Defensive position
by Roseanne Gerin
Offset agreements hinder defense industry sell-offs.Investing in Poland's defense industry is a double-edged sword.
There are dozens of companies for sale but buying into them is becoming increasingly complicated in the wake of Poland's four-month-old legislation that requires investors to plow millions more into the sector through offset agreements.Take last August's deal with Spain-based European Aeronautic Defense and Space Company (EADS) CASA. Poland agreed to purchase eight CASA C-295 military transport planes for $212 million, but as part of the transaction, EADS CASA and its partner Avia System Group were also obliged to buy a 51% stake in the money-losing state-owned light aircraft manufacturer Państwowe Zakłady Lotnicze (PZL). On top of that zł;. 28.5 million ($7 million) investment, the group was required to invest another zł. 16 million ($3.9 million) in PZL-Okęcie during the next two years.The buyers also had to agree to invest a total of zł. 125 million ($30.5 million) in the aircraft factory within five years. Plus they committed to creating a development program for the company, providing training for PZL-Okęcie employees, introducing state-of-the-art equipment and tools, and selling the company's products in the EADS CASA network. In turn, EADS CASA was given an option to buy an additional 34% stake in PZL-Okęcie at a later date.
The so-called offset requirement, enacted by the Solidarity Election Action (AWS) government last September to stimulate long-term growth in Poland's ailing defense industry, is also one of the major obstacles preventing more foreign companies from investing in the sector, according to industry professionals.Tale of the tape
Speedy restructuring and massive outside investment are needed to modernize Poland's 37 big state-run defense firms if they are to compete on global markets. In addition, NATO, which Poland joined in March 1999, demands that its members meet certain technological and equipment specifications. This means substantial equipment and vehicle upgrades for countries like Poland, although this year the government has been unable to free up enough resources to meet its NATO obligations. But how soon and what path Poland will take to restructure and modernize its defense sector is still up in the air. Yet industry insiders say the only way to modernize the sector is to modify or eliminate offset agreements and kick start the privatization of state-owned firms. "We need investment quite badly," said Krystian Piątkowski, the director for international cooperation at the Polish Chamber of National Defense Manufacturers, which represents the interests of 200 mostly privately owned defense companies. "We need new technology (for) the modernization and restructuring of the companies and new marketing procedures and practices. We need to modernize this industry as much as possible and as quickly as possible." One of the biggest barriers to increasing foreign participation in Poland's defense sector, according to industry professionals, is the law mandating offsets. Under the legislation, investors are, for example, required to purchase military vehicles or weapons systems from domestic manufacturers, boosting the economy and providing jobs in depressed areas of the country. For purchases worth more than O5 million, the offset contracts must be equal to or above the amount of the purchase order, with 50% of the investment geared toward Poland's defense sector. While the offset requirement wasn't enough to prevent EADS CASA from investing in Poland, some industry insiders criticize the offset obligation as a form of forced compensation for foreigner suppliers. Because the requirement was mandated by law, the government must now determine if there is "flexibility to maximize the effectiveness of the investment or (if it) will hold investors hostage and penalize (them)," according to a Western diplomat who asked not to be named. Yet, because offsets are deemed necessary to help countries like Poland upgrade sick industries and boost their overall economies, several industry professionals have called for the law to be modified. "Until this government starts realizing how serious the offset question is, it can no longer be done successfully with just a small band of people, and it requires adopting some structural solutions and creating a team of specialists who would be able to negotiate offset contracts professionally with Western customers," Piątkowski said. The government acknowledges the problem with offsets and various ministries have started to discuss modifications to the law, according to Mariusz Handzlik, the deputy director of the security policy department at the Foreign Affairs Ministry. He said that the ministries are considering the requests of foreign sellers to be able to invest their offsets in foreign " not just Polish " entities; to invest in companies outside the defense industry and to be given security guarantees. After the matter passes through various ministries during the next few weeks, it will move to the Council of Ministers and then to the lower house of Parliament for debates, he said. "We need to change the offset law to use it as an instrument to (en)liven the economy and the defense industry and to confirm long-lasting relations between investors, especially with foreign investors, and our industries," Handzlik said. "Only by changing (the law) will we be able to survive on the market." With three other tenders for military purchases under way and scheduled for completion this year, including one worth up to $3 billion for fighter jets, the sooner the modifications come, the better. Industry insiders also say that the mindset favoring paternalism and protection of the sickly defense industry must be altered so restructuring can take place. Such thinking is rooted in communism, when Poland's defense companies were subsidized and built their reputations on producing heavy equipment, such as tanks, artillery