Department of Public Enterprises on Future of Denel Saab Aerostructures

Meeting report

Opening Remarks
The Chairperson congratulated all the parties for their success in the local elections. He hoped that all parties would be able to deliver on their promises. He thought that the country should be commended for the peaceful way in which people conducted themselves during the elections. It was lovely to see the various party leaders standing together at the Independent Electoral Committee (IEC) building. The country was very fortunate to be able to do this, as there were other countries on the African continent that could not do so. It showed that democracy in South Africa was working.

Mr Disang Mocumi, Committee Secretary, said that he had received an apology from Ms C September (ANC) who could not attend the meeting.

Briefing on the Future of Denel Saab Aerostructures (Pty) Ltd
Mr Tshediso Matona, Director-General, Department of Public Enterprises (DPE), provided a brief background on Denel Saab Aerostructures (DSA), as well as its vision and mission. DSA specialised in advanced engineering and the manufacturing of aerostructures. DSA was concurrently designing and producing the A400M Wing Fuselage Fairing (WFF).

In terms of revenue and profit/loss performance, DSA remained a loss-making entity and a key strategic challenge for Denel. In 2008/09, DSA made a net loss of almost R450 million, in 2009/10 it made a net loss of approximately R375 million, and in the 2010/11 financial year it made a net loss of just over R200 million. It was important to note that the 2010/11 financials were still subject to audit. SAAB exited the business in April 2011. It owned 20% of DSA since 2007.

During the year under review, DSA exceeded sales, cash and Earnings Before Interest and Tax (EBIT) performance targets through restructuring the business. The restructuring included:
•significantly reducing labour costs
•significantly improving its financial management and governance
•reducing rental costs through space optimisation
•implementing shared services with Denel Aviation and outsourcing non-core activities
•transferring the steel-heat treatment facility

The operational turnaround of the business continued with a marked improvement in delivery and quality. Airbus, in particular, expressed satisfaction with DSA’s performance against key milestones on the A400M programme. Margins on all contracts however remained under pressure and were currently unacceptable. The DPE thought that intervention might be needed concerning the margins. DSA achievements during 2010/11 included improved governance, compliance with A400M contractual commitments, and implementation of the restructuring programme to reduce costs and the Sustainable Transformation Enhancement Programme (STEP). Stock accuracy improved from 65% in 2008 to better than 96% in 2011.

An employee analysis showed that there were just below 800 employees in December 2009. By May 2011, there were 397 employees, which included: 7 senior management employees, 37 management employees, 25 engineers, 85 technical staff members, 20 planners, 113 artisans, 35 operators, 55 admin staff, and 20 apprentices. This would be reduced to 258 employees over the next few years.

The DPE informed the Committee that it was considering a strategic scenario where there would be a domestic transfer of DSA to Aerosud. Aerosud submitted an unsolicited conditional proposal to acquire DSA in December 2010. Discussions between the two entities were still ongoing. Further announcements would be made once the discussions have been finalised. Another strategic scenario that was being considered was the revision of DSA’s business plan. This was already in process. The latest DSA business plan included building a robust revenue pipeline, having contract negotiations with key customers, cash flow management, improving balance sheet solvency, a further reduction in the rental footprint, and further outsourcing of non-core activities to reduce fix costs to variable costs. The revised business plan also estimated that approximately 3000 jobs would be created directly and indirectly by DSA. DSA generated approximately R760 million in consumer revenue and R180 million in taxes. It predicted approximately R400 million in future export revenue per annum. In terms of advanced manufacturing, DSA’s operations in high technology strongly support the transition to a knowledge-based economy and the national objectives stipulated in government policies. DSA wanted to be a modern, qualified, world-class state of the art manufacturing facility.

The Industrial Policy Action Plan (IPAP2) 2011/12-2013/14 released by the Department of Trade and Industry (DTI) in April 2011 had identified advanced materials and aerospace under cluster 3- sectors with potential for long-term advanced capabilities. The aerospace and defence sector profile was a critical and pervasive generator of new technologies, and was crucial to future innovation in South Africa. With DSA operating in high technology and the advanced manufacturing sector such as aerospace, it fell within the ambit of the IPAP2 long-term advanced and manufacturing capabilities.

Discussion
The Chairperson noted that there was talk about DSA looking for equity partners to improve its financial position. He asked if this was still the case. He further noted that Denel was once penalised for failing to meet its deadlines regarding the A400M. As a result, he wanted to know if there were any outstanding payments on fines. What led to Denel’s failure to meet its deadlines? What did Denel’s future as a strategic asset look like?

