Denel Progress Report: briefing

LABOUR AND PUBLIC ENTERPRISES SELECT COMMITTEE
31 May 2006
DENEL PROGRESS REPORT: BRIEFING

Chairperson: Ms M P Themba (ANC, Mpumalanga)

Documents handed out:
Creating a Viable Denel
SOE Developmental Role

SUMMARY
Denel reported progress on its restructuring process to become a viable, profit-making company. It noted that a large portion of the recapitalisation request (R3,7 billion) related to its legacy and represented a sunk cost in economic terms (although the cash outflows occur over four years). The remainder (R1,4 billion) was required for property plant and equipment and product development to access future markets which would allow Denel to achive the sustainable turnover level of R4 billion and an EBIT (Earnings Before Interest and Tax) of 8% (achievable after year 3 when the restructuring will be concluded).

The Committee raised questions about public money potentially being wasted by bailing out Denel, the proposed guarantee of 70% of South Africa's defence procurement going to Denel, weapons sales to conflict-ridden countries, retrenchments and the restructuring process.

MINUTES
Denel Presentation
Ms Poppie Baloyi (Executive Head of Communications and Corporate Affairs) briefed the Committee on how Denel was restructuring to be a viable, profit making business entity. She gave an overview of the global defence industry and Denel’s standing in the global sector. She outlined Denel's strategy imperatives and recapitalisation requirements. Also explained was the status of the strategic implementation process, the transformation strategy, reforms and developments at Head Office in line with the core changes and transformation. A status report was also given on the disposal of non-core assets (see document for details).

Discussion

Ms S Mabe (ANC, Free State) asked whether political stability in South Africa had led to a loss of business for Denel. How many personnel would be retrenched? What would happen to the land where Denel would close operations, such as the site in Phillippi? Would the land be sold, surrendered to government or leased out?

Mr N Hendricks asked about the cost of relocating staff, the composition of the Board and whether these were not the same people who managed to get the company into trouble? What guarantee is there that the public money being put into Denel would not again go to waste? He also expressed concern on the proposal by Denel to be guaranteed 70% of defence expenditure by the Department of Defence. Would this not lead to bad business practices?

Mr J Sibiya (ANC, Limpopo) expressed concern noting that while the cost of restructuring was put at R5 billion and that of shutting down at R12 billion, would Denel not again in 5 or 10 years ask for billions from the public purse? He noted that the old structure had nine units and the new structure the same number; what restructuring had therefore occurred? The presentation had indicated 30% progress on equity partners; and yet there had been no new activity; how could this be reconciled?

Mr D Gamede (ANC, KwaZulu-Natal) asked if the SA Bureau of Standards (SABS) assured the quality of Denel’s weapons systems. He also asked about the political implications of weapons sold to foreign governments. What were the chances that these would fall into the hands of rebels or militia groups that were terrorising civilian populations in most of Africa?

Ms Baloyi pointed out that the munitions industry was part of Denel’s core business. Small arms and ammunition could be sourced anywhere although cost of production in SA was higher than, for instance China. The biggest Denel client was the SA Police Services (SAPS). The company could become viable in future, although it was difficult to sell products to other countries. Denel had trained most of the scientists in the country and was a scientific hub. Most of these highly trained staff had since left the company. Defence was a sensitive sector and government had to have control over the sector. She pointed out that the country had invested a lot of resources in Denel and, even though the defence budget was going down, other sectors like technology still stood to benefit from the company.

Ms Baloyi said there was general consensus among army generals that the country needed to have its own arms manufacturing industry. This guided all equity partnership discussions and agreements. On retrenchments, she did not have exact figures, but Denel had been careful and very cautious in its approach. It had studied how arms industries around the world had approached similar processes as points of references. While the process was painful, it was better to restructure and recapitalise now to become profitable and later create jobs.

Ms Baloyi stated that the land belonged to Denel, but where they would relocate or vacate land, the company would sell the land either to the government or the local authority. She noted that the land in question had to be rehabilitated before communities could be settled there due to the nature of the defence industry. There were cost implications because of this.

Mr Butcher Mututle (Denel: Head of Government and Industrial Relations) pointed out that where industries were in the midst of communities such as Macassar, this raised security and safety questions and relocation became more imperative because of these concerns.

On management, Ms Baloyi noted that the current management was new and not synonymous with the old one. Denel had made a lot of changes in this regard with new people on board who have turned around the company under a new strategy and vision. This strategy was anchored on a strong monitoring and tracking system to ensure management was on course and achieving the stated objectives.

On restructuring, Ms Baloyi pointed out that while the numbers seemed the same, there was a different approach where the old system was based on systems-based manufacturing; the new strategy was component-based manufacturing. Added to this, subsidiaries that were not profitable had been closed, while viable ones continued under the new structure.

Ms Baloyi explained that the 70% defence-spending figure referred to all defence industry players. Denel was not claiming the 70% for itself, but was acting on behalf of all other players in the sector. In responding to questions of finance, she explained that the R5 billion was split in two with R3.7 billion to be used to pay for ‘sins of the past’ and R1.3 billion for upgrading manufacturing machinery.

On quality assurance and standards, Ms Baloyi explained that the industry had its own quality checking mechanisms embedded in the manufacturing process. Thus both internal and external evaluators conducted inspections upon which certificates would be based. At times complaints would be received from clients, but this was a normal business aspect.

On selling to countries with internal security problems, Ms Baloyi pointed out that the South African defence sector was highly regulated. Government had to approve any foreign sales. The national committee that oversaw this process was very strict and geopolitical considerations dictated the nature of or limitations on business. She used India / Pakistan as an example. SA’s long-standing relations with India had implications for any weapons sales to Pakistan.

Lastly, Ms Baloyi informed the Committee that Denel had made significant progress on retrenchments by providing social and financial counseling to assist the affected employees. The plan had so far worked according to plan (see SOE Developmental Role document for details).

The meeting was adjourned.