Pre-Sale Syndrome

Ukraine has made a firm decision to reduce the state’s role in managing military-industrial complex (MIC) facilities. In principle, this is what experts have been advising for a long time. Yet, the key question is not whether it is necessary to privatize munitions plants but how to do this. Will the state still be able to run the large defense enterprises that will be struck off the list of those not slated for privatization? This applies in particular to the state-run Artem holding company, Zoria-Mashproekt, and the FED Corporation, which produce air-to-air missiles, gas turbines for warships, and warplane accessories, respectively.

It would be wrong to think that the Ukrainian MIC is now completely state-owned. Although a lot of officials have been publicly discussing the value of the MIC, many of its sectors were privatized long ago. The state has lost part or complete control over such enterprises as the Dnipropetrovsk Mechanical Engineering Plant (producer of air defense components), the Khartron joint-stock company (producer of missile and spacecraft guidance systems), the Luhansk Machine-Tool Building Plant (manufacturer of cartridges), the Donetsk-based Tochmash (producer of large-caliber cartridge cases), as well as such leaders of shipbuilding as Leninska Kuznia, Sevmorzavod, and the Black Sea Shipyard.

While the state, represented by the National Space Agency of Ukraine, still holds a 50-percent stake in the Kharkiv-based Khartron, 24.56% of its shares have been acquired by the Moscow-based companies Conversion Promotion Association Ltd. and Konvers-Elektropibor Ltd. As a result, Russian orders placed with this missile- and space-oriented plant account for about 10%. (The share sale of this strategically important enterprise was explained by the need to seize new opportunities on the Russian market.) Moreover, Khartron will almost double the share of missile- and space-related products in its overall output: up to 55.8% compared to 29.4% in 2004. The businesses that comprise this holding company are planning to participate in the Tsyklon-4, Dnipro, Rokot, and Strila launch vehicle programs, as well as in the production of MC-2-8 microsatellites and the all-purpose space module for the Alpha international space station. This means that Russian investments in the missile and space sector have proved to be not as dangerous as some pessimists feared.

To tell the truth, the Ukrainian MIC’s privatization could not avoid scandals. The State Property Fund is suing the owners of the Kherson and Black Sea shipyards for failure to meet their investment commitments. According to First Vice-Premier Anatoliy Kinakh, the main demand was that the buyers of these facilities must renew the primary activity. As the obligations have not been fulfilled, it is perhaps too early to claim that Russian investments in the Ukrainian MIC (the Black Sea Shipyard is now owned by Russian business) are of great use. Yet, there have been instances in modern history when Western investments also proved ineffective. Earlier, the sale of the Moscow-based Mil Helicopter-Making Plant served as an example. Now all the talk is about the Czech experience of privatization by Boeing (US) of a sizable block of shares at Aero Vodochody, the producer of training jets and light combat aircraft. The Czech Republic had to repossess this company, having assessed cooperation with the United States as a failure.

Thus, neither of the above examples clearly shows who the best buyers are of defense-related facilities. As for future prospects, even against the backdrop of Ukraine’s Euro-Atlantic aspirations, investments in the MIC are chiefly expected from an eastern direction. Already by late 2004 experts were noting that Russian business might be interested in some MIC enterprises. For example, according to Ruslan Pukhov, director of the Center for Strategic and Technological Analysis (Moscow), this may chiefly concern the Feodosiya Shipbuilding Company, the Artem state- run holding company, the Iskra state- run electrical equipment plant, and the Topaz state-run holding company. In 2004 big Russian business, in the person of Aleksandr Lebedev (State Duma member, founder and co-owner of the National Reserve Corporation, one of the largest investors in Ukraine’s economy), suggested to the new Ukrainian leadership that they set up an interstate aircraft-building consortium composed of the Antonov research and production association, the Voronezh Aircraft Plant, the Ilyushin Design Bureau, and Ilyushin Finance Company.

The Russian MP suggested merging these research and production facilities according to the principle ‘two states plus private capital.’ “This kind of structure could manufacture the An-148 aircraft and negotiate selling a part of its shares to the Europeans,” Mr. Lebedev pointed out in early 2005.

