Denel is worth saving but needs reinforcements
• Injection of state capital will have to be done soon
If any of the failing stateowned enterprises is worth saving, it is arms manufacturer Denel. But if the state is to inject more capital into the failing business, it will have to do so soon, before the vicious cycle of its decline accelerates. The group has a wealth of technical know-how and design capability and, according to interim group CEO William Hlakoane, has the potential to become sustainable in five years if it can get state funding to settle its outstanding debt of about R3bn, and for working capital and money to pay retrenchment packages.
If any of the failing stateowned enterprises is worthy of a bailout and worth saving, it is arms manufacturer Denel. But if the state is to inject more capital into the failing business, it will have to do so soon, before the vicious cycle of its decline accelerates.
Denel is at the heart of a military-industrial complex supporting a host of interconnected defence businesses which employ about 11,000 people, including 2,400 at Denel itself.
The group has a wealth of technical know-how and design capability and, according to interim group CEO William Hlakoane, has the potential to become sustainable in five years. This is if it can get state funding to settle its outstanding debt of about R3bn, and for working capital and money to pay retrenchment packages.
It will also need to restructure, downsize and change its strategic focus to concentrate on the commercial market rather than on defence.
The group manufactures artillery, armoured vehicles, missiles, unmanned aerial vehicle systems, helicopters, fighter aircraft, precision guided weapons and combat turrets, and does aircraft maintenance — all through its main subsidiaries, Denel Aeronautics, Denel Dynamics, Denel Land Systems and Denel Vehicle Systems. It has a promising order book over the next three years of R11.7bn (in former years it was about R40bn) on which to build.
“We have work to execute and are chasing orders all over the world,” says Hlakoane, who is adamant that Denel’s financial malaise has not damaged its international reputation to the extent that customers have lost confidence in the group.
However, Denel faces severe liquidity challenges, which have led to about 250 of its highly specialised design engineers leaving because salaries were not being paid in full and there was not enough work. This has affected the execution of R2bnR3bn in orders.
Saab Grintek has applied to liquidate Denel for outstanding debt of R126m, but Hlakoane says talks are under way to settle this out of court.
Today the group is a shadow of what it was in about 2015/ 2016, when it made a net profit of R385m on revenue of R8.2bn and employed about 7,000 people. Its guided missiles and armoured vehicles were world renowned and it exported to countries in Asia, the rest of Africa, South America, the Middle East and North America.
It made losses between 2006 and 2010 and then returned to profitability between 2011 and 2016 under former CEO Riaz Saloojee. The decline began in 2016/2017 and losses were suffered in the next three years.
Denel embarked on a number of turnaround strategies, which led to the winding up of loss-making subsidiaries. Nevertheless, in the 2019/2020 financial year it made a net loss of R2bn on revenue of R2.7bn with a staff of about 3,330 and debt of R3.6bn. In August 2019 Denel received a R1.8bn bailout from the state.
Hlakoane attributes the group’s problems largely to delays in the R14bn Hoefyster project to produce sophisticated infantry combat vehicles for the SA National Defence Force (SANDF). Started in 2007/2008 and with about R7bn already spent, it is bogged down in interpretational differences over the technical contract specifications laid down by the department of defence’s procurement arm, Armscor. Another factor was the loss early last year of a multibillionrand contract for missiles.
The departure of design engineers has seriously affected Denel’s manufacturing capabilities, while the absence of acquisitions from Armscor over many years has also played a major role.
According to defence analyst Helmoed Romer Heitman, there are a few major reasons for the group’s decline, with state capture by the Gupta family one of them. The Guptas are friends of former president Jacob Zuma and business partners of his son Duduzane.
They used the relationship to score billions of rand in contracts and tenders with the government and state-owned enterprises. This included an attempt to create a joint partnership between Denel and Gupta-controlled, Hong Kongbased marketing company VR Laser, which had secured several Denel contracts before.
Key to Denel’s decline, Heitman says, was the sharp drop in acquisitions by the SANDF as the economy stagnated and ever smaller budgetary allocations were made to the department of defence as the fiscus came under pressure.
The department represents about 60% of Denel’s revenue.
Heitman adds that the government had failed to support Denel with its international marketing efforts. Another reason for its decline, he adds, was its reluctance to take on foreign partners that could have injected cash, management skills and technological know-how — as was the case with the 51% stake by German arms manufacturer Rheinmetall in a Denel subsidiary to create Rheinmetall Denel Munition.
Weak management also played a role, with Denel having had only one permanent CEO for one year between 2015/ 2016 and the present.
A more recent issue was the demand by the National Conventional Arms Control Committee that on-site inspections take place of enduser certificates which ensure that goods purchased will not be transferred to other countries.
Heitman says this has had a negative effect, especially on Denel’s important Middle Eastern customers, but Hlakoane says this problem has now been resolved.
Heitman is convinced that Denel is worth saving because it produces defence products suitable for local conditions. Also, a local arms manufacturer will generate export earnings and obviate the need for SA to import its defence requirements.
Despite its challenges, Hlakoane believes Denel can be salvaged and become sustainable within five years if it restructures and receives significant state support. It will also require the sale of noncore, or unprofitable, assets, which he conservatively estimates will realise R1.5bn over the next five years, as well as the retrenchment of about 600 redundant staff, mainly in support services.
The five-year turnaround plan involves reducing Denel’s current operating divisions (plus one subsidiary) from six to two.
One division will focus on engineering and design, while the other will focus on manufacturing and maintenance. In terms of the plan, Denel’s engineering division will merge all the company’s capabilities in artillery, infantry and vehicle systems, its missile and precision-guided munitions business as well as its management of complex integrated systems.
The maintenance and manufacturing division will focus on aeronautics, unmanned aerial vehicle systems and the production of small- and medium-calibre ammunition as well as the production of combat vehicles.
The executive cost structure will be cut and a shared services model in areas such as supply chain management, human capital, IT and finance will be introduced. With no acquisitions from the government expected, Hlakoane says Denel’s strategic focus will shift towards using its design and manufacturing capabilities to produce for the commercial market rather than for defence.
In terms of financing, it will look at special-purpose vehicles and project financing but will consider a strategic equity partner only once the group is on a sound financial footing.
If this plan is to succeed and SA is to retain an invaluable resource, the government has to provide financial support. It is only likely to come, if at all, in the medium-term budget policy statement later this year.
LIQUIDITY CHALLENGES LED TO 250 OF ITS HIGHLY SPECIALISED DESIGN ENGINEERS LEAVING OVER SALARIES NOT BEING PAID IN FULL