8% per annum.
It has a potential to increase the share in the company’s revenue with product as well as market development of
markets such as civil aviation industry in emerging economies
5. Milco’s Competitive Position
• Stars: With 35% & 20% of market share MFS Service & Maintenance
and MRO IT System Services, contributes 20% & 11% to net profits
respectively
• Cash Cows: MFS has a negative market growth but highest Return on
Assets (RoA) of 26%. MFS Instruction market is stagnant yet adds 17%
to the revenue. Milco would need to invest in new product as well as new
market development
• Question marks(?): MRO IT System, though a growing market, Milco is
not able to capture the larger market share, with competitors squeezing
the profit margins which reduces ROA to as low as 13%. Milco has two
options, either to invest in these products/services to increase market
share through market penetration or market development, or to divest in
the products/services.
• Dogs: Milco, having core competency in Flight Simulators and MRO IT
Systems could not diversify successfully, in the market of Military Facility
Construction. Moreover the lowest ROA and negative profit margins are
eroding Milco’s bottom line Market share
Marketgrowth
HighLow
High Low
• MFS
Service &
Maintenan
ce
• MRO IT
System
Services
• MRO IT
System
• Military
Facility
Constructio
n
• MFS
• MFS
Instruction
In Million USD
Military Flight
Simulator
MRO IT
System
Military Flight
Simulation
Instruction
Military Flight Simulator
Service/Maintenance
MRO IT
System
Services
Military Facility
Construction
2014 Market $3,000 $3,000 $1,750.00 $1,120.00 $1,150 $125,000
Market Growth Trend Decreasing Increasing No Change Increasing Increasing No Change
Milco's Market share 20.0% 10.2% 20.0% 35.0% 20.0% 0.1%
Milco's Revenue $600.00 $306.00 $350.00 $392.00 $230.00 $125.00
Contribution to Net Profit $78.8400 $40.2084 $45.9900 $51.5088 $30.2220 $16.4250
Contribution in Revenue 30.0% 15.3% 17.5% 19.6% 11.5% 6.2%
Product Asset Value $300.0 $300.0 $300.0 $300.0 $300.0 $500.0
Return on assets (RoA) 26.28% 13.40% 15.33% 17.17% 10.07% 3.29%
6. MRO IT System and Services
• Global Economic slowdown has propelled the cutbacks on
defense budget by country governments, who prefer to maintain,
repair, upgrade and use the same products in aerospace
activities rather than buying new equipment
• MRO IT system and MRO IT System Services have respective
market share of 10% and 20%, contributing to 15% and 11.5% of
the revenue for Milco, with positive market growth in both
product categories
• As given in the data, market growth rate for both these
categories has shown positive trend in 2014-15
• The profit margin would increase in the future with COGS
increasing at decreasing rate relative to revenue forecast
Current competitive position
7. MRO IT System and Services
• Grab the market share from competitor who are exiting from the market
• Focusing on the non users to persuade them to buy MRO IT System from Milco
Market
Penetration
• MRO IT System, are not very sensitive product as compared to arms & weapons,
• Targeting defense service sector of emerging countries such as India, South Africa,
Brazil, Turkey, Israel, Russia etc., would be relatively easier
• Take advantage of regulatory changes such as, allowing FDI in defense,
outsourcing MRO activities in India as well as in South Africa has given rise to
related industries
Market
Development
• MRO IT System for Civil aviation:
• Civil aviation in emerging markets, especially in Asia, is rising steeply with 18% of
growth rate, with this growth rate MRO industry is also on the rise.
