Private warship builders live off scraps, while the figures tell the real tale

MoD claims public and private shipyards compete on equal terms, but the deck is loaded against private builders

By Ajai Shukla

Kathupalli, Chennai

Business Standard, 25th March 18

An hour’s drive north of Chennai, Larsen & Toubro’s shipyard at Kathupalli sprawls over 900 acres, a spacious, modern facility very different from the cramped precincts of defence public sector undertaking (DPSU) shipyards like Mazagon Dock Ltd, Mumbai (MDL) and Garden Reach Shipbuilders & Engineers, Kolkata (GRSE).

A fortnight ago, Kathupalli delivered to the navy a Rs 468 crore (4.68 billion) floating dry dock (FDD), which is now operationally deployed, repairing naval warships in the Andaman & Nicobar Islands.

Meanwhile, the first of seven offshore patrol vessels that L&T (Larsen & Toubro) is building for the Coast Guard has concluded successful sea trials. The new vessel is getting a lick of paint before being handed over on March 31.

Vice Admiral B Kannan (Retired), who headed the navy’s nuclear submarine project and now oversees L&T’s shipbuilding business, points out that both vessels were completed before the contracted time and within budget – a rarity in defence shipyards. Further, both were constructed entirely in-house, and designed in L&T’s Warship Design Centre at Manapakkam, Chennai.

Yet, despite conforming fully to the Make in India initiative, Kathupalli is struggling to win defence orders and the shipyard’s capacity is severely under-utilised. In three navy tenders opened in September, public sector shipyards comprehensively outbid L&T, leaving its order book worryingly depleted.

In the tender for building 16 anti-submarine warfare shallow water craft (ASWC), L&T put in a bid of Rs 1,234 crore (12.34 billion). Public sector rival Goa Shipyard Ltd (GSL) quoted Rs 797 crore (7.97 billion) and Kerala state PSU, Cochin Shipyard Ltd (CSL), won the order with a bid of Rs 674 crore (6.74 billion) – a whopping 45 per cent lower than L&T’s.

Bids for 16 x Anti-submarine warfare shallow water craft (ASWC)

Shipyard	Quote (Rs crore)	Remarks
L&T	1,234
Reliance	891
Goa Shipyard (GSL)	797
Cochin Shipyard (CSL)	674	45% cheaper than L&T

In the simultaneous tender for building five survey vessels, L&T quoted Rs 742 crore. (7.42 billion) Three public sector shipyards – CSL, GSL and GRSE – bettered that with intriguingly similar bids. GRSE won the contract with a Rs 520 crore (5.20 billion) quote – 30 per cent lower than L&T’s.

Bids for 5 x Survey vessels

Shipyard	Quote (Rs crore)	Remarks
L&T	742
Shoft Shipyard	670
Cochin Shipyard (CSL)	573
Goa Shipyard (GSL)	568
Garden Reach (GRSE)	520	30% cheaper than L&T

Finally, in the tender for building two diving support vessels, L&T quoted Rs  1,584 crore (15.84 billion). Beating it comprehensively were three public sector shipyards, CSL, GSL and Hindustan Shipyard Ltd (HSL), with the latter’s winning bid of Rs 1,010 crore (10.1 billion) being 36 per cent lower than L&T’s bid.

Bids for 2 x Diving support vessels

Shipyard	Quote (Rs crore)	Remarks
L&T	1,584
Cochin Shipyard (CSL)	1,188
Goa Shipyard (GSL)	1,086
Hindustan Shipyard (HSL)	1,010	36% cheaper than L&T

Why did L&T bid so high?

Amongst defence industry analysts, the first question this raised was: is L&T running Kathupalli so inefficiently that public sector yards can build warships 30-45 per cent cheaper than them? How did public sector shipyards win so conclusively?

Confronted with that question, Jayant Patil, L&T vice president who oversees its defence vertical explained how his company structured their bids. Working off a “basic material price”, L&T added to that labour cost and services, escalation, yard recovery, working capital costs, contingencies and a provision for warranty.

“Our final quote was about 1.7 times the basic material price, to cover the other costs. But our public sector competitors’ quotes were just 1.1 or 1.2 times the basic material price. Clearly, they did not need to factor the costs that we did,” said Patil.

What Patil left unsaid was what everyone in the industry knows: that public sector shipyards, which get most of their income from “nominated” orders from the defence ministry, enjoy enormous financial advantages in bidding against private shipyards.

DPSUs have financial buffers that accumulate from being able to cost “nominated” project lavishly, in a single-vendor environment, and obtain advance payments from the defence ministry that pile up into large cash reserves. Consequently, public sector shipyards incur no working capital costs and, in fact, earn billions in interest on their cash reserves. Last year, MDL’s cash reserves of Rs 8,363 crore (83.63 billion) generated Rs 765 crore (7.65 billion) under “other income”, turning an operating loss into a net profit. Meanwhile GRSE’s “other income” of Rs 227 crore (2.27 billion) enabled the shipyard to squeak out of the red and show a profit of Rs 12 crore (120 million) last year.

