Israel's Arms Makers to Become More American Under New Military-aid Pact

A gradual end to local procurement will mean more production in the U.S. and greater collaboration with American companies.

Heron 1 UAV
An Israel Aerospace Industries Heron 1 UAV, on display at the Singapore Airshow, February, 2014. Bloomberg

The key to Israeli defense firms not losing business under the new U.S. military aid deal will be to follow Elbit Systems and set up subsidiaries in the United States to bid for defense orders, industry officials said over the weekend.

They were speaking days after the United States and Israel signed a 10-year memorandum of understanding that will provide Israel with $3.8 billion in annual grants.

In the deal, Israel will no longer be entitled to spend 26.3% of the money – equal to around $815 million annually in recent years – in Israel. But the local-procurement clause only goes into effect in 2025, the sixth year of the agreement, and winds down to zero by the 10th year.

Defense sources said the grace period should give Israel’s biggest defense companies – Tel Aviv-listed Elbit as well as state-owned Israel Military Industries, Rafael and Israel Aerospace Industries – time to adjust.

Elbit has a large presence in the United States with its Elbit Systems of America unit. Its units include EF, Kollsman and 50% of Rockwell Collins ESA Vision Systems, which make electronics for the defense, homeland security and medical sectors. Elbit codeveloped the high-tech helmet being used on the next-generation Lockheed Martin F-35 fighter jet.

“The big defense companies need to do what Elbit has been doing for a long time to win Defense Ministry contracts – open successful subsidiaries in the U.S. or collaborate with American companies,” said one source who requested anonymity. “Rafael and IMI aren’t scared at all and are confident they can cope with the change. IAI is somewhat apprehensive, but it’ll be fine.”

As defense officials envision it, Israel will keep its technology and know-how at home while sending the production to the U.S. unit.

“We’ll have cooperative agreements with American companies .... The development work will be done here and the manufacturing in the U.S.,” said one source. “Smaller Israeli companies can act as subcontractors to American subcontractors.”

This source even echoed the view shared by many defense officials that sometime during the life of the agreement, the local-procurement section will be restored in whole or in part.

The big problem for Israel’s defense industry, a key employer and one of the world’s 10 biggest arms exporters, will be preserving jobs as more manufacturing shifts to the United States.

The Israeli industry, which is heavily reliant on exports, has been dealing with the problem for some time as governments demand as a condition for awarding contracts that production be moved to their countries. India, which has emerged as one of Israel’s biggest customers, has been in the forefront.

IAI is developing the Barak 8 defense missile for protecting offshore gas rigs with India’s Defense Research and Development Organization. It’s also collaborating with India’s Alpha Design Technologies make mini-drones.

Rafael has formed a joint venture with India’s Kalyani Group to produce missile systems and other defense equipment.

Israel’s smaller arms makers, however, face a more challenging environment. While they may benefit from great transparency in Israeli Defense Ministry contracts, they don’t have the resources to set up operations in the United States.

A year ago, the Economy and Industry Ministry’s Industrial Cooperation Authority launched efforts to help these companies. It has crafted models under which smaller firms can win business from American companies through voluntary offset agreements, which condition Israeli government contracts on buying or investing in Israeli companies – not just traditional arms makers but cybersecurity companies too.

Ziva Eger, the head of authority, pointed to companies like engine-maker Pratt & Whitney, which buys products from Israel’s Beit Shemesh Engines, Carmel Forge, and Blades Technology. All told, about 133 U.S. companies have offset agreements with Israel defense firms that led to $11.7 billion of orders in the last decade.

“The new aid agreement increases the potential for offset agreements,” Eger said.