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CHAPTER 1– BACKGROUND AND RESEARCH

Vietnam Economy

Vietnam is one of the fastest-growing of all Southeast Asia’s emerging economies. With an annual growth rate of 7.1 percent in 2018, the country is well on its way to becoming a formidable economic powerhouse. (https://www.worldbank.org/)

Vietnam’s development over the past 30 years has been remarkable. Economic and political reforms have spurred rapid economic growth, transforming what was once one of the world’s poorest nations into a lower-middle-income country. Between 2002 and 2018, more than 45 million people were lifted out of poverty. Poverty rates declined sharply from over 70% to below 6% (US$3.2/day PPP), and GDP per capita increased by 2.5 times, standing over US$2,500 in 2018. (https://www.worldbank.org/en/country/vietnam/overview)


Vietnam has continued to expand its economy, growing the fastest in Southeast Asia in 2019, in part due to the US-China trade war. Manufacturing, tourism, and private consumption contributed to Vietnam’s strong GDP growth of 7 percent.(https://www.vietnam-briefing.com/news/us-china-trade-war-inspires-vietnam-growth.html/)

Overview of the modernization of Vietnam People’s Army

Vietnam has devoted significant budget to achieving military modernization targets focused on:

  1. The designing and manufacturing of new types of weapons and equipment.
  2. revamping of training methods
  3. procurement and retrofitting of existing weapons

China’s increased naval presence and territorial claims in the disputed waters of the South China Sea are the major factors compelling the Vietnamese Government to increase its military capabilities. Over the last decade, there has been a significant increase in the expenditure of the Vietnamese Military. Vietnam’s total arms imports between 2011 -2019 represented a 699% increase from the 2006-2010 period. In 2019, the Vietnamese Government allocated close to US$5.5 billion towards military spending, of which 32.5% is earmarked for the procurement of defense equipment.

 

Exhibit 1: Vietnam Military Expenditure 2010 – 2018

 

The lack of technology and low domestic defense capability has forced the country to import weapon systems from foreign OEMs to fulfill its military requirements.

(https://www.businesswire.com/news/home/20190418005440/en/Future-Vietnamese-Defense-Industry-2024-Defense-Budget)

Looking to the future, the modernization of Vietnam People’s Army is likely to be accelerated in response to China’s intensifying civil and military activities in the disputed waters of the South China Sea. The SEA region is experiencing some destabilization due to the Chinese governments’ aggressive actions in the South China Sea. Beijing insists it has sovereign rights to nearly all of the South China Sea, a strategic waterway through which about a third of all the worlds traded oil passes. The disputed waters – also claimed in part or whole by Vietnam, Malaysia, the Philippines, Taiwan and Brunei – have also become the stage for a struggle for regional dominance between Beijing and Washington, the world’s two largest economic and military powers. Vietnam considers itself a leading nation in SEA and is currently allocating both diplomatic and military resources to remain a dominant force and maintain its national interests. In their effort to strengthen its dominance, Vietnam is continuously developing its defense capabilities intending to create a long-lasting “Balance of Power” in the region.

 

Exhibit 2:

 

The opportunity for Israeli companies

Traditionally the Russians remain the dominant ally of the Vietnamese Government. However, due to the current economic situation in Russia and the fact that Moscow has further solidified its relationship with Beijing, the leaders in Hanoi are looking for alternative sources for Defence capabilities. It is expected that the Military Expenditure in Vietnam will rise to  US$5.8 billionby the end of 2020 and trend around this value in the coming years.

Exhibit 3: Vietnam Military Expenditure 2010 – 2025

Given the circumstances, Israel has become an attractive and reliable source for Vietnams’ defense technologies due to several key factors:

  1. Leading state-of-the-art technology
  2. The embargo on China (Israeli defense technologies is not accessible in China as opposed to Russian technology)
  3. Flexibility to provide tailor-made solutions and transfer of know-how programs.

As a result of the enhanced cooperation between the two countries, In 2015, Israel has officially opened its IMOD (Israel Ministry Of Defense) office in Hanoi with a designated Defence Attaché.In the last five years, Russia remains the largest supplier of military hardware to Vietnam, with a share of over 77.9% of Vietnam’s military imports. However, Israel has managed to become the second-largest exporter of military equipment to Vietnam, with over 9.1% of the market share followed by much larger countries such as Belarus, South Korea, and Ukraine, with 4.1%, 2.8%, and 2% respectively (see exhibit 4). In 2018, the two countries conducted the first-ever defense policy dialogue in Hanoi at the headquarters of the Vietnamese defense ministry. The meeting was co-chaired by Vietnam’s deputy defense minister and the director-general of the Israeli defense ministry. The dialog between the leadership of the two countries will open new opportunities for the Israeli defense industries such as establishing JV in Vietnam and allow Israeli companies to invest in the local market.