• Especially India, UAE and Turkey are taking working hard to increase the market
share in MRO industry by taking an advantage of their geographical location
Product
Development
• India, currently contributes 1%, i.e. $600 Million to the global civil aviation MRO, but
growing at the rate of 14% per annum with expected market size to be $1.8 Billion
by 2020
• There are many service providers in Indian MRO Industry such as Indamer,
Airworks, Max, HAMCO
• Target these companies and position the new product
Diversification
Growth Prospective
8. Military Flight Simulator, Maintenance &
Services and Instruction
Weapon System
Simulator Cost /
Hour
Aircraft Cost /
Hour
CH-47 $256 $1,771
UH-60 $59 $1,448
AH-64 $70 $3,101
• Military Flight Simulator is widely used to train the pilots so as
to save cost of training. The training cost on simulator is 5-
20% of that of training on aircraft
• With chronic defense budget cuts, have increased the use
of flight simulators, flourishing the market of Flight Simulator
and its services
• Apart from Military Flight Simulators, Milco should develop
and introduce a Flight Simulator for Civil aviation
• Civil aviation is growing in terms of passenger traffic as well
as new players are coming into the market. India, China,
Malaysia, Thailand, Singapore are the countries where civil
aviation is on the rise due to flooding of Low Cost
Carriers(LCC)
• With increase in number of aircrafts, the employment of
pilots in the industry would increase which would give rise
to training institutes for pilots.
• This is the new market for Milco to enter into: Go to Market
Strategy
Know the competitors in
the new market
Partnership with
the local vendor
Target the
institutes for
Service offering
Offer the world
class
maintenance
and services
Grab the market
gradually with
Milco’s products
9. Military Facility Construction
Current competitive position
• Milco has the market share of meager 0.1% in
the $125 billion industry.
• The profit margins are very low due to cut-
throat competition in the market with more
than 100 players, hence selling the product
will not be profitable unless the company has
a substantial market share
• IP assets for this product category is valued as
$500 Million ,with amortization of $20 Million
every year as per our calculation
• Milco has earned the revenue of $130 Million
with net profit of around $16 Million in this
product category
• This product category market though huge in
size, it is stagnant with apparently no growth
opportunities. Return on Assets in 2014 is
3.29%, lowest in the all product category as
traded by Milco
Recommendations
• Calculations from the given data reveal that
Milco has made the loss of $ 4 Million in the
year 2014 in this product category
• If Milco sells off this business unit in 2015 , it
would achieve either of the three benefits-
• Reduction in the amortization expenses by $20
Million, thereby increasing the EBIT of the
company by around 7%
• The amount received by selling off the business
could be invested in the new or the existing
product or market developments, so as to improve
the top product segments
• The amount received could be useful to repay the
debt so as to save on the interest costs,
eventually increasing Net Profit
• Otherwise, if the current market share for this
segment is prevalent in the future, with product
asset valued at $500 Million, it would take
around 5.25 years to break even.
10. Appendix
Assumptions
• The forecasting period is of 6 years from the year 2014 to 2019
• Net profit margin is equal for all product and services offered by Milco
• Asset base as well as the asset proportion remains the same for forecasting period
• Assets are increasing with the increase in sales of the products/services with the respective rate of increase
• Long term debt is increasing at the constant rate of 5.56% for the forecasting period
• The company has kept the capital structure same by maintaining debt/equity ratio of 28.8% for making
investments in 2016 and in 2019
• No other investment is made by the company in the forecasting period
• Interested rate on long term borrowing is constant over the forecasting period
• Return on Equity is 25%
• Sales growth rate is assumed to be constant in the respective product categories
References
• http://www.washingtonpost.com/blogs/wonkblog/wp/2013/01/07/everything-chuck-hagel-needs-to-know-
about-the-defense-budget-in-charts/
• http://people.stern.nyu.edu/adamodar/New_Home_Page/datafile/roe.html
• http://csimarket.com/Industry/industry_ManagementEffectiveness.php?ind=201
• http://www.12newsnow.com/story/26200291/need-to-reduce-costs-of-pilot-training-drives-the-global-
commercial-and-military-flight-simulation-market-according-to-new-report-by-global-industry
• http://www.marketwatch.com/story/the-global-military-simulation-and-virtual-training-market-2014-2024-
2014-02-12
• http://online.wsj.com/article/PR-CO-20130122-904850.html