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EDITIONS
Monday, 3 December, 2001, 16:22 GMT
Business targets defence contracts
British military training exercises in Oman in 2001
Training helicopter pilots is considered a PFI success
Undeterred by the government's effective renationalisation of Railtrack, the UK defence industry is gearing up to take advantage of an expected boom in Ministry of Defence (MoD) contracts.

For the businesses like Europe's biggest defence contractor BAE Systems and many others, the MoD's private finance initiatives (PFIs) represent billions of pounds in regular income.


In the public sector PFIs you don't have a lot of common ground but in defence, people recognise what the risks are and it's given it a much more mature dialogue

Keith Hartley
Centre for Defence Economics
The City financial institutions who fund many PFIs, view the Railtrack incident as a betrayal of trust by the government and will be looking at PFI contracts much more carefully.

"Post-Railtrack, the level of competence isn't what it was and there are concerns the government can and will change the rules," said one City defence and aerospace analyst who wanted to remain anonymous.

But the Ministry of Defence says it has seen no slackening of private sector interest in a scheme that is being pioneered in the UK.

"Not at the MoD, it's been a particularly busy year preparing for PFIs," said a spokesman, a sentiment echoed by a number of contractors.

The MoD is considering 50 PFIs, including some of the largest planned, which when awarded would be worth over 1bn to the defence industry per year on top of the 400m already being paid through existing contracts.

Defence PFI contracts are considered more secure than those in the public sector because "body bags are involved" claims Professor Keith Hartley of York University's Centre for Defence Economics.

"In the public sector PFIs you don't have a lot of common ground but in defence, people recognise what the risks are and it's given it a much more mature dialogue," he adds.

Collateral risk

Under PFIs, the government leases a service, rather than investing in equipment and personnel, at a fixed yearly cost for a period of 15 to 30 years.

The PFI transfers the risk of delivering on time and on budget to the contractor, who can lease out the equipment and personnel to other customers when its not being used by the MoD to generate extra income.

Chasing deals can cost contractors several million pounds in the bidding process but that is more than compensated for by the regular income.

VC10 tanker with F1-11s
BAE is bidding for the biggest defence PFI to replace the RAFs air-to-air tankers
For a company like BAE Systems, which last week cut 1,700 workers in its civil aviation division and issued a profit warning because a slump in that sector, PFI deals help maintain profits during downturns in its business cycle.

BAE declined to be interviewed citing "sensitivities" due to the number of PFIs they were bidding for.

But BAE sources expressed their pleasure with defence PFIs to BBC News Online, citing the size and duration of "regular income streams".

Despite a 20% fall in profits in the last half, core profits at BAE were up 4% to 482m and chief executive John Weston has assured investors the group is "well positioned to resume growth in 2002".

Other defence contractors, like Rolls Royce, and Vosper Thorneycroft have set up special units to take full advantage of the contracts available.

Meanwhile, service companies like WS Atkins, Serco and Amey - which supply accommodation, servicing equipment and maintain installations for the MoD - have boasted about the benefits PFIs and reported half year profits up 12%, 18% and 40% respectively.

Not perfected

As in the public sector, PFIs for the armed forces are still failing in some key areas.


The difficulty is that large elements on both sides still have to accept that this is a thoroughly different way of doing business

Peter Smart
Brown and Root
Privately owned Brown and Root, a subsidiary of US oil services giant Halliburton and the UK's fifth largest defence contractor, is bidding to supply the MoD with air-to-air refuelling planes and heavy transporters for tanks and other big equipment.

It began talks with the MoD five years ago for PFIs but identifies defining procurement needs as a perennial problem in the process.

"What's caused us concern is that there are a number of programmes that set-off down a PFI route, and for reasons not always sound, they (MoD) flipped it," said Peter Smart, Director of Defence Business, Brown & Root.

"The difficulty is that large elements on both sides still have to accept that this is a thoroughly different way of doing business," said Mr Smart.

Mixed results

The results so far of PFIs have been mixed.

Last month, serious problems emerged in a 300m PFI to supply the MoD with a computer payroll system, which threatened to halt pay to over 300,000 personnel, including the special forces in Afghanistan, and 800,000 pensioners.

US software solutions company Electronic Data Systems (EDS), the UK government's largest IT contractor, could not deliver the system and reportedly received a government bailout.

CAE logo
Simulated flight training is considered a PFI success
The deal had to be renegotiated and showed all the signs of PFI failures in the public sector.

In October, the company reported third quarter profits were up 20% at $334m and well above traget for the full year.

But 275m helicopter training contract with Canadian company CAE for a Royal Air Force in Oxfordshire is considered a big success.

When not in use by the RAF, CAE has signed contracts to supply the Dutch and Canadian air forces with training for their pilots.

"That is a really good case because the whole thing is measurable right the way through," said John Reid, editor of Jane's World Defence Industry.

"It's possible to identify exactly what the requirements are, how much is needed and for how long and the excess capacity can be sold on," he said adding "both parties seem happy".

In the second quarter ending in November, CAE's profits rose 7% and it reported record order book.

How defence has become the latest target of privatisation initiatives


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