Reliance Infra's Pipavav buy to spur ADAG's defence equipment business

Anil Dhirubhai Ambani Group's (ADAG) entry into the defence sector through Reliance Infrastructure 's acquisition of India's largest private sector defence company - Pipavav Defence and Offshore Engineering Company - will usher in a new wave of defence sector equipment manufacturing business in India.

Reliance Infra on Wednesday announced it would acquire Pipavav Defence by acquiring 18 per cent stake (for Rs 819 crore), along with an open offer for 26 per cent of shares at Rs 66 per share, for close to a total of Rs 2,080 crore investment. The company says the acquisition has potential to tap about Rs 1,20,000 crore or $20 billion over the next five years.

"This deal should be viewed as a precursor to many such deals going to happen in this sector," says Sanjay Sethi, who runs Nector Consulting and was the senior executive director and head of infrastructure Group at Kotak Investment Banking.

"We are confident that our strategic investment will create long term value for all stakeholders", ADAG Chairman Anil Ambani said in a press release. In the same release, Nikhil Gandhi, the founder promoter and Chairman of Pipavav Defence, said the transaction is an endorsement of the vision they set out to achieve almost 10 years ago.

Sethi says the deal is good for the promoters of Pipavav, who earlier had sold off a port in a similar fashion by pioneering the business, creating the infrastructure and selling off at the right time for good valuation to initiate another business.

India has the third-largest armed force in the world. On average India earmarks an annual budget of about $38 billion and 40 per cent of this is used for capital acquisition. In the next 7-8 years, India would be investing more than $130 billion in modernisation of the armed forces.

Anil Ambani's elder brother Mukesh Ambani's Reliance Industries is also eyeing big business in the sector. It is planning to invest about $1 billion in aerospace over the next three years and had set up Reliance Aerospace Technologies and Reliance Security Solutions in 2011. A year later, Mukesh partnered with Dassault Aviation to enter defence and homeland security sectors, and with Boeing for supplying military aviation components. Other major private sector groups already active in this field include the Tata Group, Mahindra & Mahindra, L&T and Bharat Forge.

"India is one of the largest importers of conventional defence equipment and spends about 40 per cent of its total defence budget on capital acquisitions. About 70 per cent of its defence requirements are met through imports", says a PriceWaterhouseCoopers (PWC) study led by Dhiraj Mathur, executive director and leader, National Aerospace and Defence Practice, on India's aerospace and defence sector.

Though the defence sector was thrown open to private sector participation in 2001, there were many entry barriers for the domestic industry like licensing and foreign direct investment restrictions. Obtaining industrial licence under IDR Act was very cumbersome and was a major roadblock for the industry, particularly small and medium industry, to get business for making parts, components, sub systems and sub-assemblies.

The Narendra Modi Government liberalised the FDI policy regime by allowing 49 per cent through government route (with FIPB approval). FDI above 49 per cent is also allowed on a case-by-case basis with the approval of Cabinet Committee on Security. The new government also removed the restrictions in the earlier policy related to Foreign Institutional Investment (FII) and majority shareholding to be held by single Indian shareholder.