Restructured Denel securing international partners
to ensure sustainability

Keith Campbell

State-owned defence industrial group Denel is today a very different entity to what it was two years ago when Shaun Liebenberg (portuguese version)was appointed CEO with the mission of refloating the then effectively insolvent operation.

The group had a net loss of R1,67-billion in financial year (FY) 2005, which declined only slightly to R1,36-billion in FY 2006. Under Liebenberg, the group’s management structures have been reformed, transformed, and strengthened, and it is now halfway through a four-year restructuring programme designed to return the group to financial and commercial viability.

FY 2007 saw the net loss improve to R0,55-billion, representing a 60% improvement on the previous year. Turnover, at R3,27-billion, was up nearly 18% in comparison with the FY 2006 figure of R2,77-billion, while gross profit rocketed 675% from minus R131-million in FY 2006 to plus R754-million in FY 2007.

In real terms, costs have been reduced by 10% year-on-year. And new business has been won. Sales order cover has risen from a base of 45% last year to 75% as of April 2007. The group’s sales pipeline now stands at R3,3-billion for the current year, with total group forward contracts about R13-billion.

“We are making sure that we have a focused management team with very clear responsibilities and roles – previously there was a lot of fuzziness [as regards these],” he reports. “We’ve gone from a group executive of 14 people to one of 9 and there have been a number of personnel changes: new people brought in, old people moved to new posts. Of the current executive, five are new people and I’m the only white male left.”

A key part of the restructuring process has been the reorganisation of the group into (currently) ten subsidiary businesses, namely Denel Aviation, Denel Saab Aerostructures, Carl Zeiss Optronics, Turbomeca Africa, Denel Land Systems, Denel Munitions, Denel Dynamics, Denel UAVs (that is, unmanned air vehicles), Mechem, and what is simply called “the Rooivalk business”. Of these, Denel now holds only a minority shareholding in Carl Zeiss Optronics (the former Denel Optronics) and in Turbomeca Africa. Saab has a minority stake in Denel Saab Aerostructures, but Saab does have the option of becoming the majority shareholder.

Authority and responsibility have been delegated to these companies. “This is very important – previously, these were business units, run by managers assisted by technical teams; now they are companies, each with its own CEO and CFO, meaning that there now is much more commercial expertise at this management level,” he explains. “Most of the CEOs and CFOs are new, with no links to the past – we need to move from being a State agency to being a commercial company with a commercial mindset, and this requires new people.”

Each of the new subsidiary companies has its own board of directors, its own audit committee, and its own transformation committee. “Where we went wrong in the past was the way we tried to manage all these businesses with a single mindset from head office; we are now trying to give each company the opportunity to develop its own methodologies,” he says.

Further, this restructuring allows each of these companies to be ringfenced, with its own balance sheet. In the past, the income from the units that were performing well was taken away from them and put into the units that were performing badly. The result was the underperforming units continued to do badly, while the successful units were starved of investment, with the result that their situations deteriorated. “Now the good businesses get to prosper and the bad businesses can be fixed and we can exit them,” sums up Liebenberg.

The new structure for the group also makes it easier to find international partners for Denel. Previously, the government had tried to sell the whole group to, first, BAE Systems, and then to EADS. Neither effort succeeded as neither of these international groups wanted the whole of Denel. “Now, with the new structure, inter- national partners can invest in the parts of Denel they are interested in,” he points out.

Fears that bringing in international partners involves the selling of South African-developed intellectual property (IP) to foreigners and will see local design teams closed down and this home-developed expertise transferred abroad are not grounded in reality, he assures. Rather, it is failure to restructure and bring in foreign partners that will cause the loss of this IP.

“South Africa can no longer fund this industry as it did in the past, with the State providing 100% funding, so either we get international partners or we lose the industry,” he asserts.

“The reason that international partners are investing in this country is specifically for South African expertise at South African costs. “Engineering research and development (R&D) in Germany costs three times what it does in South Africa,” he highlights. “We have world-class engineers at developing-world costs. If we do not find these international partners who will fund our R&D, we’ll lose our companies and our people. “Without Carl Zeiss, we would have had to totally close Optronics,” cites Liebenberg. “We have [have managed to get] a world-class company to invest in South Africa and in South African expertise, and so are keeping this expertise alive.” Only 10% of Optronics’ income comes from the South African market, and neither the government nor Denel has the money to invest in the R&D Optronics needs to develop new products and so stay competitive, and thus alive, in a fast-develop-ing and rapidly changing world market.

“We keep control of South African IP through IP contracts, which are very tightly controlled,” he assures. “The government also retains a ‘golden share’ in each company, to protect the companies, the people and the IP. The idea that we are selling South African expertise and IP is a complete misconception – the foreign companies cannot walk away with it.”

