Labor and Welfare Minister Haim Katz won’t be participating in the socioeconomic cabinet meeting on Tuesday which is expected to approve the purchase of drone-maker Aeronautics by the state-owned defense company Rafael. Katz wanted to take part in the deliberations but the Attorney General Avichai Mendelblit barred him from doing so.
Katz may have no direct connection with the pair of companies involved in the deal, but he’s supremely connected to another government-owned defense industry, Israel Aerospace Industries. He served as the company’s workers committee chairman for nearly 20 years before bequeathing the post to his son, Yair. Thousands of IAI workers who belong to the Likud make up his power base in the party.
Rafael’s acquisition of Aeronautics is not good news for IAI. It would enable Rafael to enter a market in which IAI dominates locally and allow it to bid for a giant Defense Ministry project. The contract is worth hundreds of millions of dollars and includes a research and development component.
IAI would be a natural contender, but the company has decided to opt out. The R&D costs are expected to be enormous and the contract terms would limit the freedom of the winner to sell the drones it develops to overseas customers. IAI decided that even were to win the bid, it would end up losing money on the project.
Rafael, on the other hand, was prepared to pay a lot of to get ahold of Aeronautics. One of its considerations was that same defense contract. With Aeronautics under its wing it would be ready and able to compete even if, as is likely, the ministry sticks to its draconian terms.
Not just Rafael, Elbit Industries – the one major private sector player in the local defense industry – is anxious to chip away at IAI’s drone dominance.
Inside IAI, there were those who say the company had no choice but to bid for such a big and strategic contract. If it were to win, it could enter into negotiations with the ministry over the exact terms. IAI, they said, could reduce its high labor costs by spinning off a lot of the work to lower cost subcontractors and suppliers.
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But in the end management said no; the financial feasibility of the contract was not sufficiently guaranteed.
Welcome to the new IAI. It’s still a state-owned company, but one that’s on the path to an initial public offering on the Tel Aviv Stock Exchange.
IAI turned in an $81 million profit in 2017 and then posted a $44 million loss in 2018, but that was related to a changing of the guard at the top. Yossi Weiss wanted to end his last year as CEO with a profit at all costs; his successor, Nimrod Sheffer, wanted to start his term by cleaning the stables of losses Weiss had left behind.
The goal of Sheffer and IAI Chairman Harel Locker for 2019 is to break even on an operating basis and then to post a profit in 2020 and an even bigger profit in 2021. That will give a boost to the IPO, which calls for selling a 25% stake in the company to the public.
The IPO process won’t get under way until the next government is formed. But in the meantime, IAI executives are working with the Israel Securities Authority and Justice Ministry to put all the pieces in place so that all that will be left for the next defense minister to do is to sign off on it.
Getting a good valuation for the company in the IPO means that its 2020 financial report must show a significant improvement in profitability metrics. One way to achieve that is not to compete for the tender. It may be a prestigious project but will likely saddle IAI with tends of millions of dollars in losses and hurt the valuation.
Another thing IAI is doing to get itself IPO ready is to avoid noisy labor disputes. The cost-cutting measures the company needs to undertake are thus being done as slowly and quietly as possible. But they are happening: IAI has let go of more than 200 staff this year and plans to let another 200 go in 2020 as it merges its civilian and military aviation divisions. That move could justify as many as 900 jobs cuts, but management isn’t prepared to fight a war with the union and is settling for less. While it negotiates severance terms for employees getting the ax, it’s also seeking a new collective labor agreement to replace the current one that dates to the 1970s and is responsible for the company’s high labor costs.
The company’s goal for the years 2019-30 is to reach the top quarter of the world’s defense contractors. To do that, it will have to boost earnings before interest, taxes, depreciation and amortization of 10% of sales. The plan also calls for upgrading production lines, including robotics, R&D and improved outsourcing procedures.
But as the attorney general’s decision on Katz shows, IAI no longer needs to keep good relations with the workers committee in order to ensure the support of politicians. At IAI, business is now just business.