A few years ago the word "privatization" would not even have been uttered in the defense industry. Now, five years after the collapse of the Soviet Union, the Russian government is attempting to lighten the huge financial burden its defense complex represents by doing what was once unthinkable -- it is beginning to sell off state shares in the military-industrial complex's crown jewels.
The process kicks off Dec. 7, with the sale of a 25 percent stake in OKB Sukhoi, a key long-range fighter aircraft design bureau, as well as a 13 percent stake in the Ulan-Ude aviation company and a 25 percent stake in the Progress aviation company located in Arsenyev, in Russia's Far East. Both of the latter are major warplane production plants.
The auction is part of the loans-for-shares scheme, by which businesses -- mostly banks -- receive equity in state enterprises as collateral for loans to the Russian government.
OKB Sukhoi is not, as one may expect, a major aircraft manufacturer. It is a design bureau, with only a small experimental plant and test facilities for building and testing prototypes. The design bureau has given birth to the main Russian long-range fighter, the formidable Su-27, and a ground attack plane, the Su-25.
As with most of the defense complex, Sukhoi has suffered since the breakup of the Soviet Union. Orders from the military now cover only 20 percent of the OKB's everyday needs. The company's work force has fallen by half to about 3,000, and the average monthly salary at the plant is just 600,000 rubles ($133). The Russian air force will not buy any more Su-27 jets this year or next.
The big fighters, with a price tag of about $30 million each, have few potential overseas customers, although they have proven a hit with China, which has ordered 24. According to Mikhail Simonov, general constructor of Sukhoi OKB, a new export deal will be signed next month. He declined to say what the client country will be, but sources say that India and South Korea have been negotiating possible purchases.
Sukhoi is far from collapse. It has a technological edge and has developed prototypes of enhanced versions of the Su-27 -- the Su-32FN and Su-35. According to industry sources, the bureau is set to receive 7 to 10 percent of the sums involved in the China contract.
In its own factory, Sukhoi makes highly regarded light acrobatic planes. The company has a partnership with the U.S.-based Pompano Air Center Corp. In 1995 around 100 planes, worth $200,000 each, were exported to the United States, France and Switzerland, according to company officials.
Altogether at the moment the company is working on 10 new aircraft projects, including sport and passenger planes. But the fruits of these ventures will have to come fast.
One major initiative that has fallen by the wayside is a collaboration, mooted during perestroika, with U.S. executive-jet manufacturer Gulfstream to make a supersonic business jet; Sukhoi still has ambitions to go ahead on its own.
"Our main asset is our brains, but it is getting more difficult every day to keep them in the company," said Vladimir Yakovlev, head of the company's public relations department.
To talk of Sukhoi as an aircraft-making entity it is necessary to include not just the bureau, but the plants which churn out the planes. The principal factories are at Komsomolsk (Su-27 fighters), Irkutsk (Su -27UB trainer, Su 30 fighter-bomber) and Ulan-Ude (Su-25 ground attack fighter).
This division of design bureaus from aircraft-manufacturing plants is a throwback to the monolithic Soviet-era system of construction, dating back to the 1930s. The Soviet aviation industry was part of the system of central planning, and thus was not organized along the lines of interlinked design bureaus and production units. The defense ministries decided what should be designed, design bureaus then built prototypes, and finally a factory or factories were instructed to mass produce the chosen prototype. Some plants worked for one bureau, others for several.
Moreover, although the Aviation Ministry controlled most of the industry, some of its elements were subordinate to other ministries and financed from other sources. Producers of avionics, for example, were funded by the Ministry of Electronic Equipment.
The first level of the aviation industry's system still has nine major design bureaus, and at least 20 major production plants. A second level includes hundreds of smaller design bureaus and research centers, which are in charge of engines, navigation systems, avionics and weaponry. They work with the first-level companies as subcontractors, and also with independent production facilities in charge of corresponding spare parts.
All this makes the prospects of immediate consolidation unlikely. Moreover, few of the heads of the bureaus and factories are going to let their ship sink without a fight. This explains the continued jockeying to get a piece of dwindling government funding, and the current lack of any long-term, strategic planning.
Some consolidation, nevertheless, has taken place. In May 1995 the Moscow-based Mikoyan design bureau, which was responsible for the MiG-29, Russia's main tactical fighter, linked up with Mapo, the Moscow aviation production association, and its two Moscow-region factories, to form the Mapo-MiG company. At present, however, most aviation production units work with several design bureaus, and similar acts of "spontaneous" consolidation are unlikely, even if they would benefit industry. Furthermore, MiGs are selling quite well abroad, even if the Russian Air Force is not presently buying any.
