Denel has ‘stabilised’, but is its future secure?

The Engineering News article “Denel seeking to rebuild itself after severe collapse” provides interesting reading. There have been no audited Denel financial statements released for the last three years. The business has been insolvent. Losses amount to over R9 billion in the four years from 2019-2022. 2022-23 revenue (not to be confused with turnover when you read the Denel Financial Reports) is R1.466 billion from a staff complement of just 1 670 people.

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Denel states that it is in the process of stabilising the organisation. The company is seeking to re-establish the correct skills mix for its needs. There has been a large scale staff exodus. An analysis of Denel financial reports shows that its workforce is less than 12% of the group size in the post 1995 era.

Revenue performance has flatlined in Rand terms. If the US Dollar was the method of reporting, the figures would be dismal.

The challenge for the business is highlighted in the turnover generated per employee. Denel is languishing at sub R1 million returns from each employee. Denel can be seen as a manufacturing entity or even a technology house. The turnover per employee for these types of business should be a minimum of R1.5 million per employee. Current Reutech Allied Electronics results indicate that this is achievable for a company with majority exposure to the defence sector.

Denel’s financial reports since 2004 have a common theme: either Restructure or New Strategy. It can be seen that the 2014-2016 period saw a focused implementation that reaped rewards. Unfortunately this was very short lived as state capture intervened and reversed these gains.

There has been a realisation that export is a potential source of revenue. With the exception of short periods, Denel’s export percentage remains low. This shows that Denel is tightly aligned with local defence spend. This is also telling in its revenue performance.

The South African defence industry (SADI) has focussed on exploiting the export market. Export value analysis indicates that the private defence industry has absorbed Denel’s contractions and is now the leading element in the SADI. This highlights that there is a private industry capable of covering local needs. This is in contradiction to the Denel Group CEO statement that “Loss of Denel’s capabilities will mean that the SANDF will have to rely on imported systems in future and this will mean that it will have no security of supply”.

So, the current rehashing of new strategies needs to be evaluated. The people generating these strategies have no “skin in the game”. This is a general problem for all state-owned entities (SOEs). So what if the Board and Executive run the business into the ground?

Denel has most recently been allocated R3.4 billion by the National Treasury for restructuring. R1.8 billion has already been distributed for reviving Denel. This means that there is another R1.6 billion that needs to flow (this is contingent on Denel meeting certain targets). This to an entity that has almost no people and that has stated it needs to partner with local and international entities to enable deliveries.

Alternative Solution

Privatisation, or semi release of control, is not acceptable for the state. The perception is that if a business entity shareholding is sold then there will be job losses and the local market would be negatively impacted and South Africa’s sovereignty would be compromised. The SA defence industry has actually proven this perception to be incorrect. One good thing did come out of the 2006-07 restructuring plan: foreign partners were sourced for Denel Munitions, Denel Optronics and Turbomeca Africa. Today, Rheinmetall Denel Munitions and Hensoldt Optronics are high performers in the SADI stable. It can be seen that in the period 2009 to 2015 Denel shed a further 14% of jobs, while the three associated companies added 20% to their workforce. This is the result of having “skin in the game”.

The new Denel strategy proposes streamlining into four business units. Denel is restructuring in a capability destroying manner. This goes against the approved Aerospace & Defence Master Plan statement that “A game changing vision encompassing a vision of an Entrepreneurial State and focussed collaborative action to move forward into growth, is supported.”

This is while a basic analysis indicates that there is potential for 18 business units that can be created around current Denel intellectual property. The challenge is that this is too much for Denel to manage internally. There is an option to disperse these entities into the private SADI sector. As we know Denel cannot exercise orders without industry support, or, in the words of the Denel Chief Restructuring Officer, partnership. This could be made formal in an entrepreneurial manner.

Previous Denel experience shows that co-investment by a foreign entity (30%) can bear fruit for exploiting export markets. This would need to be offset with a majority local custodian (40%). The key is allocating the remaining R1.6 billion from government to the capabilities for support to establish a basis without losing any remaining Denel employees. The R1.6 billion could cover the current liability for a remaining share in the business (30%). This is a basis for a profit generating entity.

The role of the Denel Board would then be to act as the investment manager on behalf of the proposed new super State Owned Investment House that is going to control the shareholding of the SOEs including Denel. The aim is to flow funding (read profit) back to the state for their seed investment. The secondary aim is for the entities to be self-sustainable (no future funding from the state). This while the government still has influence over sovereign and strategic elements still within the Denel stable.

The state can set rules for identifying local and foreign partners, but time is of the essence. The ongoing SAA saga needs to be avoided. The value associated with Denel’s intellectual property is diminishing quickly as both local and foreign entities recreate the current Denel knowledge set in other companies.

Some guidelines for the proposed alternative to rejuvenating Denel:

1. Only majority local owned entities can take up the larger stake.
2. A local entity can only be involved in one of the Denel business entities.
3. A foreign entity can only be involved in one of the business entities (previous Denel investors in the Associate companies cannot take on a new business entity).
4. No more than two business entities can accept investment from a single country. The aim is to expand the market.
5. Each business entity needs to commit to establish or partner with at least one apprenticeship college.
6. Each business Entity needs to align with at least one institute of higher learning to promote knowledge expansion and future research and development (R&D).
7. The business entity needs to commit at least 2.5% of turnover to R&D.
8. The local custodian and foreign entity to commit to local production for a minimum of 60% of the business unit turnover in South Africa.
9. Target for the entity must be to sustain a minimum of 75% foreign sales.

Below is a template for distributing the final R1.6 billion funding to grow Denel’s capability. Government should invest in capability, not own it.

Written by James Kerr, Orion Consulting CC, which provides Market Entry Strategy and Bid & Proposal services to the Aerospace & Defence related industry and assists international SME mission system product suppliers to gain traction in South Africa.