The Committee met to be briefed by arms manufacturer Denel, the National Defence Industry Council (NDIC) and the Directorate Conventional Arms Control (DCAC) on the state of the industry, as well as for an update on Department of Defence (DoD) projects.
The Committee heard that Denel had been experiencing a liquidity crisis for almost three years. This had resulted in a delay in the implementation of projects such as the Hoefyster infantry combat vehicle project. However, Denel had a turnaround strategy which involved the replacement of management within the entity. The turnaround plan had resulted in an order intake of R7.8 billion during the 2019/20 financial year, compared to only R509 million during the previous year. It had also resulted in Denel securing an arms deal of R30 billion. However, the order intake was being threatened by the requirement of an end-user certificate and onsite inspections. This requirement was frustrating some of South Africa’s biggest arms clients, including the Kingdom of Saudi Arabia and the United Arab Emirates, and the Committee expressed concern that this was going to result in a loss of business. The issue had been escalated for consideration, and the outcomes were still pending.
The NDIC said it had created a task team for Denel to diagnose the challenges within the organisation and make recommendations. The task team had found that the root causes of the Denel liquidity crisis included a collapse in governance, corruption and inappropriate investment decisions. The task team had made several recommendations, including the recapitalisation and reset of DoD contracts with new realistic timeframes and contractual arrangements. A Member questioned whether the recommendation to recapitalise Denel was realistic.
Minister’s opening remarks
Ms Nosiviwe Mapisa-Nqakula, Minister of Defence, said Denel’s presentation would touch on some of the challenges faced by the Department of Defence (DoD) in relation to the manufacturing industry. She was not present at the meeting as a Minister leading the Denel delegation, but as a member of the defence industry. She said that Denel fell under the Department of Public Enterprises.
The Denel presentation would indicate which projects were behind. It would also touch on some of those areas where the DoD had made advance payments on work which had not been done.
She appreciated the positive changes within Denel, including the appointment of a new board. She was aware of the interaction between Denel and Armscor, and was happy that the chief executive officer (CEO) of Armscor was present at the meeting to make comments on all delayed or outstanding projects. The presenting delegates from all the entities in attendance would brief the Committee on progress made on all projects. She asked the Committee to avoid a detailed discussion on the projects that were going to be presented, and to limit its discussion to financial issues.
Mr William Hlakoane, Group Chief Operations Officer: Denel, said that the entity was facing a liquidity crisis due to a number of reasons, including lack of basic financial discipline and internal controls, and general corruption as was being shown in the case of the state capture currently before the Zondo Commission. However, Denel had a turnaround strategy. As part of this strategy, it had reduced the number of executives in the executive authority from 15 to 4. The new management team and board was determined to address the performance culture and consequence management within Denel.
With the turnaround plan, Denel had secured an order intake of R7.8 billion during the 2019/20 financial year, compared to R509 million during the previous financial year. It had also secured a winnable order pipeline of R30 billion in a 24-month window. In addition, it had a solid order backlog of R17.4 billion, covering roughly four years of sales revenue. Denel had received its largest export order -- a contract of R6.3 billion.
Mr Hlakoane showed a chart illustrating the transition of Denel. Its core future activities include missiles and Precision-Guided Munitions (PGMs), artillery systems, and dyber and infantry systems. The manufacturing of items such as the Rooivalk attack helicopter required strategic partnerships.
On business development , he presented a graph showing an order intake from countries including Oman, the United Arab Emirates and the Kingdom of Saudi Arabia over the next five years.
He said Denel had spent over R417.5 million on black-owned and managed businesses, over R308.3 million on female-owned and managed businesses, and over R20 million on youth-owned and managed businesses.
The Chairperson commented on the extended coverage of the presentation in respect of the Hoefyster infantry combat vehicle project. He asked the COO to state the names and the value of the capital projects that Denel had stated it had ring-fenced funds for. Also, he wanted it to account for the advance payments it had received from the Minister.
Mr S Marais (DA) agreed with the Chairperson that Denel needed to account for the money it had received from the Minister. He asked it to explain the reported difficulties surrounding the end user certificate and inspection requirements. Iraq and Saudi Arabia were among the countries being affected by the end user certificates and inspection requirements. He asked for further details on Denel’s aerospace activities. Were South Africa’s intellectual property (IP) rights in the defence industry protected, and did Denel share IP rights with the DoD and Armscor? This was important, because in the past there were reports of South Africa’s IP rights getting lost or transferred. It was important that the Committee get an update on the Hoefyster project, since Denel had stated at the last meeting that there was going to be a 46-month delay in the implementation of this project. Was it still possible to stop the project or make amendments? Did Denel co-operate with other organisations such as Armscor on research and development (R&D)? Cooperation was important to save money.