systems and helicopters for countries belonging to the Warsaw Pact. After the collapse of the Soviet Union, orders from the East stopped when markets dried up. With the introduction of a market economy in Poland, the defense sector was excluded from the country's 'shock therapy" restructuring because it was considered a sacred cow that should not be subject to market forces. The defense sector continued to be subsidized and influenced by the demands of powerful unions, company managers and politicians " all of whom generally opposed change. "The problem is that the ones who define what the problems and solutions of the defense industry are, are the people who have a vested interest in not changing anything because neither the managers nor the trade unionists are interested in a radical shakeout," said one industry official. He said that while the Treasury Ministry owns the country's large defense firms, they are managed by the Economy Ministry, which has close relations with company managers, so that it's "like the Bermuda triangle where all policy is lost in a dark hole." Sitting on their hands Politicians of all stripes have been unwilling to take a firm stance on the industry's reform over the years because modernization would lead to job cuts and plant closures in areas already suffering from high unemployment. Piątkowski estimates that about 70,000-80,000 people are employed in majority state-owned defense companies. "Because of the (industry's) prestige and pride, it's going to be very tough to stand up to both the unions and the management and tell them that maybe half of you can reform yourselves, but the rest of you have to close," an industry professional said. "And nobody's had the courage to say that. These companies could be a drain on resources for years to come just because no politician is going to have the guts to pull the plug." Without orders for heavy equipment, state-owned defense companies have to transform themselves to create technological niches where they can compete on world markets, industry insiders said. "Ultimately the real solution for Polish defense factories is to become small-parts suppliers for large Western companies, producing widgets, elements and sub-assembly work," said one industry insider. Despite their resistance to change, unionists are starting to realize that privatization and restructuring are inevitable, Piątkowski said. Others report that some factories are willing to change, especially in plants where competitive practices are in place. "Where you have exposure to the best practices, you have managers who don"t want to depend on government subsidies but want to be independent," said the Western diplomat. Finally, industry professionals point to Poland's poor record on defense-company sell-offs as another reason for the industry's weak state. Privatization would provide necessary capital for upgrades and allow companies to compete on international markets, especially as defense firms in Western Europe and the United States continue to consolidate. Bad aim Apart from the privatization of PZL-Okźcie, only one other defense company has been privatized successfully. The U.S. high-tech concern United Technologies last September agreed to purchase Wytwórnia Sprzźtu Komunikacyjnego (WSK) PZL Rzeszów, a military communication equipment factory in southeastern Poland for more than $70 million with an offset contract to invest another $70 million in the company within the next five years. People familiar with WSK PZL Rzeszów said the company was attractive because it is profitable, unlike most other state-owned defense firms. It also has established export markets. Meanwhile, the majority of loss-generating, state-controlled defense concerns are limited by a lack of regular orders from the government or from external markets " one of the main draws for prospective investors. In turn, government spending on procurements has dropped because of budget cuts this year. In addition, the major amounts of capital that state-owned companies need to upgrade production is yet another turn-off for foreign investors. "The problem is that Western arms companies are owned by their shareholders, so the question is why should we buy this factory and how are we going to get a return on it'" an industry professional said. He cited the example of the Łucznik Radom Arms Factory, a producer of small arms and machine guns as "a classic basket case (that) is suffering hugely due to a lack of orders." Poland's track record on defense privatizations has been dismal. The former Solidarity Election Action-led (AWS) government made verbal commitments to privatizing defense companies but made little progress after failing to attract domestic capital and expecting too much from foreign investors, industry insiders said. Meanwhile, the current Democratic Left Alliance-led (SLD) government has yet to formulate its strategy. Privatization of the defense sector will remain in limbo until a clear policy has been established, industry professionals said. The Treasury Ministry declined to comment on its plans for privatizing defense firms, and only said that it was working on updating its policy. But Treasury Minister Wiesław Kaczmarek has remarked publicly about the possibility of grouping the state-owned defense companies into four holdings based on their production profiles rather than selling them piecemeal. He has also made comments about favoring a privatization policy that would be based on convincing or forcing foreign investors to buy a Polish company for every completed defense tender, according to industry experts. Some industry professionals are dismayed at Kaczmarek's comments and see his ideas as a step in the wrong direction. "It's a retrogressive step because it is going back to this concept of consolidating industry (and) cross-subsidizing factories," one industry insider said, arguing that such a plan would give those in charge of factories less incentive to reform their companies.
