Cover Story: Tribulations of the LCS project

This article first appeared in The Edge Malaysia Weekly, on May 9, 2022 - May 15, 2022.
Cover Story:  Tribulations of the LCS project
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IT is no secret that the RM9 billion littoral combat ship (LCS) project awarded to Boustead Heavy Industries Corp Bhd’s (BHIC) subsidiary 11 years ago has been beleaguered with cost overruns and delays, without a single vessel delivered to date.

But how did the situation turn so bad, considering that the project — which has already received RM6 billion in progress payments from the government — has threatened the solvency of BHIC’s parent company, Boustead Holdings Bhd (BHB), and is a major investment of Lembaga Tabung Angkatan Tentera (LTAT)?

On Dec 16, 2011, Boustead Naval Shipyard Sdn Bhd (BNS), in which LTAT has an effective stake of 61%, received a letter of award from the Ministry of Defence to deliver six LCS dubbed “Second Generation Patrol Vessels Littoral Combat Ships (Frigate Class)” as part of its fleet renewal plan. BNS was supposed to deliver the first vessel in 2017, with each of the remaining units to be handed over at six-month intervals until 2021. BNS is an indirect unit of BHIC and is substantially controlled by BHB.

A formal contract was finally signed a year later on July 17, 2014. By this time, BHB stated that the first delivery had been moved to April 2019, instead of 2017 as originally proposed.

In 2015 and 2016, BNS booked losses, partly due to foreign exchange provisions on contracts with the original equipment manufacturers for the LCS project and variation orders (VOs). After a profitable 2017, it made a loss in 2018 — again as a result of the VOs involving ship design and equipment.

Discussions on the VOs and additional costs took centre stage following the change in government in 2018. The project was suspended the following year, pending the outcome of negotiations.

In October 2019, then defence minister Muhammad Sabu told the Dewan Rakyat that the project was 55.7% completed as at 3Q2019, as opposed to its completion target of 78%. Consequently, the first vessel would be delivered three years later than the April 2019 deadline.

It was also revealed that the project’s contract value came to RM9.1286 billion, and that the additional cost to complete all six vessels amounted to RM1.4 billion, or RM10.63 billion in total.

In August 2020, then senior minister (defence) Datuk Seri Ismail Sabri Yaakob told the Dewan Rakyat of a plan to cap the project cost at RM9 billion — but for just two vessels, to be done either by BNS or another company.

Meanwhile, BHB submitted a proposal to the government. It was tabled at a cabinet meeting in May last year. In March this year, the government decided to continue with the project.

In 2019, Muhammad Sabu said the problems faced by the project included failure by BNS to complete its detailed design, equipment procurement delays and unsatisfactory quality of work. In October 2020, it was alleged that RM1 billion of the RM6 billion spent on the project thus far was unaccounted for.

In 2020, BHIC undertook a forensic audit and later lodged a report with the Malaysian Anti-Corruption Commission (MACC) on possible irregularities in the project. In January, MACC arrested three individuals to facilitate its probe.

In an interview with The Edge, LTAT CEO Datuk Ahmad Nazim Abdul Rahman gave some insights into the problems faced by the project. The following is an excerpt from the interview.

 

The Edge: LCS has been a major problem for the group.

Datuk Nazim Rahman: If it is not resolved, it will have a huge impact on Boustead group and eventually LTAT. If you analyse the financial information, it will trigger a cross default of the loans. So, the cabinet decision is significant. It essentially saved us from having to make an impairment on the retirement fund to the tune of RM2.1 billion.

 

There are calls for a Royal Commission of Inquiry. Do you think it is necessary?

It is not my place to comment on whether there should be an RCI or not. Our role is to make sure that we put in place the necessary infrastructure for the company to deliver the ships.

 

Some people have called the continuation of the LCS project as a government bailout for LTAT and Boustead Group, as it has already paid RM6 billion and now needs to pay another RM4 billion for the project to be completed, or a total of RM10 billion. What is your comment?

I do not have the authority to respond on the additional money. But regardless of the funding, this is not a bailout of either LTAT or Boustead. The government was focused on saving the project, rather than the two entities. That is why in its deliberation, the government considered multiple options, including terminating the contract with BNS and handing it over to a new party to build the ships. But the latter would cost multiple times more and require a longer time to deliver.

Yes, the cabinet decision in favour of continuing with BNS has averted a massive financial fallout across the economic value chain, but the government’s paramount consideration was the security and sovereignty of the nation. LCS is not just another government project, like highways, schools or hospitals. LCS is a key combatant asset that we urgently need to protect our maritime security and economic interests.

The cost-benefit analysis from an economic perspective is very clear. The economic impact in terms of technical capacities, job creation and the development of the supply chain has been enormous and far outweighs the cost. Having said that, even if we were to look at LCS purely from a cost perspective, public records show that the US’ LCS cost the Americans about US$600 million per ship, while it cost Egypt and the UAE about €375 million per ship. This is not an apple-to-apple comparison, but from a cost perspective alone, they are comparable.

 

As the project will be continued by the same party that failed to deliver the last time, what is the guarantee that it will succeed this time and that the RM4 billion will translate into ships being delivered? Why did it fail the last time?

That has been the public perception, but it would not be accurate to describe the project as a failure. A delay, yes.

The contract has been designed in such a way that the construction of the ships will be done simultaneously. As such, the equipment, combat system and weapons have been purchased in advance for all the ships. A large portion of the money has been spent on these purchases.

We could continue to debate why it was not built consecutively, but the fact is that the detailed design, done in partnership with France’s Naval Group, has progressed to more than 90%. The physical construction progress of the first LCS is at more than 60%, with varying degrees of development for the rest of the LCS. So, there had been substantial work done on the ground until the work stopped in 2019.

It would be hard to single out a reason for the delay. BNS had the misfortune of inheriting hundreds of millions in liabilities from PSC-Naval Dockyard when Boustead took over the company in 2005. So, some of the money meant for LCS had to be used to pay off PSC’s outstanding debt. In the meantime, the changes made to some of the mission-critical equipment in the middle of the project were not dealt with early and conclusively.

It affected the flow of the project management. The MACC investigation and multiple Public Accounts Committee hearings have implied that there may have been integrity-issues related to the project. So, there are many factors — financial management, project management, loan structure that is not aligned to the cash-flow profile — that have contributed to the delay. This delay cost billions of ringgit. But some of these are issues of the past that are now being handled by the relevant authorities.

What we are concerned about is the future. So, the question is how we make sure we deliver on time. A robust governance, a complete change in the management team, a more structured organisation, a better approach to project management and a restructuring of the company and all of its loans and liabilities. These would be the first order of business when the BNS board sits this month to remobilise the project.

It helps that the entire management of the Ministry of Defence, LTAT, the Boustead Group and BNS comprise an entirely new team. It allows us to look at the project and the issues from a fresh perspective. We have also put in place another layer of governance — a project management committee — on top of the board, chaired by the Treasury Secretary-General and the Secretary-General of the Ministry of Defence, and a monthly report on the progress to the cabinet. So, money in, money out will be scrutinised very rigorously at every level. A robust governance framework is critical to ensure the integrity of the project is beyond reproach.

 

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