Aided by Israel, Russia is building a $9 billion drone air force. Or rather, Russia was building a $9 billion air force.
Thanks to President Putin's Ukrainian adventure, plans to modernize Russia's air force with a 21st Century drone fleet have run into some turbulence. Specifically, Russia seems to have lost access to cutting-edge drone technology from Israel.
A bit of history
Six years ago, Russian ground forces, who were invading the sovereign state of Georgia on their southern border, found themselves flummoxed by Georgia's collection of unmanned aerial vehicles -- commonly referred to as "drones." Purchased from Israel, Georgia's drones were able to silently monitor Russian troop movements from the air, and report them back to headquarters. Conversely, Russia's lack of drones at the front left its own forces blind to the disposition of Georgian forces on the ground.
While Russia's vastly superior army made short work of less numerous Georgian forces regardless, the 2008 Georgian war still highlighted Russia's "drone gap." It also inspired Russia to embark on an ambitious program to first buy foreign-made drones, then develop its own domestic drone industry. Within a year of the war's end, Russia had inked a $53 million deal to purchase two Bird Eye-400, eight I-View Mk150, and two Searcher Mk.2 drones from Israel Aerospace Industries.
A year later, Russia upped its purchase order by an additional $400 million worth of drones.
It's now, four years later. Russia announced plans earlier this year to invest $1.5 billion annually during the next six years -- $9 billion in all -- to buy, build, and develop the technology to build even more drones for its air force. At least some of this money was earmarked for purchases of additional Israeli drones. But last month, Israel's defense ministry confirmed that it has instructed Israeli defense contractors to terminate negotiations for the sale of additional drones, and to sign no new contracts with Russia for such sales. Contracts currently in force, however, will continue to be honored.
What this means to Russia
Why is this important to Russia? Simply put, access to Israeli technology is key to Russia's drone development efforts. In the war with Georgia, military experts generally agree that the few Russian drones that made it to the front were of "poor quality."
Buying drones from Israel gave Russia, first and foremost, a way to quickly upgrade the quality of its drone fleet with advanced technology from the world's leading exporter of drones. What's more, agreements to co-produce certain Israeli drone models may have helped to accelerate Russia's efforts to build its own drones.
Russia is downplaying the effect of Israel's decision, of course. Quoted on ITAR-TASS after the decision was announced, Russian Deputy Defense Minister Yuri Borisov pooh-poohed its effect: "We [already] bought everything a long time ago and we have no current contracts" to buy drones from Israel.
What it means to investors
But now, it seems Russia won't get any more "current contracts" with Israel either -- whether Russia wants them or not. So what does this mean to investors in the defense industry?
First and foremost, it means that the threat to the U.S. from Russia's $9 billion drone push has diminished. Perversely, that's probably a negative for investors in publicly traded companies such as industry leader Northrop Grumman (NYSE:NOC), which builds Global Hawks, Fire Scouts, and X-47B combat drones for the Pentagon. The lower Russia's capability to produce drones sinks, the less urgent the need for the U.S. to spend and invest to maintain superior drone technology.
On the other hand, by eschewing drone sales to Russia, Israel has cut itself off from a key market for its defense products. Actually, that's two markets. Just this week, Israel confirmed that, in order to avoid upsetting Russia, it's canceling a drone sale to Ukraine, as well, which had been in the works.
This hurts Israeli drone manufacturers -- and seeing how Israel is currently the world leader in drone exports, it helps U.S. drone manufacturers. By denying Israel access to a market that Northrop Grumman and its peers were already unable to sell to, Israel's decision not to sell drones to Russia and Ukraine helps to level the playing field, competition-for-sales wise, between U.S. drone makers and their Israeli counterparts.
For Northrop Grumman, which makes billions of dollars of drone sales annually, that alone is a win.
Rich Smith has no position in any stocks mentioned. The Motley Fool owns shares of Northrop Grumman. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.