The government has reached an agreement with management and unions to privatize Israel Military Industries, one of the last state-owned behemoths in the defense sector. Whoever buys the company will inherit a rich array of technologies and products, but also a business that bleeds money. The second of a two-part series on Israel Military Industry’s past and future.
- Israel Military Industries: Powerful arms, but feet of clay
- U.S. billionaire Ira Rennert, Ehud Barak mull Israel Military Industries bid
- Shower of red ink for Military Industries buyer?
- Privatization plan gets cold shoulder from Israel's capital market
- Sale of Israel Military Industries gets under way
In 2008 Israel Military Industries CEO Avi Felder, with the cooperation of trade union representatives, began drawing up a plan for privatizing the company.
The plan envisaged 2010 as the company's turnaround year, during which 150 new employees were to be taken on, one for every six to be let go. The company projected that its operating profits would reach NIS 42 million in 2011, NIS 62 million in 2012 and NIS 85 million in 2013.
Taking the price-earnings ratio of Elbit Systems as a benchmark, this would have put IMI's market valuation in the NIS 2 billion range, close to the price estimated in internal discussions. But the plan never went into effect and the company accumulated more than NIS 500 million in losses over the past two years.
IMI based its projections on costs of NIS 200 million a year for the 950 redundant workers, NIS 75 million for maintaining money-losing production lines that are nonetheless vital for national interests, and NIS 25 million in payments to retirees. Also taken into account was a cost of NIS 50 million a year attributed to the company's inability to keep expenses down.
The company's business plan for 2016, reviewed by accounting firm Ernst & Young, also presents a rosy picture for the purpose of luring buyers. It projects revenues increasing at a rate of 10% annually, to NIS 2.7 billion, due to organic growth. It also forecasts a 20% increase in IMI’s gross margin every year, lifting it to 23% in 2016 from 12% today, which is too small to cover the company's management, marketing and research and development costs.
The company aspires to reach a 6.5% net profit margin in 2016, an ambitious goal given the cutthroat competition in the arms industry.
IMI now has several teams examining ways to streamline operations. "Until now the company was concerned only with survival," says a senior company source. "The company's business culture has changed. It now has many balls in the air and, along with going private, we will implement all the efficiency measures."
He says the company has switched to the design-to-cost system of production planning and has significantly reduced its "time-to-market," the time elapsed between a new product's conception and the start of sales. "We’re putting defense systems on the market within three to four years, instead of the 10 to 12 years it took 15 years ago," says the source.
Felder, who also serves as chairman of Ashot Ashkelon Industries, which supplies systems and components to the international aerospace, defense and automotive industries, says the number of employees at Ashot has increased by 60, to 460, but sales have increased by a far greater proportion. “Despite this small increase we've been selling 60% more," says Felder. "This could also be done at IMI."
But to accomplish this, IMI must receive 20% to 30% more in new orders than its sales currently reflect. It would also have to reduce the number of company divisions from five to three, scale down management, combine operations, streamline procurement and upgrade its information systems.
The privatization roadmap, to be presented for approval by the cabinet committee for privatization on October 15, should solve the company's payroll problem. The state will forgive IMI some NIS 2.5 billion in loans and other debt, the 950 workers will be let go at a cost of NIS 1 million each, and an NIS 830 million fund will be established to ensure the retirement benefits of veteran workers who stay on after the privatization.
Meanwhile, the company's facilities will be moved from the expensive land they now occupy in the Sharon region to Ramat Beka in the Negev, a move that will cut its steep municipal tax costs and wasted payments for land sitting empty in the Negev and center of the country. The land to be evacuated can accommodate tens of thousands of housing units valued at some NIS 20 billion, money the government will need to pay off the liabilities it is assuming in the privatization and to decontaminate the land. The government is also committing itself to buying a certain amount of IMI equipment for national security.
But some say that letting go the 950 workers isn't a panacea. "The company's problem is it lacks a next generation of skilled people," says one former IMI employee. "Some of the people leaving are a national resource of knowledge without any replacement, and that’s a real blow to security. IMI needs to hire young staff to replace the ones being retired. This is a company with amazing technology, but even the remaining 2,000 employees will need to be motivated to get them to work hard. They are good people, but the past 10 to 15 years has taken the zest out of them."
Over the past few years IMI has been trying to change the configuration of its workforce irrespective of the privatization. "In the past five years we have taken on 500 people in areas such as computer hardware and software, aeronautics and software engineering," says a senior company source.
Potential buyers will need to take note that much of the company's Givon division, which produces systems that are classified, won’t be part of the deal because the government doesn’t want it falling into private hands. "I understand there are security issues," says former IMI chairman Avner Raz. "But on a business level Givon is profitable and interesting."
Despite the grandiose plans, privatization isn’t necessarily a done deal. The company has been on the verge of being privatized for so many years that nobody would be surprised if the whole thing comes to naught.
In 2005, when Amir Peretz was defense minister, the government decided to privatize IMI but the workers’ committee seized the company’s headquarters building. Peretz made way for Ehud Barak, who also pursued the plan. In 2009 the privatization road map was agreed upon. Since then, however, it has been snagged in disputes that arose with the Histadrut labor federation over guarantees for the staff.
While the sides quibbled over the size of the safety net, another state-owned defense company, Rafael Advanced Defense Systems, declared an interest in merging with IMI. Soon after, Israel Aerospace Industries said it too was interested in a merger.
Both companies backed down in the face of opposition from their own unions. A year ago, IMI management came to an understanding with the union over a plan, but progress was stalled due to the election that followed earlier in 2013.
"Sometimes the government pushes a company into a terrible state and then sells it in order to get rid of it," says a senior company source. "It's as if it is saying: 'We'll make things difficult, the workers will get fed up, management will get fed up, and it will be easy to sell.'"
If so, it was a costly effort for the Finance Ministry, which has spent NIS 1.5 billion since 2005 to prop up Israel Military Industries. IMI also paid a heavy price, in the form NIS 2.1 billion of needless spending on surplus staff and extravagant pensions, say company sources.
"In IMI's case, the gain from privatization is the privatization itself," says Eldad Avraham, a mergers and acquisitions consultant. "The government profits by removing the burden.”
He said that from a business standpoint, it might be better to sell off parts of Israel Military Industries.
“Selling it off piecemeal could increase the proceeds the government gets, but it could jeopardize the privatization process,” says Avraham. “The possibility of the government remaining a partner in the company should be considered. It would ensure that national security interests are maintained as well as allow it to sell its retaining holdings in another few years at a higher value than it could get today."