Comptroller to deliver damning report on IMI privatization

Joseph Shapira

The report is in the final stages of preparation for publication after a year's delay.

State Comptroller Judge (ret.) Joseph Shapira will complete preparation of a special report on the privatization process for Israel Military Industries Ltd. (IMI) and the state's attempt to sell it to Elbit Systems Ltd. (Nasdaq: ESLT; TASE: ESLT), controlled by businessperson Michael Federmann.

Publication of the report has been delayed for more than a year in order to obtain responses from parties involved in the privatization process. The process has been suspended for the past year, among other things due to the state comptroller's probe and has since been renewed by Ministry of Finance Accountant General Rony Hizkiyahu.

Sources inform "Globes" that Ministry of Defense auditing department manager Yossi Beinhorn recently completed the obtaining of responses and comments by agencies and persons criticized in the report in preparation for publication of a final report concerning the state's policy in the process, with an emphasis on the Ministry of Finance, Accountant General department, and Government Companies Authority.

While Hizkiyahu was promoting IMI privatization through a sale to Elbit Systems for NIS 1.75 billion, the Office of the State Comptroller told "Globes" that following the auditing actions taken, a second and final draft report had been written, and was in the summary stages before its release to the general public. "During the period of the audit, several of the audited agencies made changes in the process on some of the questions raised in the first draft of the report, which was sent to the audited parties for comment according to standard procedure," the office stated. The State Comptroller's Office refused to give a date for the report's publication, which is believed to include harsh findings and defects in the IMI privatization process to date.

Concern about a rise in prices

While the State Comptroller's Office is busy completing its audit report, the Antitrust Authority is expected to complete in the coming weeks a comprehensive probe by its team of economists concerning the effect of selling IMI to Elbit Systems on all the defense industries in Israel, with an emphasis on Rafael Advanced Defense Systems Ltd. and Israel Aerospace Industries Ltd. (IAI) (TASE: ARSP.B1), both of which are state-owned defense companies.

The two companies have previously expressed concern about a possible sale of IMI to Elbit Systems because they believe that this situation will upset the balance of power in competition in the missiles segment, in which the main players are IAI and Rafael.

In the past, IAI and Rafael warned that an acquisition of IMI by Elbit Systems would give the latter monopolistic power in land-based weapons and make it the absolute leader in procurement for the IDF's land forces. The company is currently dominant in the activity of IDF ground forces, mainly due to the Ground Forces Digitalization Program that it has installed over the past decade at a total cost believed to be in the billions of shekels.

Commenting on a possible acquisition of IMI by Elbit Systems, antitrust experts previously said that it would not cause overconcentration in the economy, because most of the revenue comes from overseas sales: 80% of Elbit Systems' products are exported to dozens of countries around the world, and most of its revenue does not come from local deals.

This is one of the reasons why the Antitrust Authority is inclined to approve the merger between the two defense companies.

According to Elbit Systems' reports, 20% of its sales are in Israel. The company's sales totaled NIS 11 billion, NIS 1.3 billion of which is to IDF ground forces. IMI's sales amount to NIS 2 billion yearly, half of which is to the domestic market.

According to previously published figures, the Ministry of Defense Procurement and Production Directorate's (PPD) procurement for IDF ground forces totaled NIS 5 billion in 2016. Adding IMI and Elbit Systems' sales to IDF ground forces gives a market share of nearly 50%, but this will still not make Elbit Systems a monopoly in land-based weapons.

"Elbit Systems may not be a monopoly, but it enjoys a strong position among IDF ground forces, and this position will become stronger following an acquisition of IMI," a defense source well informed about the privatization process told "Globes." "Such a situation will only add to and strengthen the affinity of Elbit Systems to the IDF ground forces, expose it to a high level of knowledge about the directions in which the ground forces are thinking, and as a result, like any other company seeking to make a profit, it is likely to conduct research and development ahead of competing companies, enabling it to prevail and accumulate power. This matter must be addressed." The sources warned that this situation was liable to lead to an increase in the prices that the Ministry of Defense pays, thereby affecting the defense budget, and could prevent the entry of new competitors into the sector.

Defense industry sources have previously warned that an acquisition of IMI would also increase Elbit Systems' power in the missiles segment, and could exclude Rafael, a leading focus of know-how in the segment, from certain activities, while having a negative impact on its chances of promoting future missile projects. Similar concern was also expressed by senior IAI executives.

Even though leaders of the two companies have been warning for years against this situation, the Ministry of Defense and the Government Companies Authority did not undertake a comprehensive probe of the effect of a merger between the defense industries on the defense market in Israel. The prevailing assumption in the Ministry of Defense and the Ministry of Finance is that Israel has too many defense companies, and that the ideal market structure is only two defense companies: one private and one government-owned.

Published by Globes [online], Israel Business News - - on January 16, 2018

© Copyright of Globes Publisher Itonut (1983) Ltd. 2018

Joseph Shapira
Joseph Shapira
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