(https://thediplomat.com/2018/10/whats-in-the-new-vietnam-israel-defense-dialogue/)

An excellent example is the “Z111” project. The Israel Weapon Industries (IWI) has established a production facility in collaboration with the Vietnamese Ministry of Defence for the manufacture of “Galil” rifles for the Vietnam People’s Army. The goal was to replace the Kalashnikov rifles with in a project estimated at more than 100mUS$ investment. (https://www.israeldefense.co.il/en/content/production-galil-rifles-vietnam-has-begun)

Exhibit 4: Vietnam military’s share of importer’s total import 2018[1]

 

CHAPTER 2 – THE INVESTMENT

In 2018, Israel Global defense export surpassed $7.5 billion, while Asia and the Pacific region lead the way with 46%.https://www.israelhayom.com/2019/05/21/israel-wraps-up-second-highest-defense-export-year-in-past-decade/

Only Three Israeli companies are ranked in the top 100 global defense exporters of 2019: https://people.defensenews.com/top-100/

  1. Elbit Systems Ltd-global ranking 28, US$3.6 billion in revenue
  2. Israel Aerospace Industries Ltd – global ranking 37, US$3.6 billion in revenue
  3. Rafael Advanced Defense Systems Ltd – global ranking 42, US$2.6 billion in revenue

Elbit Systems

Elbit Systems is an international high technology company engaged in a wide range of programs throughout the world. We develop and supply a broad portfolio of airborne, land and naval systems and products for defense, homeland security and commercial applications. Our systems and products are installed on new platforms, and we also perform comprehensive platform modernization programs. In addition, we provide a range of support services.

Financial Snapshot

Profitability:

  • 5% profit margin in 2018
  • 7 profit margin in 2017
  • 6 profit margin in 2016

With a drastic increase in the cost of revenue, Profit declined for the year 2018. The cost of revenue should be controlled or decreased. The cost of revenue includes; the cost of production, distribution, and other services provided by the company.

 

 

Asset management ration

  • ROA 2018 (Net Income/ Total assets) = 3.2%
  • Total asset turnover (2019 revenue / average asset 2019) = 0.65

ROA 2017 and 2016 were 5.1% and 5.4%. During 2018, The total assets increased significantly. Includingproperty, plant, and equipment. Moreover, long term trade and unbilled receivables also increased during 2017 and 2018.

Total asset turnover, the ability of the company to use its assets for the generation of revenue, in 2018 was 0.57. An increase of 0.9 points in 2019 shows growth in sales/revenue.

Debt management

  • Long term debt / total assets:
    • 2018- 26.1%
    • 2017 – 19.2%

The increase in the Debt ratio puts the company at higher risk. Long term loans increased radically, in 2018. The company completed two acquisitions of the privately-owned U.S.company Universal Avionics Systems Corporation (Universal) and IMI Systems Ltd. (IMI)

 

The Investment: Establish a Factory in Vietnam

ELBIT Systems’future success depends on its ability to develop new offerings and technologies, to structure its businessthrough joint ventures, teaming agreements, and other forms of alliances, to reflect thecompetitive environment.Part of the company growth strategy includes its continued activity in mergers and acquisitions and jointventures with respect to businesses, assets and complementary technologies both in Israel and internationally – [ELBIT financial report 2018]

ELBIT Systemswill invest in Vietnam to take over market share and expand its sales potential in the SEA region. The company will establish a Factory to manufacture military-grade communication systems and electro-optic devices (2 out of the company 9 main activities). The factory will sell its products to Vietnam’s Ministry of defense with an option to expend to other countries in the Asian region.