Finances of public sector shipyards

(Rs crore)

Shipyard	Turnover from operations	Profit	Other income	Profit (less other income)	Long term borrowings	Cash balance
MDL	3,524	533	765	(-) 232	--	8,363
GRSE	930	12	227	(-) 215	--	1,185
GSL	1055	177	47	130	2	504
HSL	618	54	21	33	372	230
CSL	2,058	322	163	159	123	676

(Source: Shipyards’ annual results)

Nor are PSU shipyards burdened with infrastructure costs, since those have been built up over decades with taxpayers’ money. In contrast, private shipyards like Kathupalli and Reliance Defence’s shipyard at Pipavav, Gujarat, must service debt of Rs 50-100 billion (5,000-10,000 crore), which drives up their bids. The cost of commercial borrowings, which exceeds 15 per cent per annum, amounts to over 40 per cent of the cost of multi-year shipbuilding contracts.

Also allowing public sector shipyards to get away with quoting low is the permissive oversight of the defence ministry, which has never penalised them for time and cost overruns. Parliament’s Standing Committee for Defence reports show CSL’s budget to build an indigenous aircraft carrier swelled 593 per cent from the originally sanctioned Rs 3261 crore (32.6 billion) to Rs 19,341 crore (193.4 billion), while the build time rose by six-nine years. Similarly, in Project 15A to build three destroyers, MDL’s cost burgeoned to Rs 11,662 crore (116.62 billion), 325 per cent of the originally sanctioned Rs 3,580 crore (35.8 billion).  In many such cases the defence ministry justified, and quietly paid, the excess.

Public sector: time and cost overruns

Ship type	Cost overrun			Time overrun
	Sanctioned	Final cost	Rise %
Aircraft carrier	Rs 3,261 cr	Rs 19,341 cr	593%	6-9 years
P 15A destroyers	Rs 3,580 cr	Rs 11,662 cr	325%	6 years
P 28 corvettes	Rs 3,050 cr	Rs 7,852 cr	257%	5 years
P 75 submarines	Rs 13,000 cr	Rs 23,562 cr	181%	5 years

(Source: Standing Committee on Defence reports)

Private shipyard executives are confident that, with adequate orders, they can stabilise their finances and compete on equal terms with the DPSUs. But the high-value contracts for capital warships – corvettes, frigates, destroyers, aircraft carriers and submarine, with their advanced sensors and weaponry – are “nominated” to DPSUs. The defence ministry says this is because private shipyards have no experience of building capital warships.

A top navy admiral told Business Standard that “it would be too risky” to entrust a private shipyard with the impending Rs 10,000 crore (100 billion) contract to build two Russian-designed Krivak III frigates for the navy because “The Krivaks are too complex and weapons-intensive.”

Arguing that private yards should “build their skills in a graduated and calibrated way”, he said private shipyards would be allowed to compete for building the eponymous Next Generation Missile Vessels, for which the tender is soon expected.

Meanwhile, GSL is being entrusted with building the Krivak III frigates, even though it has never built a frigate before. “Different logic for the public and private sector”, rues a private shipyard executive.

This is not the first time GSL has benefited from ministry largesse. Manohar Parrikar, as defence minister in 2015, did his home state shipyard a favour by “nominating” it for a Rs 32,000 crore (320 billion) order to build 12 minesweepers – a contract worth 30 times GSL’s turnover. Since then, GSL has made little progress in discharging the order.

While the combined turnover of five public sector shipyard for the year ending March 31, 2017 was Rs 8,185 crore (81.85 billion), their order book adds up to Rs 180,000 crore (1,800 billion) – that is 22 years of production.

Defence ministry officials, in public interactions with industry, claim the days of “nomination” are over, and that public and private shipyards now compete on equal terms. But the figures tell a different tale, in which public shipyards feast at the high table with the defence ministry, with only scraps being tossed to private shipbuilders.

A Business Standard analysis of shipbuilding orders in the last twenty years indicates that 90 per cent by value, worth Rs 2,23,100 crore (2,231 billion), were “nominated” to public shipyards, while private shipbuilders were allowed to compete for contracts worth only Rs 25,600 crore (256 billion).

Even for that tiny slice of the shipbuilding pie, private shipyards had to compete with the DPSUs, eventually winning contracts worth only Rs 10,350 crore (103.5 billion).

“We don’t need orders for Rs 100-200 crore (1-2 billion) vessels. We have invested Rs 5,000-10,000 crore (50-100 billion) into state-of-the-art shipyards. We need commensurate orders,” private shipbuilders have repeatedly told the ministry, to no avail.

In December, navy chief, Admiral Sunil Lanba, said: “We have also identified about Rs 40,000 crore (400 crore) worth of [shipbuilding] projects for private shipyards”. But the wait continues.

State of private sector shipyards

Lanba stated that 23 private sector shipyards are qualified for defence shipbuilding. Amongst these, there are just four shipbuilders -- L&T, Reliance Defence, Bharti and ABG. The others, some of which have potential, are really boat building yards.

Of the four large, private shipyards, two – Bharti and ABG – are insolvent, and there is little serious interest from buyers. The other two, L&T and Reliance Defence are kept afloat by their parent companies’ deep pockets.

According to Parliament’s Standing Committee, the defence ministry has 53 warships and six submarines in the procurement pipeline. This number could increase if the government utilises shipbuilding capacity to build naval craft for our regional maritime partners. How these orders are distributed and tendered could determine the future of India’s private warship building industry.