Sukhoi has also made some progress in industrial consolidation. It has linked up with the Ulan-Ude aviation plant and 32 other production units to form the Sukhoi corporation -- a structure which, in its production principles, avoids rigid centralization.
Not all of the elements in Sukhoi's constellation, however, appear on the loans-for-shares list. Sukhoi's other main production centers are the Ulan-Ude plant, another at Irkutsk -- a plant which wriggled off the list at the 11th hour, and a third at Komsomolsk, which was never on it. The Ulan-Ude factory, in the Buryat republic in Siberia 4,000 kilometers southeast of Moscow, was not the most logical to include -- it is the only one in the country which has produced both airplanes and helicopters.
As for the Progress plant, situated in the small town of Arsenyev in the Russian Far East, which is on the loans-for-shares list, it has nothing to do with Sukhoi. It was the major producer of the Soviet army's Mi-24 main battle helicopter.
In recent years, production of the Mi-24 has been stopped and the facilities were refitted for the new state-of-the-art Ka-50 Black Shark helicopter, one of Russia's latest export hopes. The company is now producing Mi-34 light civil helicopters in small numbers. This year eight such helicopters were produced, five of which were sold to Brazil. Some of the plant's 10,000-or-so staff, meanwhile, have been shifted over to the production of washing machines and furniture. In a pattern typical in the defense industry, every third inhabitant in Arsenyev is connected with Progress.
If none of these plants is in a good position, and they don't add up to logical grouping to be further consolidated, why, from among all the country's defense enterprises, were they and OKB Sukhoi picked for privatization?
One relatively straightforward reason is that, strange as it may seem, these enterprises were not included in President Boris Yeltsin's August degree naming over 3,000 firms considered vital to Russia's national security, thereby leaving them open to privatization.
The legal basis for the privatization of any element of Russia's defense industry is open to question, given that the law on privatization adopted in 1992 placed military-oriented enterprises off-limits. Instead, according to experts, the current selloff of defense-related enterprises has been mandated by presidential decree, overriding the earlier law.
"The government has decided not to wait until the parliament adopts new regulations on privatization, but, instead, to sell as much as possible, so there won't be a way back," said a military expert from the State Duma, who declined to be named.
The final decision on which companies to include was the result of a compromise between the three major figures involved in the process. Defense Minister Pavel Grachev and Viktor Glukhikh, head of the State Committee on Defense Industries, had pressed Yeltsin to take all defense enterprises off the loans-for-shares list. First Deputy Prime Minister Anatoly Chubais, on the other hand, wanted to sell off the entire government stake in these companies.
Prior to the start of the loans-for-shares auctions earlier this month, the list of companies headed for the auction block included a fourth defense-related firm -- the Irkutsk aviation company, much more closely linked in to Sukhoi than the other two factories. After two months of internal debate over privatization in the defense sector, the State Property Committee took Irkutsk off the list, and also reduced the percentages of shares to be auctioned in the other three companies.
It says something about Chubais' influence within the government that he managed to keep the three others on the privatization list at all, and that he prevented his opponents from reducing to a minimum the number of shares for sale.
Another reason to put the three companies on the block together is that they are going concerns, even if just barely so. They possess valuable technologies and qualified personnel.
"The government understands that any further delays in restructuring will lead to the total loss of high technologies," said Sergei Aznobichev, an analyst from the USA and Canada Institute.
Yet there remains the question of why the government did not choose plants less central to the defense complex, or indeed from the civil aircraft industry, which is desperately in need of investment.
Asked about this at a press conference, Alfred Kokh, head of the State Property Committee, declined to give a reason. Instead he said that other aviation companies could also become part of the loans-for-shares scheme, depending on the results of the first auctions.
Experts say the choice of Sukhoi involved, as much as anything else, its name recognition. By choosing such a famous enterprise, the government hopes to attract the interest of investors to other aviation industry enterprises, as well as to demonstrate its commitment to a radical restructuring of the military industrial complex.
But Sukhoi is pretty much lumped together with all the aviation industry by the investment community.