Assumptions:

  1. Israel’s leading defense companies represent 70% of the market share in Vietnam divided equally at 23.3% per company (in the defense sector, the selling cycle is long, and the deals are not finalized annually. I have accumulated this estimation and spread the calculation on a period of 5 years
  2. Vietnam Military Expenditure 2020 – 2025 – US$5.8 billion (annually)
  3. Expenditure allocated for procurement of defense equipment: 32.5% = 1.9 US$5.8 billion
  4. Market share for Israeli defense exporting companies: 9.1% = US$171 Million
  5. Elbit potential market share in Vietnam –23.3% = US$39.9 Million
  6. Market share in Vietnam after establishing the factory (full operation): 35% = US$60 Million
  7. Israel defense export volume to Asia and the Pacific region 2018 – US$3.5 billion

ELBIT SYSTEMS – SWOT Analysis

Strength

·         Global leader in defense technology with strong reputation

·         As an Israeli company, enjoy the strong Bilateral relationship to export its technology to Vietnam

·         Strong financial capabilities

·         Competent workforce

Weakness

·         Culture barrier

·         Strong competition from US and Russian manufacturers

·         Limited infrastructure in Vietnam

·         Risk of changes in government approval regarding export licenses.

·         Changes in Exchange rate, if production cost is not denominated in USD

Opportunity

·         Could gain market power in the south-east Asia region.

·         Transfer of applicable activities and facilities

·         Tax incentive and land rental waivers from the Vietnamese government

·         Low Labor wages and production cost

Threats

·         Sanctions by theUSA

·         Rapid demographic and Social changes (World Bank report)

·         Costs to moving containers from factories to seaports are higher in Vietnam (World Bank Doing Business report)

·         Deterioration of diplomatic relations

 

 

 

The competition – current and future

  • Russia

    • Russia is the leading provider for Vietnam ministry of Defence with around 80% market share
    • Vietnam is the biggest customer of Russia in the ASEAN
    • Some of the Main programs in recent years included: 3 strategic submarines, the SU- 30 new fleets, missile systems and; battleships
    • Leading Russian exporting agency – ROSOBORONEXPORT
  • INDIA

    • The first Indian PM to visit Vietnam in 15 years in September 2nd 2016, with the arms to strengthening links with Southeast Asian countries through his “Act East Policy.”
    • A new $500 million line of credit for Vietnam from India to facilitate deeper Defense cooperation (including 2 missile programs)
    • Leading Indian exporting company – BHARAT-RAKSHAK
  • USA

    • The milestone visit by US President Barrack Obama to Vietnam on 22-25 May 2016 gave immediate and essentialresults as the US fully lifts its long-standing lethal arms embargo on Vietnam.
    • The lift of the defense embargo enables the penetration of the largest defense companies in the world to enter the Vietnamese market for the first time.
    • Leading Indian exporting company – Lockheed Martin, Boeing, Raytheon

 

 The Investment:

  • Investments >100M USD
  • CAPEX
    • Factory establishing cost – $100 million
    • Land – free (will be provided by the Vietnamese Government)

FINANCIAL PROJECTION

Total Investment $100 million

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 year 8
Revenue growing 10% 15% 20% 10% 20% 10%
                 
Revenue 39 39 42.9 49.3 59.2 65.1 78.1 86.0
Cost of revenues 27.3 27.3 29.2 33.5 37.3 41.0 49.2 54.2
Gross profit 12 12 14 16 22 24 29 32
Operation Expenses 7.8 7.8 4.3 4.9 5.9 6.5 7.8 8.6
Operating Income 4 4 9 11 16 18 21 23
Financial expenses, net 0.47 0.47 0.51 0.59 0.71 0.78 0.94 1.03
Income before taxes 3 3 9 10 15 17 20 22
Tax Income 1 1 1 1 2 2 2 2
Net Income 2.7 2.7 8.0 9.2 13.7 15.1 18.1 20.0

 

  • Year 1-2 Revenues only from exporting of equipment from Israel – 23.3% of the total market share for Israeli companies in Vietnam
  • Year 3-4 The factory is operating and starting to generate revenues. The operation of a local factory decreasesthe operating costs. The saving in operation cost, logistics, and Tax Increase the Net income of the company over the years from 7% to 15%
  • Year 5-6 The factory producing in full capacity (domestically) and allows ELBIT to take over 35% of the market share (from Israeli companies)
  • From Year 7 Products from the factory are being exported to other countries in the ASEAN region increasing the revenue by additional 20%

 

Net Profit Margin

Net Profit Margin for year 1 = Net income / Total Revenue

= 0.069 or 6.92%

For year 2: NPM =  6.92%

For year 3: NPM = 18.64%

For year 4: NPM = 18.66%

For year 5: NPM = 23.14%

For year 6: NPM =23.19%

For year 7: NPM = 23.17%

Net Progit Margin for year 8 = 23.2%

Avergae Profit Margin for projected years = 17.11 %

Required rate of return

  • ROI – Estimating revenue growthof 5% from year 8 = ROI in year 11

The Weighted Average Cost of Capital (WACC) is

WACC = % of Debt * cost of debt * (1-tax) + % of Equity * cost of Equity

= 10.75% * 6.30% (1- 23%) + 89.25% *10.58%

= 10.00%

Note: Country Risk premium of Vietnam is 3.55% and the Average Unlevered beta is 1.10