Offset agreements hinder defense industry sell-offs.Investing in Poland's defense industry is a double-edged sword.
There are dozens of companies for sale but buying into them is becoming increasingly complicated in the wake of Poland's four-month-old legislation that requires investors to plow millions more into the sector through offset agreements.Take last August's deal with Spain-based European Aeronautic Defense and Space Company (EADS) CASA. Poland agreed to purchase eight CASA C-295 military transport planes for $212 million, but as part of the transaction, EADS CASA and its partner Avia System Group were also obliged to buy a 51% stake in the money-losing state-owned light aircraft manufacturer Państwowe Zakłady Lotnicze (PZL). On top of that zł;. 28.5 million ($7 million) investment, the group was required to invest another zł. 16 million ($3.9 million) in PZL-Okęcie during the next two years.The buyers also had to agree to invest a total of zł. 125 million ($30.5 million) in the aircraft factory within five years. Plus they committed to creating a development program for the company, providing training for PZL-Okęcie employees, introducing state-of-the-art equipment and tools, and selling the company's products in the EADS CASA network. In turn, EADS CASA was given an option to buy an additional 34% stake in PZL-Okęcie at a later date.
The so-called offset requirement, enacted by the Solidarity Election Action (AWS) government last September to stimulate long-term growth in Poland's ailing defense industry, is also one of the major obstacles preventing more foreign companies from investing in the sector, according to industry professionals.Tale of the tape
Speedy restructuring and massive outside investment are needed to modernize Poland's 37 big state-run defense firms if they are to compete on global markets. In addition, NATO, which Poland joined in March 1999, demands that its members meet certain technological and equipment specifications. This means substantial equipment and vehicle upgrades for countries like Poland, although this year the government has been unable to free up enough resources to meet its NATO obligations. But how soon and what path Poland will take to restructure and modernize its defense sector is still up in the air. Yet industry insiders say the only way to modernize the sector is to modify or eliminate offset agreements and kick start the privatization of state-owned firms. "We need investment quite badly," said Krystian Piątkowski, the director for international cooperation at the Polish Chamber of National Defense Manufacturers, which represents the interests of 200 mostly privately owned defense companies. "We need new technology (for) the modernization and restructuring of the companies and new marketing procedures and practices. We need to modernize this industry as much as possible and as quickly as possible." One of the biggest barriers to increasing foreign participation in Poland's defense sector, according to industry professionals, is the law mandating offsets. Under the legislation, investors are, for example, required to purchase military vehicles or weapons systems from domestic manufacturers, boosting the economy and providing jobs in depressed areas of the country. For purchases worth more than O5 million, the offset contracts must be equal to or above the amount of the purchase order, with 50% of the investment geared toward Poland's defense sector. While the offset requirement wasn't enough to prevent EADS CASA from investing in Poland, some industry insiders criticize the offset obligation as a form of forced compensation for foreigner suppliers. Because the requirement was mandated by law, the government must now determine if there is "flexibility to maximize the effectiveness of the investment or (if it) will hold investors hostage and penalize (them)," according to a Western diplomat who asked not to be named. Yet, because offsets are deemed necessary to help countries like Poland upgrade sick industries and boost their overall economies, several industry professionals have called for the law to be modified. "Until this government starts realizing how serious the offset question is, it can no longer be done successfully with just a small band of people, and it requires adopting some structural solutions and creating a team of specialists who would be able to negotiate offset contracts professionally with Western customers," Piątkowski said. The government acknowledges the problem with offsets and various ministries have started to discuss modifications to the law, according to Mariusz Handzlik, the deputy director of the security policy department at the Foreign Affairs Ministry. He said that the ministries are considering the requests of foreign sellers to be able to invest their offsets in foreign " not just Polish " entities; to invest in companies outside the defense industry and to be given security guarantees. After the matter passes through various ministries during the next few weeks, it will move to the Council of Ministers and then to the lower house of Parliament for debates, he said. "We need to change the offset law to use it as an instrument to (en)liven the economy and the defense industry and to confirm long-lasting relations between investors, especially with foreign investors, and our industries," Handzlik said. "Only by changing (the law) will we be able to survive on the market." With three other tenders for military purchases under way and scheduled for completion this year, including one worth up to $3 billion for fighter jets, the sooner the modifications come, the better. Industry insiders also say that the mindset favoring paternalism and protection of the sickly defense industry must be altered so restructuring can take place. Such thinking is rooted in communism, when Poland's defense companies were subsidized and built their reputations on producing heavy equipment, such as tanks, artillery systems and