But selling a majority stake in various Denel subsidiaries to foreigners does not absolve the South African State of all responsibility for those companies, as it will, through Denel, retain anything from 30% (as in the case of Carl Zeiss Optronics) to 49% (Turbomeca Africa) of the enterprises concerned. “If the government doesn’t invest anything in these companies, then, in the long term, the country won’t get full value out of them,” he warns. “South Africa, the Department of Defence (DoD) [and] the South African National Defence Force (SANDF) must continue to support these companies.” Bringing in foreign partners may reduce the State’s responsibilities concerning the industry, but it does not eliminate them.

The restructuring process is by no means completed. The group’s board of directors recently approved another international partnership, although the identities of the Denel subsidiary and the foreign group involved, or the size of the stake to be taken in the former by the latter, cannot yet be revealed.

Nor is the focus exclusively on finding international partners. One or two of the remaining Denel subsidiaries may have local partners, although they will also have international ones.

Then there is Denel UAVs. This company, like Denel Dynamics, has been formed by splitting the former Denel Aerospace Systems, which, in turn, was previously known as Kentron. Denel UAVs, assuming regulatory approval, is to be merged with another South African UAV manufacturer. Again, the identity of this partner has not yet been made known. However, this country only has one other significant UAV maker, and that is private-sector group Advanced Technologies & Engineering (better known as ATE). This business will thus, all being well, remain 100% South African although no longer 100% Denel.

UAVs are an area which clearly reveals the dilemmas and challenges Denel has been fac- ing. In 2004, Denel could fairly consider itself one of the world leaders in UAV design and expertise, with the proven and successful Seeker II on the market, and the impressive Bateleur medium-altitude long-endurance UAV concept available for development. (Denel did not have the funds to develop it on its own.) But the pressures of war in Iraq and Afghanistan, and the continuing Arab-Israeli violence have seen significant increases in investment in UAV programmes by the US, Israel and, perhaps most dramatically, by the UK, as well as the launch of important programmes by Germany and France, while Japan, South Korea, Pakistan and Singapore have all started, or are considering starting, UAV projects.

And this represents only one part of a global defence sector which is becoming increasingly competitive and in which Denel must succeed, if it is to survive. “That is why we need inter- national partners, both to access markets we can’t access on our own, and to access their strong balance sheets, to fund R&D we can’t afford to finance on our own and which the SANDF is not funding,” reiterates Liebenberg.

As a result, the group will probably retain 100% control of only two of its businesses – Mechem, which specialises in demining technologies and services, and Denel Aviation, which specialises in aircraft assembly, overhaul, refurbishment, and repair. “We can be competitive on our own in these businesses,” he affirms. “We don’t need international equity partners for these.”

The Rooivalk business is to be folded into Denel Aviation. The Rooivalk is owned by the DoD and the SANDF. “They must decide the future of the Rooivalk,” he states. Denel is merely a supplier to them. “We have given them three or four alternatives, and we await a response from them.” In the meantime, Denel has a three-year contract to roll out and support the Rooivalk in its current form.

With the completion of the corporate restructuring, the group will probably have nine subsidiaries, two of which will be 100% owned, others majority owned, and with minority stakes in the rest. “What is important is that we get each individual business profitable – we have a couple that still have serious problems which will need three years to rectify,” he reveals, without naming them. “One is marginal – it has very high levels of technology and can compete technologically with the best in the world, but it doesn’t have access to a market, so we must decide, with the government, what we are going to do with this business.” It is basically a ‘research environment’ yet it is part of Denel, which cannot support it without assistance. Liebenberg hopes it can be transferred to government, most likely the Department of Science and Technology, as an R&D agency or facility. Talks with the various stakeholders are under way. “It’s a world-class facility. Some of these technologies – if we lose them, we’ll never get them back; we need to find ways of utilizing them better.”

After several years in which Denel won very little in the way of new business, the last year saw a string of welcome new contracts. ‘Legacy contracts’, characterised by poor margins, are being superseded by new deals. “The sales wheel is beginning to turn,” he enthuses. Nearly every one of the group’s subsidiaries has secured new business or gained new, follow-on, contracts from established customers.

Major programmes that have now begun include the South African Army’s R8,3-billion Project Hoefyster (Horseshoe) for 264 armoured fighting vehicles. This programme, the biggest in Denel’s history, is divided into a four-year, R1-billion, development phase, followed by a production contract, which will run to 2018. Another is the R1-billion A-Darter air-to-air missile project, being developed in a technology and funding partnership with Brazil – development should take about five years; there is no production schedule yet. It should be noted that income from these big programmes is not spread evenly over their lives; rather, it starts out at low levels and then ramps up over time.

But Denel is not out of the mire yet. The group last year asked government for R5-billion for essential funding. It was given R3,5-billion. “We have been told we won’t get any more, but we need more – however, we have been raising it elsewhere,” says Liebenberg. The group’s improved financial and equity situation has allowed it to raise money on the markets, and the new equity partners are pumping funds into their respective subsidiary businesses.

“We can make the Denel group sustainable if our restructuring plan, as supported by government, is implemented 100%,” he assures. “But, if it is not, we can give no guarantees.”