Mr Marais said he wanted to know the risks with regard to the pre-payments. When one looked at the order intake of R7.8 billion in isolation of working capital, it appeared“fantastic”. Was there sufficient working capital to manufacture and deliver orders? He asked for an explanation of the cyber technology that Denel was looking at, and whether it was doing this in co-operation with the DoD and Armscor. On security and border control, the Border Management Bill that was coming in would be looking at the border points of entry. The DoD and the South African Defence Force (SADF) would be involved in border patrols, and he wanted to know if Denel would also be involved.
He asked if Denel cooperated with the private sector or had future plans to do so. Had it done any research or strategic planning on South Africa’s movement from conventional warfare to peaceful regional stability and border control? He asked Denel to clarify what the North Atlantic Treaty Organisation (NATO) barriers to entry were. Finally, he asked Mr Hlakoane to clarify whether the additional R1 billion Denel was waiting for was part of the bailout money it had already received, or if it was additional to what it had already received.
Mr T Mmutle (ANC) asked whether the components that Denel wanted to get rid of were the problem within the organisation, or if there was another problem which the entity had not mentioned. Was the R6.3 billion mentioned on page 9 of the presentation not affected by the end user certificate? What was affecting sustainability within Denel if the entity had an order intake of R7.8 billion? With a backlog of R17.4 billion, which projects did Denel look forward to completing. He said Denel had spent part of its procurement on black-owned businesses, women and youth, and asked what type of businesses these were. Had transformation extended to the manufacturing sector?
Mr M Shelembe (DA) asked for how long Denel had been struggling with weak supply chain management (SCM), and what the causes of this were. Were the staff in the procurement department equipped and have the capacity to properly manage funds in the face of the economic decline? Had consequence management been implemented against people implicated in situations that had resulted in a monetary loss within Denel. Were there were time frames in place to resolve its internal problems, such as its supply chain management.
Ms A Beukes (ANC) asked for a progress report on addressing the challenges within Denel. Was it maintaining oversight on the new management? Was there a tool to measure partnerships?
Mr Hlakoane said that end user certificates and inspections were a requirement of the National Conventional Arms Control Committee, where the government of an importing country assures the government of an exporting country that controlled items would not be transferred, alienated, re-sold or re-exported to another country without approval. Countries such as Saudi Arabia and the United Arab Emirates complain that on-site inspections violate their sovereignty, and were blocking arms sales. Consequently, South Africa was losing up to R30 billion in sales.
Denel was involved in the production of various products for the aerospace sector. However, it required a strategic partnership for the development of products that had never been sold in South Africa, such as the Rooivalk.
Denel had conducted some research on securing IP rights permanently. He clarified that Denel and Armscor owned separate IP rights. However, Denel required the use of Armscor’s IP rights when it came to the development of specific products. On the issue of stolen IPs, both Denel and Armscor had conducted internal investigations and found nothing substantial pointing to that.
Mr Hlakoane said he had not prepared a presentation to provide specific details regarding the delays in the implementation of the Hoefyster project. Moreover, he was wary about the media.
With regard to R & D, he confirmed that there had been ongoing collaboration between Denel and Armscor to develop technology further. Denel had not done anything for the South African Police Service (SAPS), but was looking into it.
Mr Hlakoane proposed that the subject of pre-payments this be discussed at a separate forum.
Regarding working capital, Denel had requested R2.8 billion from the government and had received R1.8 billion. The R1 billion Denel was waiting for was the outstanding amount. At the time it had received the money, it had owed suppliers up to R900 million. On top of that, it also owed the South African Revenue Service (SARS).
Mr Hlakoane said Denel had not done much in the cyber technology area, and had only mentioned this as part of its future plans. It was in discussion with various stakeholders on this aspect.
Regarding border security and patrols, he said Denel did not do patrols -- its role was to manufacture and control equipment which was used in border patrols, hence the phrase “border control”.
On cooperation with the private sector, he said Denel had a good partnership with the defence industry. Denel was part of the Aerospace, Maritime and Defence (AMD) Industries Association.