What did our government say in reply? The first signal to the Ukrainian defense sector was the Cabinet of Ministers’ instruction of 20 June 2005 approving the 2005 Action Plan and the State Program of Reforming and Developing the Military-Industrial Complex until the Year 2010. The latter calls for drafting a law “On Introducing Changes to the Law of Ukraine ‘On the List of State-Owned Facilities Not Subject to Privatization,’” which excludes such businesses as the Kharkiv-based FED Mechanical Engineering Plant, Kyiv’s Aviant Aircraft-Building Plant, Artem, the Kyiv-based Radar plant, and the Kharkiv State Aviation Enterprise from the list of facilities that are not subject to privatization (for the purpose of their further restructuring). The law is to be drafted by the Ministry of Industrial Policies, the Ministry of Defense, the State Property Fund, and the Security Service of Ukraine.

Speaking to Ukrainian and Czech businessmen on June 14, President Viktor Yushchenko also said that in order to improve the investment climate, Ukraine was prepared to offer a list of enterprises soon to be open to investors, including the Kharkiv-based Turboatom and the Mykolayiv-based Zoria-Mashproekt state-run facility. This immediately triggered lobbying to expand this list to include the MIC enterprises that are direct competitors of Russian plants. For instance, Aziz Abdulayev, Minister for Industry, Transport, and Telecommunications of the Crimean Autonomous Republic, proposed allowing the Feodosiya- based state-run More Shipbuilding Company to go private, although the prevailing mood at this enterprise is that privatization will be a setback, as was the case with the Black Sea Shipyard, which is still neglected despite privatization. On the other hand, the state is not in any position to place orders with the More Company. “Even the cutter production order that was placed last year by the State Border Security Service was never fulfilled,” says the plant’s management.

A cursory glance at the above- mentioned MIC facilities reveals that Artem is a serial producer of air-to-air missiles initially developed by Russia’s Vympel Design Bureau. At a certain point Artem also became an obvious contender of Russian designers who, after putting missiles with an active homing head into small-lot production, had no desire to develop seemingly lucrative cooperation with the Ukrainians. Speaking in late June at an international conference in Kyiv, Oleksandr Kachura, president of Artem’s board of directors said, “Paradoxically, Russian and Ukrainian warplanes have no missiles with active radar homing heads, while planes from China, India, and Malaysia are already equipped with them. Ukraine’s Arsenal Plant also produces and exports dog-fight missiles that are considered the best in the world. The question is: Why not equip our own aircraft with them? But all the attempts to solve this problem together with Russia on a governmental level have failed.” Mr. Kachura believes that the only solution is to refurbish our missiles jointly with Russia (or with NATO, if it agrees) because they are the world’s best. Interestingly enough, while earlier he was pinning hopes for Artem’s development on Russia alone, now he is prepared to look for an alternative. In reality, Russia would consider it profitable to purchase Artem if it were not a strong enterprise but one slightly weakened by market competition.

Almost the same thing could be said about another Ukrainian plant that produces exclusive export-oriented items. The Zoria-Mashproekt company supplies gas turbines for warships more than ten countries. As a partner of Russian industrialists, the enterprise seems to complement the closed production cycle of warships in the Russian Federation. Moreover, the Russian side was so resentful of its dependence on Ukraine in this matter that it began to set up a similar kind of production. Naturally, it would be more expedient for Russia simply to buy the facility and manage it. The Kharkiv-based FED is performing the same complementary functions. Until recently it was assisting Russia in carrying out a number of contracts to supply warplanes to some countries in Southeast Asia.

Almost all the Ukrainian MIC plants that may be privatized share one important feature. Unique in a way, they cannot develop on their own because they manufacture components (even large ones) for military hardware. They may be of interest to Russia or for a business that will be able to mediate between Russian and Ukrainian interests. On the other hand, only one Western firm, the US’s largest mechanical engineering conglomerate United Technologies Corporation, has been saying in the past few years that it might invest in the Ukrainian aerospace industry. Ruth Harkin, one of this corporation’s top managers, noted in April 2004 that if Ukraine decides to integrate into the word’s aviation industry, UTC would be ready to consider the possibility of participating in privatization, depending on whether this fits in with the corporation’s portfolio. Another entity that wanted to work on the Ukrainian market was the Sigma Bleyzer investment company whose executives highly praised the An-140 aircraft. Yet, both investors are interested in purchasing MIC plants in Ukraine no more (or, rather, less) than in any other Central and Eastern European country. Therefore, what the Ukrainian MIC can see most clearly is the possible advent of Russian investors. But the question is to what extent they will be interested in developing the defense sector of a state that is no longer in the wake of Russian foreign policy. This problem is to be solved by those who will be setting conditions for future privatization.