"At present shares in aviation plants are not very interesting for investors," said Konstantin Melnikov, a stock analyst from the Rinako-Plus brokerage house. "All of them are in a very difficult financial situation and need huge injections of money. So only big strategic investors can buy the share blocks."
The process kicks off Dec. 7, with the sale of a 25 percent stake in OKB Sukhoi, a key long-range fighter aircraft design bureau, as well as a 13 percent stake in the Ulan-Ude aviation company and a 25 percent stake in the Progress aviation company located in Arsenyev, in Russia's Far East. Both of the latter are major warplane production plants.
The auction is part of the loans-for-shares scheme, by which businesses -- mostly banks -- receive equity in state enterprises as collateral for loans to the Russian government.
OKB Sukhoi is not, as one may expect, a major aircraft manufacturer. It is a design bureau, with only a small experimental plant and test facilities for building and testing prototypes. The design bureau has given birth to the main Russian long-range fighter, the formidable Su-27, and a ground attack plane, the Su-25.
As with most of the defense complex, Sukhoi has suffered since the breakup of the Soviet Union. Orders from the military now cover only 20 percent of the OKB's everyday needs. The company's work force has fallen by half to about 3,000, and the average monthly salary at the plant is just 600,000 rubles ($133). The Russian air force will not buy any more Su-27 jets this year or next.
The big fighters, with a price tag of about $30 million each, have few potential overseas customers, although they have proven a hit with China, which has ordered 24. According to Mikhail Simonov, general constructor of Sukhoi OKB, a new export deal will be signed next month. He declined to say what the client country will be, but sources say that India and South Korea have been negotiating possible purchases.
Sukhoi is far from collapse. It has a technological edge and has developed prototypes of enhanced versions of the Su-27 -- the Su-32FN and Su-35. According to industry sources, the bureau is set to receive 7 to 10 percent of the sums involved in the China contract.
In its own factory, Sukhoi makes highly regarded light acrobatic planes. The company has a partnership with the U.S.-based Pompano Air Center Corp. In 1995 around 100 planes, worth $200,000 each, were exported to the United States, France and Switzerland, according to company officials.
Altogether at the moment the company is working on 10 new aircraft projects, including sport and passenger planes. But the fruits of these ventures will have to come fast.
One major initiative that has fallen by the wayside is a collaboration, mooted during perestroika, with U.S. executive-jet manufacturer Gulfstream to make a supersonic business jet; Sukhoi still has ambitions to go ahead on its own.
"Our main asset is our brains, but it is getting more difficult every day to keep them in the company," said Vladimir Yakovlev, head of the company's public relations department.
To talk of Sukhoi as an aircraft-making entity it is necessary to include not just the bureau, but the plants which churn out the planes. The principal factories are at Komsomolsk (Su-27 fighters), Irkutsk (Su -27UB trainer, Su 30 fighter-bomber) and Ulan-Ude (Su-25 ground attack fighter).
This division of design bureaus from aircraft-manufacturing plants is a throwback to the monolithic Soviet-era system of construction, dating back to the 1930s. The Soviet aviation industry was part of the system of central planning, and thus was not organized along the lines of interlinked design bureaus and production units. The defense ministries decided what should be designed, design bureaus then built prototypes, and finally a factory or factories were instructed to mass produce the chosen prototype. Some plants worked for one bureau, others for several.
Moreover, although the Aviation Ministry controlled most of the industry, some of its elements were subordinate to other ministries and financed from other sources. Producers of avionics, for example, were funded by the Ministry of Electronic Equipment.
The first level of the aviation industry's system still has nine major design bureaus, and at least 20 major production plants. A second level includes hundreds of smaller design bureaus and research centers, which are in charge of engines, navigation systems, avionics and weaponry. They work with the first-level companies as subcontractors, and also with independent production facilities in charge of corresponding spare parts.
All this makes the prospects of immediate consolidation unlikely. Moreover, few of the heads of the bureaus and factories are going to let their ship sink without a fight. This explains the continued jockeying to get a piece of dwindling government funding, and the current lack of any long-term, strategic planning.
Some consolidation, nevertheless, has taken place. In May 1995 the Moscow-based Mikoyan design bureau, which was responsible for the MiG-29, Russia's main tactical fighter, linked up with Mapo, the Moscow aviation production association, and its two Moscow-region factories, to form the Mapo-MiG company. At present, however, most aviation production units work with several design bureaus, and similar acts of "spontaneous" consolidation are unlikely, even if they would benefit industry. Furthermore, MiGs are selling quite well abroad, even if the Russian Air Force is not presently buying any.
