IAI case in Israel

Source: http://www.economist.com/node/18281744

Case scenario:
IAI is the national owned Israeli company focusing on defense and aircraft manufacturing. It has been announced that IAI is going to be privatized soon. Our customer, which is a big private fund in Israel, wants us to evaluate this deal and tell them whether it’s a good idea to buy shares of the company when it’s privatized.

Framework and Analysis:
This is a business situation case. We will look at 4 factors:
1, Customer.
2, Company.
3, Product.
4, Competition.

Start with Customer. Obviously the major customer is the Israeli army, the IDF. Israel has a large military funding every year due to the frequent unrest in middle east and it’s tense diplomatic relationship with Palestine and Iran. The recent unrest in Arab world adds uncertainty and pressure for IDF for bigger budget. The IDF also has a keen sense of maintaining a technological advance relative to it’s rivals, which will ensure they buy the most advanced and expensive equipment the company produces. Chech +1 for this factor.

Now, company. The IAI is said to be in a financial and organizational mess for the past few years. This is part of the reason why the company is going private and fired its current management. Two factors to consider: 1, whether the new management can successfully manage the business. 2, the Union in the company (Israel Aerospace Industries) is powerful, and will they agree to layoff people and cut down costs. Check ? for this factor.

Product. They offer three major categories of products: 1, observational and communications satellites. 2, anti-ballistic-missile defenses. 3, mid-size business jets. The company has a competitive advantage in the first two categories of products, thus they have remained profitable consistently, and even has potential to market in Asian markets. The business jets sector has been barely profitable for two years due to the financial crisis, but has slightly recovered in recent months (80m/3b =~ 3%). Check +1.

Competition. There are no major domestic competitors because it’s previously national owned business. Foreign competitors can not compete because of security concerns (barrier to entry). Domestic competitors could arise but should take a long time because of technological constraints and huge investment required to start such a business. Check +1.

Conclusion: we should buy the shares of IAI. (brief summary goes here)

Some potential risks: 1, Regulatory. There could be some constraints about the money that are allowed into this sensitive national defense business. 2, The funding for the IDF could be slashed in future, (say the Israeli government suddenly runs into huge deficit and needs to slash budget), in such case the company will have to explore foreign markets. 3, Barriers to exit the investment. 4, The management and Union/company structure problem is still a risk. 5, The rising oil price will threat the business jet sector, which we may need to sell if the situation gets worse (it wasn’t very profitable to start with, and much vulnerable to competition).