CAPM = Rf + β (market premium) + Country Risk premium

= 0.549% + 1.10(5.89%) + 3.55%
= 10.58%

 

RECOMMENDATION

After looking at the financials of Elbit, I’ve a recommendation as whether Elbit should invest in Vietnam or not? I realized that Elbit has put great effort into put this feel forward and backing out on it could reflect badly, but my recommendation is that Elbit should invest in Vietnam. The reason is that Elbit is the only Israeli’s company to operate in Vietnam, they could gain market power in the south east Asia region. The company’s financials indicates a good return on investment, however to achieve ROI of 15%, cost of revenue shall be lessen.Profit margins shows a consecutive growth in the projected years.  Furthermore, the WACC being low indicates low level of risk, also as Vietnam’s Risk premium is higher. Vietnam’s positive economic outlook and the friendly diplomatic relations with Israel (and other major countries) adds a lot to the positive outcome of this investment.

 

 

Links:

Vietnam defense:

https://www.businesswire.com/news/home/20190418005440/en/Future-Vietnamese-Defense-Industry-2024-Defense-Budget

https://tradingeconomics.com/vietnam/military-expenditure

https://www.macrotrends.net/countries/VNM/vietnam/military-spending-defense-budget

Defence market in Southeast Asia

https://theaseanpost.com/article/defence-market-southeast-asia

https://www.jstor.org/stable/25798074?seq=1

 

ELBIT:

https://elbitsystems.com/products/communication-systems/software-defined-radios/

elbit investments in india:

https://www.business-standard.com/article/news-cm/bharat-electronics-receives-orders-worth-usd-33-mn-from-elop-israel-119022500337_1.html

 

Vietnam-Israel Defense Dialogue

https://thediplomat.com/2018/10/whats-in-the-new-vietnam-israel-defense-dialogue/

https://www.newmandala.org/vietnam-israels-closest-asean-partner/

 

IWI FACTORY

https://www.israeldefense.co.il/en/content/production-galil-rifles-vietnam-has-begun

https://en.wikipedia.org/wiki/Z111_Factory

 

 

 

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“General motors” is an automobile manufacturing company, based in USA, which manufactures and sells luxury brands of car like Chevrolet, GMC and Cadillac.

Profitability Ratios:

General Motors had maintained stable profit margins ratios from 2014 to 2017 with slight improvement from 2014 onwards. However, due to increase in cost of goods and doing business, profit margins shrank slightly in 2018. Gross profit margin increased from 8.8 in 2014 to around 12 and remained almost constant for the next three years before dropping to 9.5 in 2018. Same scenario occurred with operating profit margin and EBIT margin. However, net income margin showed a rather inconsistent behavior throughout the tenure due to varying amount payable in taxes.

Return on assets and return on equity followed the pattern of previous profitability ratios. Increasing slightly from 2014 levels, remaining stable for the next three years and then falling down slightly in 2018.

Fall in profitability ratios in 2018 can be attributable to increasing costs of raw material like steel, warming up trade tensions with China, tough competition from eco-friendly car manufacturers like Tesla, and overall slowing down of global economy.

Efficiency Ratios:

During the tenure of 2014 to 2018, General Motors has drastically improved its inventory turnover ratio which shows that the company has managed its inventory pretty efficiently. The ratio increased from 10.4 in 2014 to 13.5 in 2018.

On the other side, account receivables, another measure of company’s efficiency, has remained on the decreasing side, which demonstrate that the company has facing delays in collecting its receivables. The ratio decreased during the tenure from being at 6 in 2014 to 4.4 in 2018. This may also have caused liquidity problems and shrinkage in current ratio of the company.

Liquidity Ratios:

Current ratio of General Motors has been under 1 during the tenure with the only exception in 2014, which may indicate liquidity management problem. However, keeping in mind the long cycle of account payables in automobile industry and the reputation of General Motors, this doesn’t demonstrate any serious threat to the operations of GM. Moreover, GM has been maintaining a good operating cash flow per share which shows the availability of enough cash to keep the operations continue without any hassle.

In last two years, General Motors has increased its debt which is visible by its increasing debt to equity ratio; debt to equity ratio increased to 2.6 in 2017 from being at 1.7 in 2016.

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