The independent auditors of Anil Ambani-led Reliance Naval and Engineering (the erstwhile Pipavav Defence) have raised doubts over the company’s ability to “continue as a going concern”. The audit report shows a net loss of Rs 956.09 crore in 2017-18 compared to Rs. 523.43 crore in the previous year.

These numbers, and Reliance’s cloudy future, are important in the broader context of a much-delayed $2-billion (Rs 20,000 crore) defence project for four landing platform dock (LPDs). An LPD is an amphibious warfare ship designed to transport troops into a war zone by sea.

This project, whose acquisition process has largely favoured India’s private sector as the government put out newer versions of its defence procurement policy, now effectively has only one bidder whose financial strength is not in doubt.

In early 2011, a request for information(RFI) was put out for the construction of LPD class of ships for the Indian Navy. It was invited based on the ‘Buy and Make-in-India’ criteria mentioned in the 2011 defence procurement policy. This essentially meant that the RFI was for Indian players and that Indian ship building facilities were free to tie-up with foreign entities that had relevant technical know-how.

In November 2013, India floated a tender to four domestic shipbuilders, three of which were private players – L&T, Pipavav Defence and Offshore Engineering Company Limited and ABG Shipyard Ltd.

The winner of the bid had to construct two landing platform docks (LPDs). Another two would later be built by defence PSU Hindustan Shipyard Ltd (HSL) using the design and knowledge of the winner of the tender.

For the deal, Larsen & Toubro inked a deal with Spain’s Navantia, Pipavav had tied up with France’s DCNS, and ABG with US company Alion. Interestingly, the Indian Navy shot down a proposal from Cochin Shipyard Ltd (CSL) to participate in the tender along with HSL, saying the then ongoing work of the INS Vikrant at CSL would be affected. CSL sent a request to reconsider the decision and based on that the-then defence minister A.K. Antony put the tender process on hold to ask for expert opinion.

However, in September 2014, the Modi government denied permission to CSL by saying the tender was open only for private companies. CSL’s argument back then – which was that by the time the tender would be awarded, the work on the INS Vikrant would also be over – has since been proven to be correct.

Out of the three private Indian ship-builders selected by the Navy and the defence ministry, ABG Shipyard Ltd (ABGSL) was in financial trouble and could not restructure its debt. Latest media reports indicate that the insolvency and bankruptcy process will see the private shipyard, which is in the hole for over Rs 18,000 crore, liquidated due to a lack of high-value bids.

The Controller of Warship, Production & Acquisition, Integrated Headquarter, MoD also didn’t approve ABGSL’s participation in the tender (financial strength) for the same reason.

This left only two private sector options: Pipavav and L&T.

However, Pipavav, while not as bad as ABG Shipyard, was also in poor financial health. By mid 2014, the largest private shipyard in India with a licence to make warships had accumulated almost Rs 7,000 crore in debt and was under severe pressure from its creditors led by IDBI bank to go in for a corporate debt restructuring programme (CDR), to which Pipavav management was not interested. Any CDR might have devalued the company.

They had two other options. One was to infuse more funds, something they couldn’t do because they didn’t have any. The second option was to bring an investor that would pacify lenders and clients in one go while giving more credibility to the company.

Enter Reliance

In February 2015, Anil Ambani-led ADAG informed SEBI of the formation of three new subsidiaries by the group under Reliance Infrastructure Ltd – Reliance Defence Systems Pvt. Ltd, Reliance Defence Technologies Pvt. Ltd and Reliance Defence and Aerospace Pvt. Ltd with an aim to enter in to defence business.

On March 4, 2015, the announcement came – Reliance Group took 18% stake in Pipavav and an additional 26% would be taken over through open offer which effectively gave the management control of Pipavav to Reliance Infrastructure.

Livemint’s reportage on the deal is particularly illuminating. Quoting people who were closely involved in the negotiations, the report notes that Pipavav was approached by Hero Group, M&M and an unnamed French ship builder. All of them, however, were cautious and planned on taking time for their evaluations and offers.

However, Reliance was in a tearing hurry, which suited the-then promoters of Pipavav.

Why did Anil Ambani want to seal the deal as soon as possible? A couple of reasons, but the major one was that Pipavav at the time was in the running for a Rs 50,000 crore modern conventional submarine project.

Beside this, FICCI’s projection of the Indian defence manufacturing market’s growth – $168 billion in projects from 2014 to 2022 – was too lucrative to ignore

Incidentally, Ambani and Pipavav’s promoters have now fallen out over alleged misrepresentations made with regard to the company’s corporate governance standards. Reliance has issued a Rs 5,000 crore arbitration notice to the shipyard’s founders and their other companies.

