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Russian defense giants fight for life

The Soviet defense industry was the crown jewel of the former U.S.S.R. It was also a vital exporter and source of foreign currency. But the sector has fallen on hard times since the collapse of communism. Now, hundreds of Russian defense companies are fighting for life.  By CNBC's Sue Herera.
/ Source: CNBC

The Soviet defense industry was the crown jewel of the former U.S.S.R. It was also a vital exporter and source of foreign currency. But the sector has fallen on hard times since the collapse of communism.

Still, a few potential survivors, and even winners, are emerging from the post-Soviet chaos. Hundreds of Russian defense companies are fighting for life.

“If they do nothing, then in a couple of years a majority of these companies will disappear,” said Elena Sakhnova, an analyst with United Financial Group, a Russian investment bank.

But some Russian defense companies are battling back by trying to convert into Western style businesses. Take the Irkut Corp. It was created in the 1990s by consolidating parts of several Soviet defense contractors, including the maker of Sukhoi fighter jets. Irkut is publicly traded in Russia, transparent to investors, and hard-wired to the stark realities of the new free market.

"In commercial aircraft, I believe we lost the chance to be our own player,” said company first vice-president Valery Bezverkhniy. “And we should team up with somebody who already exists in the world.”

That means partnering — rather than competing — with giants like Boeing and Airbus. Irkut is also focusing on small, niche products like firefighting aircraft.

“This is exactly the model that will allow the Russian defense industry to recover and even gain new markets,” said Gairat Salimov, and analyst with Troika Dialogue, a Russian securities firm.

Irkut hasn't abandoned military production: it still makes Sukhoi fighters. But Russian defense budgets have been slashed over the past decade — from $75 billion in 1993 to just $10 billion last year, according to the Congressional Research Service. So many contractors are setting their sights on exports.  

“Sukhoi is the most successful of all,” said Christopher Bolkcom, a specialist in national defense at the Congressional Research Service. “I think they expect $1.5 billion in exports in 2004.”

Russian arms exports are growing. They were  up slightly to $3.4 billion last year — just a fraction of the $26 billion exported in 1984.

MiG fighters were a major part of that export picture. But not today. 

“I think MiG is really hanging on by their fingernails,” said Bolkcom.

To keep MiG production alive, the government transferred it to a company called Sokol and its shareholder, the Kaskol Group. On a recent tour, company officials showed off the MiG 31-E  — the latest version of the fighter jet.  Just a few years ago, it would have been unthinkable for a Western film crew to have access to a such defense facility.

But Kaskol, like Russia itself, realizes its struggles now are more economic than they are military, and that has led to a new openness. Kaskol is actively touting MiG's reputation as it markets new products, like the Sokol M-101 commuter plane, as well as engineering services to customers like Airbus.

“This is a real advantage because we don't have to explain our high standards of quality because you can look at our fighters and you'll understand that this is a quality (aircraft),” said Andrei Komov, a vice president at Kaskol Group.

Kaskol CEO Sergei Nederoslev is candid about his company's challenges.   

“In ten years,” he said, “we will be one of the leaders on this — on aerospace, on world aerospace — because if not, we'll not exist.”

It is a blunt outlook many experts share. With so much capacity and inefficiency, the defense sector almost certainly faces further consolidation. Some of the most revered Soviet names could disappear, while others like Irkut, may find a place in the competitive market. It is a bitter reality for an industry better geared for combat than commerce.

Russia's defense industry is actually quite small compared to its oil sector. Analysts expect Irkut's 2005 sales to be roughly $1 billion. But if Russia hopes to be a world class, high-tech economy, and not just an oil source, it may have no better place to demonstrate those skills than in its military products.