Israel Military Industries: Powerful Arms, but Feet of Clay

Despite its impressive array of defense technologies and products, Israel Military Industries has been a perennial money-loser. Will privatization save the company?

Driving through the broad expanse of the Israel Military Industries site, between Ramat Hasharon and Kfar Sava, one gets the sense of small city, rather than an industrial complex. Roads surrounded by greenery wind between the various plants and even the sprawling, seven-story headquarters evokes another place and time - namely, the Soviet Union.

"IMI, like other government corporations, such as the Nuclear Research Center or the Institute for Biological Research, looks like a kibbutz, is run like a kibbutz and the people there feel like they’re on a kibbutz," says a former employee. "There was an orchard within the complex where I worked. The company car assigned to you was a bicycle. It was a wonderful place with amazing people, but without any business sense."

IMI will celebrate its 80th anniversary this December in a somewhat anachronistic way - a postage stamp will be issued in its honor. Nevertheless, IMI is on its way to becoming a modern company that can compete in the free market of the arms industry. Earlier this month, the govenrment, IMI and the trade unions signed an agreement for the privatization of the company, bringing to an end a saga that began over 20 years ago, when IMI was converted from a Defense Ministry unit into a government company.

The Finance Ministry's budget division has been busy putting together a draft outline of the privatization roadmap that will be presented to the cabinet committee for privatization. Issues such as whether the Defense Ministry will continue ordering equipment at the same levels as in the past have yet to be resolved and it will take months until the terms of a tender are drawn up. Nevertheless, the Government Companies Authority, which oversees IMI, has already been approached by business groups interested in purchasing the company. Meanwhile, IMI is slated to embark on a recovery program, which includes letting go superfluous manpower, drafting financial statements and determining its financial structure.

The scope of the company's activity is impressive. It does NIS 1.9 billion in sales a year and has an orders backlog amounting to NIS 5.6 billion. Its activities cover a diverse range, from upgrading tanks and armored personnel carriers to manufacturing artillery shells, aerial bombs and precision rockets. It also makes protective vests and satellite launching engines, just to name a few.

Some 70% of IMI’s sales are designated for export, to countries like Italy, France, Turkey, Kazakhstan, Vietnam, South Korea and several African nations. Fully 80% of its products are based on in-house research and development and 30% of its revenue is derived from foreign companies using its R&D services to develop specialized weapons systems.

Nevertheless, IMI has posted losses for 14 straight years, reaching some NIS 250 million annually in recent years. Those losses have forced the company to rely on government infusions to survive.

IMI’s bank credit line amounts to just NIS 200 million, a sum that some in the company claim is “more suited to a grocery store than a company with turnover approaching NIS 2 billion.” But the limited credit is not difficult to understand, when one takes into account the company’s NIS 2.1 billion deficit on its balance sheet and total liabilities of NIS 4.7 billion.

IMI’s situation is so worrisome that the GCA does not release the company’s financial reports, for fear of needing to append a “going concern” warning on them.

“Already during my time there, IMI only paid suppliers with checks personally guaranteed by the divisional manager,” says the former employee. “Only after the check cleared were suppliers ready to transfer the goods.”

The turnaround record of defense sector privatzations is encourgaging. Ashot Ashkelon Industries, a company 85% owned by IMI that was floated in 1992, has generated a 430% return on its stock in the past five years. Not a high-tech company, Ashot manufactures gears, transmissions and jet engine shafts. Since 2010, its revenues have climbed 17% a year and its operating margin last year was 13%.

Another example is a small arms subsidiairy sold by IMI to Samy Katzav eight years ago for $2 million. Katzav took on another $8 million in debt and the company is now worth an estimated NIS 500 million.

One third overstaffed

For IMI management, the explanation for the losses is simple - as is the solution. The way in which the company was separated from the Defense Ministry brought with it several burdens, foremost among them steep pension liabilities for employees who retired over the past two decades on the basis of agreements made by the government long ago.

As a result, some 950 of IMI’s 3,000 employees, each costing an average of NIS 240,000 a year, are on the payroll despite the company having no use for them. It’s cheaper to keep them on the payroll than to make severance payments and pensions. The 950 are people in their fifties whose production lines have been shut down or streamlined. "Anyone who worked in production can't suddenly go tend to active defense algorithms," explains a senior company official.

IMI lost huge properties when it separated from the Defense Ministry, including 70,000 dunams of land in Kiryat Shmona, Haifa, Nazareth, Ramle, the Masmiya junction, Ramat Beka, Ashkelon and the huge compound between Herzliya, Ramat Hasharon, Tel Aviv, Kfar Sava and Ra'anana. As a result it couldn't put the land up as security for loans.

IMI was also forced to carry the burden of responsibility for environmental problems, caused by the discharge of industrial sewage over many years - along with the enormous payments required to decontaminate the land. The company has spent hundreds of millions of shekels annually to clean up the mess.

These two burdens were forced on the company. But IMI also had a hand in creating the situation. The NIS 238 million in gross profit it posed in 2012 was the lowest in the last three years and far from the NIS 400 million peak reached in 2010. Last year’s revenues were also far below their 2008 peak of NIS 2.4 billion.

One implication of excess manpower is the hidden and explicit unemployment, says an employee who left in 2005. "During my period there, the company had someone responsible for cellular communications, a job that required one half-day a week. But he worked at it full-time and received a handsome salary," the ex-exployee recalls. "Some of the excess workers were kicked upstairs into the workers' committee, some were thrown into marketing and instructed to look for projects – being told 'if you find projects that would be great, and if not, it's not a problem.' We saw people with various titles like plant manager, deputy plant manager, acting plant manager – and they're all actually the same job. The person ultimately doing the work is the shift supervisor."

The excess manpower created a chain reaction of inefficiency. "When we need to buy materials for production we fly them in, even though air freight is several times more expensive than maritime transport," says a senior company source. "But we're incapable of planning ahead for the long-term."

"We would submit bids on projects where our marginal gross profit was 3%, less than the foreign currency risk," says the former employee. "This meant that if the dollar rate moved a bit to the right or left we would take a loss. The goal of the project was often to generate work, not profit."

"The root of the problem is that the method used to turn IMI from an auxiliary unit [of the Defense Ministry] into a government corporation in the 1990s differed from thatn used at Rafael Advanced Defense Systems," says Avner Raz, who was IMI chairman until 2010. "Rafael was eble to flourish, but IMI was left with large pension debts which put us into a string of recovery programs that never reached completion. The Treasury doesn't want to invest in recovery, except in the framework of privatization." Without the excess 950 workers, he says, IMI would reach its breakeven point, if not more.

First of two parts

Guy Raivitz