Mr Matona replied that the fundamental question was under which circumstances would Denel, as a group, flourish? To answer this question one would have to revert to the model that was used to determine Denel’s use to the South African National Defence Force (SANDF). Defence budgets around the world were under pressure and as a consequence, many strategic partnerships were developing around the world. Denel had not fully integrated itself into this, as the government had not yet clarified the policy foundation for an appropriate model for Denel to follow. The DPE and the Department of Defence and Military Veterans (DDMV) had to work together to address this matter. This would also help the government to decide what in DSA they wanted to keep. It was tempting to say that DSA should be disposed of because it was not performing well. However, the entity operated in a very strategic area. The government had to work with the DDMV to determine which of the DSA’s capabilities it wanted to keep. DSA had unique technology that had been developed over time, so this decision could not be taken lightly. He was happy that the Minister of Defence and Military Veterans would be tabling a strategic document that would outline the future policy direction for the defence sector. This would inform some of the key strategic decisions concerning Denel and its subsidiaries. It was difficult to say more than this given the nature of the topic. But, the DPE had been asked by the Joint Committee on Defence to brief them on precisely this topic. Hopefully, a decision would be made once the government knew what the defence sector’s requirements were.

Mr Anthony Kamungoma, Acting Deputy Director-General: Investment and Portfolio Management, DPE, addressed the question concerning Denel’s equity partnerships. He explained that Denel, at a group level, had undertaken a turnaround strategy that was co-authored with the DPE in 2005. One of the pillars of the turnaround strategy was to bring equity partners into some of its businesses. This strategy was used to increase market access for Denel. The South African market was small. In order for Denel’s business to be sustainable, it had to increase its turnover by accessing new markets. Given the nature of the defence industry, which faced protectionist tendencies- this kind of collaborative effort was aimed at opening up access to other markets. Denel had experienced a significant turnaround since 2006/07.

Mr Weekend Bangane, Director, Denel, reported that Denel was never penalised on the A400M programme in terms of delays. However, there were cost escalations on the programme due to technical delays from the side of Airbus. This affected the revenue or turnover of the company and losses escalated in 2008.

Dr G Koornhof (ANC) cautioned the DPE to notify Members if they were asking commercially sensitive questions as the Committee did not want to discuss sensitive matters in front of the public. He noted that this was not the first meeting the Committee had to discuss the state of DSA. The DSA was the only section in the Denel group that was making such a big loss, and it was affecting the whole of Denel. The DSA had been in an ongoing crisis for quite some time. He asked why SAAB exited from this deal in April 2011. He further asked if DSA was regarded as a strategic asset or a sovereign asset. In other words, could the country do without it, or was it needed? There was no funding from the government as he understood, in the future, for State Owned Entities (SOEs). If the DSA did not receive a “rescue package” from the DPE, then the funding crisis would still exist. The DPE had to explain how Denel would overcome this crisis.

Mr Kamungoma explained that the equity partnership that was entered into with SAAB was the biggest challenge that Denel was faced with. DSA first entered into a contract to supply work packages to the A400M, but then wanted to bring some technological capability into the business by bringing in SAAB. According to the shareholder agreement that was signed at the time, SAAB had the option to exit the business at the end of March 2011. He acknowledged that Denel had developed certain capabilities, but the question was whether the country wanted to retain them.

Mr Kamungoma replied that DSA was seen as a strategic asset according to Denel’s current mandate. The DPE was trying to explore a structured a mechanism to ensure alignment between Denel and the strategic and sovereign requirements of the SANDF. People tended to look at Denel as one company when it was really made up of nine different entities. If the Committee looked at the industrial policy framework used by the country such as the Industrial Policy Action Plan 2 (IPAP2), it highlighted the quest for developing a knowledge-based economy within South Africa. If South Africa wanted to have a competitive advantage in the global market, it needed to develop advanced manufacturing capability.

He acknowledged that DSA needed quite a great funding commitment and that the introduction of Aerosud could be a good thing. It was correct that money had not been set aside for the SOE over the next financial period, and this was why the DPE had gone the route of extending the guarantees rather than injecting cash straight into the business. This was an interim support mechanism to ensure that they make it through their turnaround.

Mr P van Dalen (DA) stated that Denel seemed to have the same story as Pebble Bed Modular Reactor (Pty) Ltd where their international funder pulled out suddenly. This raised serious alarm bells. He wondered why the funder did not have any hope for the project and why the government should keep supporting it if no one else wanted to. He was more concerned about the retention of workers and intellectual property for the country. He asked the DPE to explain to the Committee why they should keep DSA.

Ms G Borman (ANC) noted that the DSA had suffered a huge financial loss in 2008/09, but there had been an improvement in the financials in the years since. She asked if the DPE thought it could turn DSA’s situation around. She asked the DPE to elaborate on its comments that the “margins on all contracts however remain under pressure and are currently unacceptable” and that this would require an intervention. The presentation showed that the number of employees in May 2011 amounted to 397 and that it would be reduced to 258. However, the DSA’s revised business plan spoke of creating approximately 3000 direct and indirect jobs. She asked if the 397 employees were technical staff and if the 3000 jobs would include non-technical staff. She noted that the DPE had said that Aerosud submitted a conditional proposal to acquire DSA; however, the DPE had not been part of this conversation. She asked them to elaborate on this.

Mr Kamungoma explained that the amount of 3000 jobs spoke to jobs created directly and indirectly by Denel, as the sector was also based on suppliers that were brought in. Denel created jobs indirectly by creating a supplier base within the country.

