IN the sweeping reorganisation of the French defence industry GIAT Industries is to play a distinct role as the main land systems manufacturer, concentrating on armoured vehicles, light arms and ammunition. Its most prestigious product is the Leclerc main battle tank which has been ordered by the French army and, in far larger numbers, by the UAE land forces.

Won against fierce competition in 1993, the UAE deal entails a huge offset commitment and has already caused GIAT some financial headaches. The long- term offset obligations could cause much greater discomfort to the company in years to come. Yet, this and other export deals are essential if GIAT is to overcome the limitations of a modest home market and win enough business to keep its production lines rolling.

GIAT Industries has put in a poor financial performance since it was separated from the Defence Ministry in 1990 and set up as an independent state company. Under pressure to contain costs and win export orders the company over-reached itself. A financial audit has revealed losses of FF 2,000 million ($390 million) on the UAE contract, due to inadequate provisioning for foreign currency fluctuations. In March, the government had to agree to a capital injection of FF 3,700 million ($733.5 million). A month later GIAT disclosed net losses for 1995 of FF 8,600 million ($1,705 million), which was higher than total turnover for the year. After these results chairman Jacques Loppion announced that GIAT would cut its five divisions down to three, focus on land systems, reduce its workforce by 2,700 and explore new prospects for civilian business.

The UAE order for the Leclerc is the biggest single overseas contract the company has ever won, with an estimated value of about $3,700 million. The Leclerc beat off a powerful rival in the form of the US' M1 Abrams which is in service with Saudi Arabia, Kuwait and Egypt. The actual buyer is the emirate of Abu Dhabi which is taking 390 of the main battle tanks and 46 armoured recovery vehicles. The acquisition will equip Abu Dhabi with more tanks per capita than anywhere else in the region. Even the French army, the only other customer for the Leclerc, has ordered just 222 of them.

Abu Dhabi also insisted on some major modifications. Instead of the original French engines from SACM, it insisted on German engines and gearboxes, as well as different air conditioning systems and view sights. Five tanks were delivered in 1994, a further 30 in 1995 and GIAT is now up to a production rate of 80 units a year and rising.

Saudi Arabia is also in the market for a new tank to equip the National Guard and the Leclerc was demonstrated in the kingdom in September 1995. Interest in the tank has also been expressed by Qatar, a regular buyer of French defence equipment. Both countries also have the option of extending the useful lives of their AMX-30 tanks, as the French army has done, through engine upgrades and the retrofit of new armour.

Offset obligation

The greater challenge facing GIAT at present is the fulfilment of the offset obligations that it has taken on as part of the Abu Dhabi deal. This entails generating investments in the emirate equivalent to 60 percent of the contract value, or about $2,000 million worth. The matrix for calculating compliance is complex and the 60 per cent ratio has never been officially confirmed. But there is no question that GIAT will be hard pressed to meet its undertakings by the cut-off date in 2003, 10 years after the tank contract was signed. 'The technocrats have prevailed and we will need a lot of discussion and deliberation at the end of the period,' says Christian de Villemandy, the Paris-based director-general responsible for offsets.

The story so far makes for easy reading, however. GIAT says it has already reached its 1997 milestone, the first of three, by meeting 20 per cent of its obligations. It has launched an air-conditioning company, built a horse racing circuit at Ghantout and in July it concluded an agreement to set up a stainless steel service centre. The latest scheme entails a $32 million investment at Mussafah in partnership with Italy's Terruzzi, the local Bin Bandooq Group and others. GIAT is confident that more offset deals will be announced before the end of the year.

All these projects have been accepted by the UAE Offset Group as meeting the requirement to establish new ventures, which must be commercially viable, in partnership with local investors and strategic allies. Abu Dhabi wants to avoid the creation of industrial white elephants and has put commercial considerations at the heart of its offset strategy. GIAT's performance will be judged by the level of investment and the operating performance of the project. When the day of reckoning comes, GIAT will also be entitled to an 'exit credit', which will be based on the expected lifetime worth of an investment as calculated on the basis of its performance over the previous two years.

There is still a huge gap between GIAT's achievements so far and the final target figure. It is very likely that the gap will be impossible to close without a radical rethink of the strategy. Abu Dhabi is small, with an indigenous population of about 200,000 people at most, and the investment opportunities are far from obvious. With the best will in the world, GIAT could fall far short of meeting its commitment in full. De Villemandy is confident that the second milestone of 50 per cent by 2000 can be reached. Doubts arise about 100 per cent fulfilment by 2003. 'There is an inconsistency between the philosophy and the reality,' he says. 'The problem is how to achieve it pragmatically. An admirable goal will not be achieved unless there is a change in the spirit, not the text, but in the spirit of the partnership.'

One way out of the potential difficulty is offered by Abu Dhabi's impressive infrastructure and its possible privatisation. A sell-off which allowed the participation of foreign investors as strategic partners could clear GIAT's offset deficit at a stroke. 'Privatisation will transfer assets into businesses in which we can invest,' says De Villemandy.

Several options have already been explored. At the invitation of the UAE Offset Group GIAT did a feasibility study on letting the Mirfa power plant as a concession to a private operator, but came down against taking it on itself. In May 1995, GIAT presented the Offset office with a far more ambitious study, on the privatisation of the massive Taweelah B power and desalination plant. The Offset office brought in Merrill Lynch to validate the study and, according to De Villemandy, the US investment bank gave it a ringing endorsement.

When this study was subsequently presented to the Abu Dhabi Privatisation Committee, the proposal took on a life of its own. In January, when a new privatisation committee was appointed it promptly decided to consider privatising the whole of the Abu Dhabi Water and Electricity Department (WED). McKinsey, the US consultant, was selected to advise on how to proceed with this far larger undertaking. As the committee and their advisers deliberate GIAT has no other option than to await the outcome.

How GIAT's offset programme will be affected by this process is far from clear. Abu Dhabi may seize the initiative and pre-empt its neighbours by becoming the first place in the Gulf to privatise its infrastructure, or it may decide to leave things as they are.

Without the investment opportunities that a privatisation of Abu Dhabi's utilities would create, the prospects for GIAT meeting its commitment in full seem slim. There is still the risk that GIAT might not even win an open competition if any concessions for the utilities were to be put out to tender. The company assisted at the outset, with the Mirfa privatisation study, but may not benefit directly if and when privatisation develops into something bigger. No one doubts the technical ability of the GIAT Leclerc to hit targets at long range in difficult terrain. The commercial prospects for a company carrying such a costly offset commitment are rather less certain.