Alternative views: throwing good money after bad

Controversial defense firm Boustead Naval Shipyard Sdn Bhd (BNS) is certain to complete at least two of the six Littoral Combat Ships (LCS) it has been contracted to build on one condition – that the government continue disbursing the remaining sum allocated for the Project of RM 9.1 billion.

All parties, including Defense Minister Datuk Seri Hishammuddin Hussein, are confident that the first two ships will be ready for sea trials in 2024 after the government begins releasing the remaining RM3.1 billion budgeted for the project.

According to the deliberations of the Public Accounts Committee (PAC), the government’s approval and its commitment to continue financing the purchase is crucial for the SNB. The shipbuilder needs RM1.5 billion to take over the LCS project. The funds are to be used to repay banks and creditors.

The fate of Boustead Holdings Bhd and its ultimate parent company, the Armed Forces Fund Board (LTAT), is also linked to the LCS project. The two entities cannot afford the failure of the SNB as it would trigger cross defaults on all loans from the two companies.

Given the implications for LTAT, it is easy to see why Cabinet in April this year gave its approval for the project to proceed. Boustead Heavy Industries Corp Bhd (BHIC), the parent company of BNS, will announce more details in the near future.

If the government releases the remaining RM3.1 billion and BNS delivers the LCS 1 and LCS 2, that would mean the cost of completing the first two ships would be estimated at RM4 billion each.

This is a far cry from the estimated RM1.5 billion for each vessel when the project was awarded in October 2010.

BNS is said to need an additional RM4 billion to complete the remaining four ships. It remains to be seen how the company will raise the funding.

Assuming BNS raises the additional RM4 billion and factoring in a change order of RM2.6 billion, the cost of the six LCS is expected to exceed RM15 billion, a staggering amount. This represents an additional cost of more than 60% compared to the initially budgeted amount, not counting delivery delays.

Based on the deliberations of the PAC, the SNB hopes for a “soft loan” to raise funds. The other option he has is to raise funds in the capital markets.

Banks would be reluctant to lend to the SNB unless it gets new government orders to build ships and, most importantly, makes a profit. In the current situation, the likelihood that the SNB will be able to obtain loans is very low unless there is some sort of guarantee from LTAT. The other option is for the government to extend the “subsidized loan”.

One question that arises is whether it is worth investing more money in the LCS project. Perhaps the government should put the project on hold and consider other options that do not involve BNS.

The current batch of people at the helm of BNS, Boustead and LTAT are made up of new faces. However, there is no certainty that they can guarantee a different outcome in terms of LCS delivery.

The current set of people who manage the LTAT and the companies that depend on it are professional managers. They – and the Minister of Defense – have all expressed their commitment to ensuring that the Navy gets the ships on a new schedule. Hishammuddin even said that he had been in contact with his French counterpart to ensure that they would give their full cooperation to complete the work.

However, these professional managers and the minister himself may be replaced after the next general election, which is not far away. What happens after that? Will the LCS project continue to be delayed and lead to higher costs?

If this happens, the problem will once again be left to the government to find a solution.

BNS’s track record of delivering projects on time and on cost is not great. Although it has a monopoly on the maintenance, repair and construction of ships for the navy, it has already required government assistance in megaprojects.

This happened before 2005 when the company was under PSC Industries Bhd (PSCI) of Tan Sri Amin Shah Omar Shah. He took over the Lumut shipyard from the government as part of a privatization exercise.

BNS was then known as PSC-Naval Dockyard Sdn Bhd (PSC-NDSB), and it was given the mandate to complete six offshore patrol boats for RM4.9 billion. PSC-NDSB did not deliver even a single ship and Boustead Group took over the business. The project has been reoriented towards the construction of new generation patrol boats (NGPV). It was a bad precedent.

In 2007, the Auditor General’s report revealed that the NGPV project had resulted in a cost overrun of RM1.85 billion, 38% more than the budgeted amount. Additionally, according to a PAC report, the delayed ships had prompted a litany of complaints from the Navy after they were delivered.

What this shows is that it is not enough for the shareholders and professional managers of government-linked companies such as the SNB to be changed. There does not seem to be any improvement in the way the company operates and delivers products to its client, namely the government.

What’s worse is that it’s not just defense projects that are riddled with delays and cost overruns. They destroy many government projects, from roads to railways and buildings.

Contractors typically blame the customer – the government – and tend to get away with obtaining change orders and securing time extensions to complete the job without having to pay penalties.

What is disconcerting is that the same contractors are receiving additional funding and a new mandate to complete the work they failed to deliver in the first place.

Most jobs are awarded through direct negotiations to well-connected companies. The latest example is the Rapid Transit Link project linking Bukit Chagar to Johor Baru and Woodlands to Singapore, which has been awarded to the little known Adil Permata Sdn Bhd. The terms of Mass Rapid Transit Corp Sdn Bhd awarding the contract to Adil Permata in 2020 remain unclear.

In most cases, the government has no choice but to incur additional costs to complete the projects. But does it need to keep old companies that failed to deliver and pump them with new money?

M Shanmugam is editor of The Edge

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