[Yang Nak-gyu's Defence Club] HD Hyundai Heavy Industries Faces Risk of Exit from Defense Market

Military Secret Violation Employee Original Verdict Overturned, Guilty Confirmed

HD Hyundai Heavy Industries is facing an existential crisis in the defense industry. With an HD Hyundai Heavy Industries employee convicted of violating the Military Secrets Protection Act, the industry views this as tantamount to a death sentence in the defense market.

According to industry sources on the 2nd, on the 30th of last month, the Ulsan Criminal Division 1 of the Busan High Court (Presiding Judge Son Cheol-woo) overturned the original ruling that acquitted some charges against HD Hyundai Heavy Industries employee A, who was accused of violating the Military Secrets Protection Act, and sentenced him to 1 year and 6 months in prison with a 3-year probation.

[Image source=Yonhap News]

A was accused of receiving and sharing on the company server a revised basic strategy for the ‘Jangbogo-III’ project, a level 3 military secret, from a researcher at a university defense-related research center in 2014. The first trial court found A guilty of collecting internal materials but acquitted him of sharing them, sentencing him to 6 months in prison with a 3-year probation. However, the appellate court recognized the charge of sharing on the company server and found him guilty, maintaining the original sentence.

Local lawmakers also criticized HD Hyundai Heavy Industries. On the 1st, all members of the People Power Party’s Geoje City Council issued a statement condemning the unfair criminal acts of HD Hyundai Heavy Industries employees. They said, "We welcome the fact that the truth has been revealed even after 10 years since the initial crime occurred."

▲HD Hyundai Heavy Industries faces exclusion risk in contract bids= The decision on whether to restart the Special Warfare Support Ship and Special Infiltration Boat projects, which have seen no progress for 15 years, is expected within this year, but HD Hyundai Heavy Industries’ chances of winning the contracts are uncertain.

The Special Warfare Support Ship and Special Infiltration Boat projects are linked. The mothership, the Special Warfare Support Ship, carries several Special Infiltration Boats, which act as smaller vessels, transporting Navy Special Warfare Command soldiers over long distances and landing them ashore. Equipped with stealth capabilities to avoid radar detection, these vessels could conduct covert retaliatory operations in case of localized provocations by North Korea. The Joint Chiefs of Staff decided to introduce the project in October 2008, and momentum increased after North Korea’s Cheonan sinking in March 2010 and Yeonpyeong Island shelling in November 2010, but disputes over domestic development versus direct overseas procurement among companies caused the project to lose steam.

Security penalty inevitable in Special Warfare Support Ship project

The new Special Warfare Support Ship is expected to consist of 4 ships, and 20 Special Infiltration Boats. The total project cost is 1.25 trillion KRW. The Defense Acquisition Program Administration (DAPA) is known to have leaned toward domestic development in its project analysis. If a final decision for domestic development is made within this year, the project announcement is expected by early 2025.

The problem is that HD Hyundai Heavy Industries has been receiving security penalty points in bids for three years since November last year due to military secret leaks related to the next-generation Korean Destroyer (KDDX) project’s conceptual design. This is also why HD Hyundai Heavy Industries was excluded as the preferred negotiator for the Ulsan-class Batch III 5th and 6th ship construction project. Notably, among the 11 cases of secret leaks were military secrets related to the Special Infiltration Boat and Special Warfare Support Ship, making it practically difficult for the company to win contracts, according to industry analysis.

[Image source=Yonhap News]

▲7 trillion KRW-scale KDDX contract battle also uncertain= This ruling is expected to significantly impact the KDDX contract competition between HD Hyundai Heavy Industries and Hanwha Ocean. The KDDX is the Republic of Korea Navy’s next-generation main warship equipped with stealth technology. DAPA plans to order six 6,000-ton KDDX ships by 2030, with a total project cost of approximately 7.8 trillion KRW.

Typically, shipbuilding proceeds in the order of conceptual design → basic design → detailed design and lead ship construction → follow-up ship construction. Hanwha Ocean previously performed the conceptual design, while HD Hyundai Heavy Industries handled the basic design. Remaining tasks include detailed design, lead ship, and follow-up ship construction.

Management crisis if 7 trillion KRW KDDX contract is lost

HD Hyundai Heavy Industries will also receive security penalty points in this contract. In defense sector bidding, where outcomes are decided by fractions of points, this is critical. For example, the 2016 Ulsan-class Batch III basic design project was awarded with a margin of 0.9567 points, and the 2020 KDDX basic design project was decided by only 0.0565 points.

Additional sanctions are also expected. At a recent National Assembly audit of DAPA, Director Um Dong-hwan stated, "It was difficult to conduct a detailed review due to the unavailability of the court ruling on HD Hyundai Heavy Industries, but we recently obtained the ruling," adding, "We plan to consider imposing debarment sanctions through contract review."

▲Overseas submarine project also at risk= The Canadian Navy plans to order 12 submarines with a budget of about 60 trillion KRW. This amount includes maintenance, with estimated construction costs of about 2 trillion KRW per submarine. The Canadian submarine project is expected to select a contractor as early as 2026.

Overseas submarine project bidding argued to be at government level, not company level

HD Hyundai Heavy Industries holds the position that it should join forces with Hanwha Ocean rather than bid alone. Since the large-scale submarine project, expected to involve 12 submarines, is difficult for a single company to handle, the Korean government should secure the submarine construction project through government-to-government (G2G) negotiations with Canada and then share the volume with Hanwha Ocean. Woo Won-sik, Managing Director of HD Hyundai’s Special Ship Business Division, recently stated at a corporate briefing, "The Canadian submarine project can be seen as a national competition," adding, "It will likely be a competition between countries in a ‘Team Korea’ format."

Hanwha Ocean, however, is drawing a line. A Hanwha Ocean official said, "Although Japan sometimes conducts defense exports via G2G deals, competition is fundamental in our defense market," adding, "If the project volume is large, it can be divided into first and second phases for production." The official also noted, "When conducting defense exports, conditions such as technology transfer complicate matters if a consortium is formed."

The rivalry between the two shipbuilders is expected to continue in the Polish submarine contract project. Poland plans to order three submarines, with construction costs estimated at about 4 trillion KRW. While the Polish submarine project is expected to favor Korean companies, HD Hyundai Heavy Industries’ chances of winning appear low.