Sukhoi has also made some progress in industrial consolidation. It has linked up with the Ulan-Ude aviation plant and 32 other production units to form the Sukhoi corporation -- a structure which, in its production principles, avoids rigid centralization.
Not all of the elements in Sukhoi's constellation, however, appear on the loans-for-shares list. Sukhoi's other main production centers are the Ulan-Ude plant, another at Irkutsk -- a plant which wriggled off the list at the 11th hour, and a third at Komsomolsk, which was never on it. The Ulan-Ude factory, in the Buryat republic in Siberia 4,000 kilometers southeast of Moscow, was not the most logical to include -- it is the only one in the country which has produced both airplanes and helicopters.
As for the Progress plant, situated in the small town of Arsenyev in the Russian Far East, which is on the loans-for-shares list, it has nothing to do with Sukhoi. It was the major producer of the Soviet army's Mi-24 main battle helicopter.
In recent years, production of the Mi-24 has been stopped and the facilities were refitted for the new state-of-the-art Ka-50 Black Shark helicopter, one of Russia's latest export hopes. The company is now producing Mi-34 light civil helicopters in small numbers. This year eight such helicopters were produced, five of which were sold to Brazil. Some of the plant's 10,000-or-so staff, meanwhile, have been shifted over to the production of washing machines and furniture. In a pattern typical in the defense industry, every third inhabitant in Arsenyev is connected with Progress.
If none of these plants is in a good position, and they don't add up to logical grouping to be further consolidated, why, from among all the country's defense enterprises, were they and OKB Sukhoi picked for privatization?
One relatively straightforward reason is that, strange as it may seem, these enterprises were not included in President Boris Yeltsin's August degree naming over 3,000 firms considered vital to Russia's national security, thereby leaving them open to privatization.
The legal basis for the privatization of any element of Russia's defense industry is open to question, given that the law on privatization adopted in 1992 placed military-oriented enterprises off-limits. Instead, according to experts, the current selloff of defense-related enterprises has been mandated by presidential decree, overriding the earlier law.
"The government has decided not to wait until the parliament adopts new regulations on privatization, but, instead, to sell as much as possible, so there won't be a way back," said a military expert from the State Duma, who declined to be named.
The final decision on which companies to include was the result of a compromise between the three major figures involved in the process. Defense Minister Pavel Grachev and Viktor Glukhikh, head of the State Committee on Defense Industries, had pressed Yeltsin to take all defense enterprises off the loans-for-shares list. First Deputy Prime Minister Anatoly Chubais, on the other hand, wanted to sell off the entire government stake in these companies.
Prior to the start of the loans-for-shares auctions earlier this month, the list of companies headed for the auction block included a fourth defense-related firm -- the Irkutsk aviation company, much more closely linked in to Sukhoi than the other two factories. After two months of internal debate over privatization in the defense sector, the State Property Committee took Irkutsk off the list, and also reduced the percentages of shares to be auctioned in the other three companies.
It says something about Chubais' influence within the government that he managed to keep the three others on the privatization list at all, and that he prevented his opponents from reducing to a minimum the number of shares for sale.
Another reason to put the three companies on the block together is that they are going concerns, even if just barely so. They possess valuable technologies and qualified personnel.
"The government understands that any further delays in restructuring will lead to the total loss of high technologies," said Sergei Aznobichev, an analyst from the USA and Canada Institute.
Yet there remains the question of why the government did not choose plants less central to the defense complex, or indeed from the civil aircraft industry, which is desperately in need of investment.
Asked about this at a press conference, Alfred Kokh, head of the State Property Committee, declined to give a reason. Instead he said that other aviation companies could also become part of the loans-for-shares scheme, depending on the results of the first auctions.
Experts say the choice of Sukhoi involved, as much as anything else, its name recognition. By choosing such a famous enterprise, the government hopes to attract the interest of investors to other aviation industry enterprises, as well as to demonstrate its commitment to a radical restructuring of the military industrial complex.
But Sukhoi is pretty much lumped together with all the aviation industry by the investment community.
"At present shares in aviation plants are not very interesting for investors," said Konstantin Melnikov, a stock analyst from the Rinako-Plus brokerage house. "All of them are in a very difficult financial situation and need huge injections of money. So only big strategic investors can buy the share blocks."
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