Hasty materials order leaves Daewoo Shipbuilding & Marine Engineering teetering on edge of ￦90B loss

After Daewoo Shipbuilding & Marine Engineering (DSME) signed a contract with Indonesia to sell military submarines, the company is teetering on the edge of a potential loss of 90 billion won ($68 million) after ordering key materials before..

The second of three 1,400-ton military submarines ordered by the Ministry of Defense of Indonesia is seen during a delivery ceremony at Daewoo Shipbuilding & Marine Engineering's shipyard at Geoje, South Gyeongsang, on April 25, 2018. [NEWS1]

After Daewoo Shipbuilding & Marine Engineering (DSME) signed a contract with Indonesia to sell military submarines, the company is teetering on the edge of a potential loss of 90 billion won ($68 million) after ordering key materials before receiving an advance payment from the buyer.

The contract has been delayed, and though DSME claims the deal is still valid, additional funds will be needed to store or dispose of major materials that are set to arrive in Korea in October. In April 2019, DSME received an order to build three 1,400-ton submarines — a project worth 1.162 trillion won in total — from Indonesia's Ministry of Defense and put in early orders for major materials needed for the submarines even before receiving an advance payment. DSME ordered about 90 billion won worth of materials, but the contract with the Indonesian ministry has already been delayed for more than three years.

Also referred to as “80 billion won worth of metal,” some number of propulsion motors, one of the key components of a 1,400-ton submarine, are expected to be delivered to DSME's shipyard in Geoje Island, South Gyeongsang from Siemens, a German manufacturer.

“When the propulsion motor is delivered, we will have to pay tens of billions of won for it,” said an insider of DSME who spoke under the condition of anonymity. “There is no place to store the propulsion motor, so we will have to pay an additional fee to prepare a storage space, and if that is not possible, we will have to pay a separate fee to dispose of the propulsion motor.”

The JoongAng Ilbo, an affiliate of the Korea JoongAng Daily, inquired about this matter through the office of Rep. Kang Min-kuk of the People Power Party and received data and answers from the Korea Development Bank (KDB), the largest shareholder of DSME, on Aug. 12.

According to the KDB report, DSME signed a contract with Siemens to purchase three sets of propulsion motors, worth 58.5 million euros (78 billion won), and paid 6 million euros in advance. These propulsion motors are scheduled to be delivered to Korea in October this year. After that, steel materials used for submarines worth about 8 billion won and engine silencers worth 1.4 billion won were also ordered from different companies.

DSME's April 2019 contract with the Ministry of Defense of Indonesia was an additional order after DSME previously exported three submarines to Indonesia starting in 2011. At the time, the April contract was to take effect on Oct. 30, 2019. However, the contract has not come into effect as of yet as the Indonesian ministry has not paid up.

“Even if a contract is signed, it only takes effect after the down payment is received,” said a former official who worked at DMSE’s special shipping division, which deals with military submarines. “In principle, you should purchase materials for building submarines after the payment is received. It is unusual to make such advanced orders of materials.”

Many have also pointed out that the use of these materials is limited to only military submarines, so DSME’s order was hasty.

“For ships that are ordered frequently, such as tankers and liquefied natural gas [LNG] carriers, parts that are constantly being used can be ordered in advance, but for a special case like military submarines, it’s unusual,” said another insider who wished to remain anonymous. “It’s hard to understand why they ordered such a large amount of materials worth nearly 90 billion won.”

DSME reasoned that because the first submarine contract with Indonesia was successful, the second is also highly likely to go into effect. The company explained that they ordered the materials for the submarines because if they waited until the contract goes into effect to order the materials, there could be a delay in the final delivery. DSME maintains the position that the contract with Indonesia is still valid.

However, according to the KDB report, DSME provisioned 70.8 billion won, excluding the 7.8 billion won already paid to Siemens, for contingent losses in March.

“Contingent losses refer to losses that are likely to occur depending on whether or not an uncertain future event takes place,” said Kim Kyung-yul, CEO of Economic Democracy 21 and a certified accountant. “The fact that DSME has set aside the costs for the propulsion motors as a contingent loss means that they are aware that the possibility of loss is very high.”

In an email interview with the JoongAng Ilbo, Indonesian defense industry expert and CNBC columnist Alman Helvas Ali said that Indonesia has no plans to continue through with the contract with DSME.

“Engineers at the Indonesian state-owned shipyard reported poor performance from the first and second 1,400-ton submarines that they received in the first contract with DSME,” Ali said. “The Ministry of Defense never officially announced the termination of the contract, but as I understand, the ministry does not trust DSME anymore.”

DSME admitted on Thursday that the company had made orders for materials though the contract with Indonesia had not yet taken effect, but said the pre-orders of materials were necessary to keep the final delivery deadline and that the Indonesian government had made no mention of a contract termination. DSME also stressed that this was not the first contract it has made with Indonesia, and that it is currently working to bring the contract into effect.

BY SUK GYEONG-MIN, LEE YOUNG-KEUN [lim.jeongwon@joongang.co.kr]