Strategic private partners

On May 31, 2017, the Centre released the ‘Chapter VII‘ of the Defence Procurement Policy 2016 elaborating on the much-awaited new “strategic partnership policy”. On May 11, the-then defence minister Arun Jaitley met the “stakeholders” – the industrialists – to discuss the issue of them not being happy with the draft policy. The Hindu reported that the private players wanted no competition in the field in which they would prefer to invest and as most of them are new to defence manufacturing arena, previous experience in the field should not be a criteria. But the government wanted at least two players in the same field for its comfort and to avoid a monopolistic situation any controversy.

On May 15, Cabinet Committee on Security (CCS) met to discuss these issues. On May 20, DAC approved the policy and within a week CCS stamped it.

Under the new strategic partnership policy, the government revised the terms of the LPD contract and asked two private ship builders – L&T and Reliance Defence (previously Pipavav Defence), whose financial and technical capabilities were evaluated and approved by Indian Navy in 2016 – to submit fresh quotes for the four amphibious war ships/landing platform decks (LPD) which was cleared by the CCS in May 2017.

It was reported then that each of these LPDs are to be of around Rs 6,500 crore, taking the total deal value to Rs 26,000 crore. The most curious part of this is that under the revised contact, Hindustan Shipyard Ltd (HSL) is nowhere to be seen.

A compilation of papers by Indian naval officers and released by FICCI says that HSL has orders worth only Rs 1,650 crore in its kitty at the time the Centre asked these two private players to submit revised quotes.

This raises some questions. Why was the Modi government interested in only including private players? If the aim was to create a competitive market in which India would get the best deal and products with advanced technological capabilities, why did all players (including PSUs, DPSUs and government-run firms like CSL) not allowed to submit quotes?

In the case of the LPD contract, the currently published financial health of Reliance Defence (later renamed Reliance Naval Engineering) raises further concerns. And to top it off, Pipavav was clearly not in a good shape when the Indian Navy rejected ABG, but gave the nod to Pipavav.

In March 2017, all major newspapers reported that the bids that the two players had submitted would be opened and that the winner would be finalised in a couple of months. But by April 2017, newspapers reported that the Centre would ask the two players to submit fresh bids and the same will be finalised by end of 2017 and within four days from the formal approval of the revised policy, govt asked Reliance Defence and L&T to submit fresh bids.

Why were new bids submitted? Was it to sideline Hindustan Shipyard Ltd, the way Hindustran Aeronautics Ltd was sidelined by this government in the Rafale deal? It appears so.

“The need for fresh commercial bids became necessary as the earlier RFP proposed that the LPDs will be divided between private shipyards selected through a competitive process and on nomination basis to Hindustan Shipyard (HSL),” Financial Express reported in April 2017, almost a month before the official finalisation of the policy.

If the Modi government’s aim was to increase competition and the efficiency of PSU shipyards, it is a little puzzling that the RFP was not sent to all interested contenders including CSL and HSL.

The above-quoted Financial Express article speculates that the decision to “give all four LPDs to private sector shipyards” was “due to several reasons including the current order book of HSL”. The implication here being that Hindustan Shipyard had its hands full.

This is odd, because the public sector shipyard’s chairman Rear Admiral L V Sarat Babu (Retd) told the same newspaper a few months later that its capacity utilisation was just 48% due to a lack of adequate orders.

In another instance last year, on a tender to build two diving support vessels for Indian Navy, where a number of government shipyards participated along with L&T, HSL bagged the order worth Rs 1010 crore whereas L&T’s bid was the highest at Rs 1,584 crore.

As Commodore K.S. Subramanian and former Director at Hindustan Shipyard wrote in The Wire recently, close scrutiny reveals that over the last few years “private shipyards bagged orders at incredibly low prices in an environment of extremely intense competition – perhaps just to get a toe-hold in the lucrative defence ship building space”.

However, Subramanian notes, “most of these projects floundered inordinately due to funding problems at the shipyards primarily because of unviable bid prices”.

There are certain other questions to be asked.

If Reliance Naval Engineering is disqualified in the LPD contract (technically it can’t be and there is zero evidence to suggest that it will be) over reasons of bad financials, it is clear that the project will end up with a single vendor situation, with only L&T remaining. This is something the government itself opposed while framing its strategic partnership policy.

Another way to look at is what if Reliance turns out to be the lowest bidder for the Rs 20,000 crore project. How can the government, in good conscience, award it the contract knowing its financial strength? And how can it be sure the company will be able to raise enough funds for execution and timely delivery?

With the government now conceding that the strategic partnership policy for defence manufacturing does indeed include PSUs, there are hard questions to be answered.