Mr A Mokoena (ANC) asked if the DPE was supposed to make this presentation to the Committee or if the leadership of Denel itself should have come before the Committee. Most of the problems that Denel was experiencing could be attributed to a lack of leadership. He would have preferred having Denel at the meeting. He understood that Denel had received a guarantee from the National Treasury for R1.8 billion to assist itin staying afloat, but he wanted to know what Denel was actually worth. What was its asset value?

Mr Kamungoma replied that Denel’s net asset value according to the 2010 financials was R644 million. He thought that Denel as a group had made significant progress since 2005. Denel had made a loss in excess of R1.6 billion per year, but this was reduced to R246 million in 2010. The major risk that Denel faced was DSA. If DSA was excluded from the Denel Group the 2010 financials would show a profit. DSA was the DPE’s primary area of focus concerning Denel.

Mr M Nhanha (COPE) observed that something did not feel right to him. He did not feel satisfied with the DPE’s answer regarding SAAB exit from the DSA partnership. The DPE did not tell the Committee why SAAB decided to leave. He was happy to hear that DSA was a strategic asset to the country; however, it was not performing optimally. As a business man, he knew that the best time to start negotiations to acquire shares in a company was to do it when the company was not doing well. How vulnerable was the DSA? Was it still possible to negotiate a deal that would be favourable to the nation? He noted that most of the people that had been retrenched were very skilled people, particularly in areas that the country needed such as artisans and engineers. In most cases, these skills were acquired while they were working for Denel. He wondered if it was possible to track these people down.

Mr Kamungoma informed Members that a South African company called Aerosud was interested in acquiring DSA. The benefit of the proposal was that the skills acquired from Denel would then remain in the country. About the exit of SAAB from DSA, an agreement between Denel and SAAB was signed in 2006. The agreement had a provision that enabled SAAB to exit the partnership after a certain time. The DPE recognised that there were challenges in this particular industry and this was probably why SAAB chose to exit the partnership. 

Mr Matona hoped that skills lost by Denel would be used by other companies in the country. However, it would be a big problem if these workers left the country as there was already a serious shortage of these specific skills.

Dr S van Dyk (DA) noted that Denel was originally established to assist the SANDF. He was not aware of any wars happening in the country or of any wars approaching South Africa. He was concerned that once the strategic document was tabled in Parliament by the DDMV, certain decisions would have to be taken about the future of the DSA. He did not want to see people losing their jobs unnecessarily. On the other hand, the government could not keep bailing DSA out with tax-payers money. The matter had to be brought before the Committee again before the DPE’s decision regarding DSA, stemming from the DDMV’s strategy document, was implemented. The Committee had to ensure that the correct decision was made.

Mr K Dikobo (AZAPO) asked why Denel was not present at the meeting. Usually with a matter of this nature, Denel would be the one presenting and the DPE would be in attendance. He wondered if there was a leadership crisis within Denel and if the DPE had lost confidence in Denel’s leadership. The Committee also wanted to know from Denel why SAAB had “jumped ship”. The Committee wanted direct answers from Denel. He asked why the DPE was there and what they were hoping for. Did they want some assistance from the Committee?

Mr Matona replied that his understanding was that the DPE was invited alone, without Denel. He assured the Committee that there was no leadership crisis within Denel at this point in time.

Mr M Sonto (ANC) said that he did not think the DPE would be able to answer the Committee’s questions adequately until after the strategic document from the Minister of Defence was tabled in Parliament. Key to this would be for the leadership of Denel to come before the Committee. Denel had always been a loss-making entity until 2005 when a decision was taken to strategically turn things around. It was 2011 and Denel was still in the process of turning things around. He agreed that DSA was a strategic asset but something was amiss.

Dr Koornhof noted that the IPAP2 put some focus on the aerospace sector. He assumed that DSA was part of this focus. If this was the case, then DSA formed part of the government’s strategic, national plan, which meant there was no point in continuing with the meeting. It had to be supported because it was part of a national decision that was taken. He noted that a defence review of the DDMV, or the “strategic intent” of the DDMV had been outstanding since 2005. It was currently on the table of the Minister, who announced it in her budget speech and would be released in a few weeks or even days. He suggested to the Committee that they wait for the DDMV’s strategic focus document as it would indicate to the country what the defence sector required. The DSA and the DPE could not make any moves until it knew what the SANDF’s needs were. He also thought it would be good for the Committee to pay a visit to DSA to see what it was doing.

The Chairperson clarified that the invitation to the DPE was clear; the Committee wanted a briefing on the future of DSA. It was a policy question that only the DPE could address. This was why DPE was at the meeting and not Denel. He assured Dr Koornhof that the Committee would definitely be visiting DSA, as it was already in the Committee Programme.

Mr Matona thanked the Chairperson for informing the Committee that they had already been invited to visit DSA. It was next to impossible for the DPE alone to make strategic decisions about Denel or parts of Denel without reference to the DDMV. There were certain people within the Defence sector saying that Denel should be included under DDMV, not DPE. There were many policy decisions from the DDMV that would impact on Denel.

The Chairperson thanked the DPE for their presentation.

The meeting was adjourned.