helicopters for countries belonging to the Warsaw Pact. After the collapse of the Soviet Union, orders from the East stopped when markets dried up. With the introduction of a market economy in Poland, the defense sector was excluded from the country's 'shock therapy" restructuring because it was considered a sacred cow that should not be subject to market forces. The defense sector continued to be subsidized and influenced by the demands of powerful unions, company managers and politicians " all of whom generally opposed change. "The problem is that the ones who define what the problems and solutions of the defense industry are, are the people who have a vested interest in not changing anything because neither the managers nor the trade unionists are interested in a radical shakeout," said one industry official. He said that while the Treasury Ministry owns the country's large defense firms, they are managed by the Economy Ministry, which has close relations with company managers, so that it's "like the Bermuda triangle where all policy is lost in a dark hole." Sitting on their hands Politicians of all stripes have been unwilling to take a firm stance on the industry's reform over the years because modernization would lead to job cuts and plant closures in areas already suffering from high unemployment. Piątkowski estimates that about 70,000-80,000 people are employed in majority state-owned defense companies. "Because of the (industry's) prestige and pride, it's going to be very tough to stand up to both the unions and the management and tell them that maybe half of you can reform yourselves, but the rest of you have to close," an industry professional said. "And nobody's had the courage to say that. These companies could be a drain on resources for years to come just because no politician is going to have the guts to pull the plug." Without orders for heavy equipment, state-owned defense companies have to transform themselves to create technological niches where they can compete on world markets, industry insiders said. "Ultimately the real solution for Polish defense factories is to become small-parts suppliers for large Western companies, producing widgets, elements and sub-assembly work," said one industry insider. Despite their resistance to change, unionists are starting to realize that privatization and restructuring are inevitable, Piątkowski said. Others report that some factories are willing to change, especially in plants where competitive practices are in place. "Where you have exposure to the best practices, you have managers who don"t want to depend on government subsidies but want to be independent," said the Western diplomat. Finally, industry professionals point to Poland's poor record on defense-company sell-offs as another reason for the industry's weak state. Privatization would provide necessary capital for upgrades and allow companies to compete on international markets, especially as defense firms in Western Europe and the United States continue to consolidate. Bad aim Apart from the privatization of PZL-Okźcie, only one other defense company has been privatized successfully. The U.S. high-tech concern United Technologies last September agreed to purchase Wytwórnia Sprzźtu Komunikacyjnego (WSK) PZL Rzeszów, a military communication equipment factory in southeastern Poland for more than $70 million with an offset contract to invest another $70 million in the company within the next five years. People familiar with WSK PZL Rzeszów said the company was attractive because it is profitable, unlike most other state-owned defense firms. It also has established export markets. Meanwhile, the majority of loss-generating, state-controlled defense concerns are limited by a lack of regular orders from the government or from external markets " one of the main draws for prospective investors. In turn, government spending on procurements has dropped because of budget cuts this year. In addition, the major amounts of capital that state-owned companies need to upgrade production is yet another turn-off for foreign investors. "The problem is that Western arms companies are owned by their shareholders, so the question is why should we buy this factory and how are we going to get a return on it'" an industry professional said. He cited the example of the Łucznik Radom Arms Factory, a producer of small arms and machine guns as "a classic basket case (that) is suffering hugely due to a lack of orders." Poland's track record on defense privatizations has been dismal. The former Solidarity Election Action-led (AWS) government made verbal commitments to privatizing defense companies but made little progress after failing to attract domestic capital and expecting too much from foreign investors, industry insiders said. Meanwhile, the current Democratic Left Alliance-led (SLD) government has yet to formulate its strategy. Privatization of the defense sector will remain in limbo until a clear policy has been established, industry professionals said. The Treasury Ministry declined to comment on its plans for privatizing defense firms, and only said that it was working on updating its policy. But Treasury Minister Wiesław Kaczmarek has remarked publicly about the possibility of grouping the state-owned defense companies into four holdings based on their production profiles rather than selling them piecemeal. He has also made comments about favoring a privatization policy that would be based on convincing or forcing foreign investors to buy a Polish company for every completed defense tender, according to industry experts. Some industry professionals are dismayed at Kaczmarek's comments and see his ideas as a step in the wrong direction. "It's a retrogressive step because it is going back to this concept of consolidating industry (and) cross-subsidizing factories," one industry insider said, arguing that such a plan would give those in charge of factories less incentive to reform their companies.
