German arms companies fear for their share of defense windfall

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In a hangar that blends into the industrial quay of the German port of Kiel, Thyssenkrupp engineers test the steel hull of a submarine to make sure it can withstand more than 50 bar of water pressure . But ships built in the country’s largest shipyard will not be delivered to the German Navy.

Instead they will go to countries like Israel and Singapore, which have placed orders with the group even as the German government shunned its local manufacturer by awarding a €4.6 billion contract for MKS frigates. 180 to a Dutch company. The snobbery of Thyssenkrupp Marine Systems (TKMS) in 2020, which had hemorrhaged money, came to sum up the dismal state of the German defense sector.

But Russia’s invasion of Ukraine and the German government‘s subsequent commitment to dramatically increase military spending suddenly turned TKMS into an asset.

“Now we have a recalibration,” said new TKMS chief executive Oliver Burkhard. Since Chancellor Olaf Scholz announced he would set aside €100 billion to modernize Germany‘s armed forces and pledged to spend 2% of annual gross domestic product on defence, TKMS has grown. Originally intended to be sold by parent company Thyssnkrupp, it became a buyer, buying up the insolvent MV Werften, based in nearby Wismar, whose Asian owner ran out of money halfway through the construction of a giant cruise ship.

Yet, behind the scenes, German industry “still fears that nothing will happen”, according to a former defense official who now advises the sector.

“There was hardly any domestic market for German arms companies,” the person said, referring to the fact that at least three-quarters of local arms production is exported. “There is no playbook.”

Several German defense companies are banking on rapid growth through closer collaboration with Scholz’s coalition government.

A few days after the Chancellor’s speech in February, Rheinmetall, the country’s largest listed arms manufacturer, presented Berlin with a list of products worth 42 billion euros that it could deliver during the of the next decade.

The majority of its orders for tanks, armored vehicles and ammunition previously came from outside Germany, the United Kingdom and Hungary.

Hensoldt, an Airbus spin-out backed by KKR and partly owned by the German government, is also expecting a windfall. “We will be part of all major procurement programs,” said a person familiar with the company who specializes in advanced radar and sensor systems.

Concerns that Scholz’s spending plans would not pass through parliament unwatered were allayed when the vast majority of the Bundestag voted on them earlier this month.

So far, however, Berlin’s big orders following Russia’s invasion of Ukraine have consisted of 35 American-made F-35 fighter jets, as well as 60 heavy-lift helicopters. Chicago-based Boeing CH-47F Chinook. Procurement from German arms producers was largely limited to ammunition and clothing from existing stocks.

Column chart of the Aerospace and Defense market (in billions of dollars) showing that the majority of German arms production is exported

Longer-term projects worth more than 25 million euros currently have to go through a lengthy tendering process led by a division of the Ministry of Defense in Koblenz which, in some cases, took several years and then be approved by two parliamentary committees – how much more production capacity could be reserved for other countries, representatives of public and private companies told the Financial Times.

Hensoldt board member Celia Pelaz, a Spaniard, agreed that “we need to look at the German government’s procurement processes”, which are mired in bureaucracy, warning that otherwise it “is going to be difficult to put that money to good use.” .

Berlin has since pledged to speed things up. In an attempt to pressure the government into further accelerating its decision-making, TKMS said it could secure up to 1,500 jobs in Wismar if chosen to build more submarines and battleships.

“I made a formula that the more you order, the more people we can employ,” Burkhard said of his discussions with the Scholz administration. “Sometimes they need a little pressure just to act.”

The Rheinmetall boss also waved a carrot at policymakers. “Over the next 12 to 18 months, we will hire 1,500 to 3,000 people, depending on the contracts we get,” Armin Papperger said.

Bar chart of one billion euros showing that Germany's defense spending was increasing even before the modernization commitment

But industry lobbyists privately concede that is not important enough to pressure government into committing to new roles. German defense companies account for less than 57,000 jobs in the country, according to the German Economic Institute in Cologne, while the French arms industry directly employs 165,000 people.

“In the past, if the auto industry had a headache, the Chancellor would probably run and hold his hand. If the defense industry has struggled, so far few people have come away concerned,” said Claudia Major, security expert at the German Institute for International and Security Affairs, SWP.

“Economically speaking, it’s not important.”

There is also public opinion to fight. “In Germany, the defense industry is seen as one of those nasty, dirty things that hardly anyone wants to come up with,” Major added. Indeed, Germany’s aversion to the sector nearly forced the sale of TKMS, as its parent group was told that banks would no longer fund Thyssenkrupp if the unit exceeded 10% of annual turnover, breaching environmental, social and governance criteria of lenders.

Consolidation among Germany’s patchwork of defense contractors — particularly with regard to shipyards — will also be needed to deliver value for money to the government, TKMS’s Burkhard said. The choice for his business, he added, is “to be lunch or lunch”.

Yet even those with unparalleled technology have struggled to attract Berlin’s interest. At its manufacturing site in Ulm, Hensoldt builds state-of-the-art passive radar systems capable of detecting enemy objects without emitting a signal. The devices, which when stowed are about the size of an airline drinks cart, were originally produced for Egypt.

The technology developed in a former army barracks in the heart of Bavaria has yet to be commissioned by Germany itself.

The lesson to be learned from the invasion of Ukraine is that “we need an industry, we need a technological base,” said Pelaz de Hensoldt. “We shouldn’t be saying now, ‘well, because we need it fast, we don’t care where it’s coming from’.”

A few new contracts have emerged. On Thursday, Rheinmetall won a 13 million euro contract for pneumatic start units from the German Air Force. But with order books like TKMS already full, the sector is mostly “on hold”, according to a senior executive, waiting for concrete commitments before making big investments.

Overlooking the Baltic Sea from his Kiel office, TKMS’ Burkhard sees the potential for a flurry of new business. “A commander told us that everything that floats is out for the time being,” he said of the German Navy’s current fleet. The next global conflict may well be in the South China Sea, making submarines and frigates all the more important.

A test of whether the German government will embrace its own arms industry is imminent. Two more MKS 180 frigates – now called F126 – are on the army’s recently compiled ‘wish list’. If those contracts weren’t awarded to Thyssenkrupp, Burkhard said, “the signal wouldn’t be great.”

Additional reporting by Guy Chazan in Berlin

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