On barriers of entry into NATO, he said NATO was more like a corporate entity in the defence industry, and was difficult to compete with. NATO protected its own interests and market, which made it difficult for South Africa to penetrate the market.
Regarding the procurement spending on black-owned businesses, he did not have the details of what businesses these companies were involved in. However, to be involved in the manufacturing process, the companies had to be certified to supply the components of what Denel produced.
As to how long Denel had been struggling, Mr Hlakoane said it had been for the past three to five years.
Denel had secured an order of R17.4 billion over a period of time, and was still chasing a further R30 billion. During the financial period under discussion, Denel had secured R7.8 billion. The R30 billion might or might not materialise.
He said Denel was in the process of implementing consequence management.
With regard to the time frame for ensuring the supply was stable, Mr Hlakoane told the Committee that Denel was in the process of dealing with this. However, he was not sure how long the process would take. He confirmed that Denel had a tool to measure procurement partnerships.
National Defence Industry Council and Directorate, Conventional Arms Control
Dr Sam Gulube, Secretary of Defence, gave an extensive background of the National Defence Industry Council (NDIC), covering its mandate, governance and membership, and informed the Committee of the defence industry strategy, funding and sector charter.
He said the purpose of the Defence Industry Fund was to finance small and medium enterprise (SME) companies that were providing products and services to Armscor and the DoD. The rationale behind the funding was the fact that commercial banks and state-owned institutions were prohibited by their founding documents and policies from providing financial support to companies operating in the defence space.
The NDIC had formulated a task team on Denel whose purpose was to diagnose challenges facing the entity, to propose a solution to address the liquidity crisis at Denel, and to compile a comprehensive report with findings and recommendations for consideration by the NDIC and relevant stakeholders. The task team had found that the root causes of the Denel liquidity crisis included a collapse in governance, corruption and inappropriate investment decisions. The task team had made several recommendations, including the recapitalisation and reset of DoD contracts with new realistic timeframes and contractual arrangements.
Dr Gulube said that companies that relied primarily on Denel and SANDF business were closing down, or were on the verge of closing. It had been discovered that 18 companies that were dealing primarily in sovereign or strategic capabilities, relied heavily on DOD funding and were very distressed. The NDIC had developed an intervention plan to propose mechanisms that could be implemented to address or alleviate the impact on distressed companies.
Mr Marais asked Dr Gulube to provide more information on the Defence Industry Fund. He wanted to know who controlled the fund, and whether it was still operational. In addition, he questioned whether the recommendation to recapitalise Denel was realistic. The recommendation to reset DoD contracts signified an oncoming train, rather than a light at the end of the tunnel, since there was no clear plan on how that would be funded. On the NDIC intervention plan, he asked where the budget allocation for this would come from.
He noted that Dr Gulube had said that the NDIC was awaiting feedback from the National Conventional Arms Control Committee (NCACC) on the issue of end-user certificates. He asked whether Dr Gulube, as a person of authority in both the NDIC and the Directorate Conventional Arms Control (DCAC), had written and replied to himself on the issue of end-user certificates. Regarding the end-user certificates, were on-site inspections a legislated and UN requirement? He asked what the argument, or reason, behind the rule was, given that it was not a legal requirement in either the domestic and international domain. He asked what the way forward was -- whether to stick to the rule, or scrap it. Sticking to the rule had resulted in the blockage of sales to Saudi Arabia and the UAE, which were South Africa’s biggest clients.
Dr Gulube briefed the Committee on the end-user certificate, and said this was a legal document recognised under international law -- Article 1 of the Hague Convention. Without a valid end-user certificate, an export could not be effected under Law.
He explained that the NDIC intervention plan had been developed on a limited budget, and some of the interventions were not implemented because of the budget. However, the NDIC was collaborating with various stakeholders on the implementation of interventions that required a budget allocation.
On the reset of contracts, he explained that this was related to contract variations, which meant a renegotiation of those contracts that Denel could not deliver on. with the goal of finding a solution and a way forward. He agreed with Mr Marais that in terms of implementation. there were some concerns, but he was definite there was light at the end of the tunnel.
Dr Gulube said the DCAC had received the issue of end-user certificates from the NDIC. The NDIC had referred the matter to the NCACC and had written to the state law advisor and received a legal opinion on the matter. The criteria were not informed by the National Conventional Arms Control Act [73 of 2008], but by an attachment to the regulations. The problem of whether the criteria would be removed from the attachment to the regulations would be escalated.
The meeting was adjourned.
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