Transnet & Denel: Minister’s briefing

Meeting report

PUBLIC ENTERPRISES PORTFOLIO COMMITTEE
14 September 2004
TRANSNET AND DENEL: MINISTER’S BRIEFING

Chairperson: Mr Y Carrim (ANC)

Relevant Documents:
Denel Annual Report (2004)

SUMMARY
The Minister of Public Enterprises, Mr A Erwin, briefed the Committee on the state of Denel, Transnet and its subsidiary, South African Airways. He discussed current challenges and argued why the defence and transportation sectors were best owned by the state. However, he also outlined a role for private enterprise within these sectors. Members thereafter questioned the separation of infrastructure and operations within Transnet, and interrogated financial and oversight issues.

MINUTES
Briefing by the Minister of Public Enterprises
The Minister, Mr Alec Erwin, stressed that Denel, Eskom, South African Airways (SAA), and Transnet would remain state-owned enterprises, as they were strategic assets with important roles in the economy. As the country had learned, it was not possible to ensure that private partners operated within a given policy framework. Eskom would be particularly difficult to sell, as it was one of the largest energy providers in the world. Thus, the only potential buyers would be banks or foreign governments, neither one of which provided a desirable alternative to state ownership. Nevertheless, the Ministry was seeking to bring private capital and expertise into the energy and transport sectors, while Eskom and Transnet controlled basic operations.

One of the greatest challenges confronting the transport sector was that modern manufacturing economies, such as South Africa, required a new form of transportation service. Logistical concerns required that the various components of the transport sector be interconnected.

Transnet had been a classic state-owned company until 1992, when it was transformed into a corporate structure. This structural change resulted in increased investment in pension funds and decreased investment in infrastructure. Therefore, Government needed to concentrate on providing Transnet with direction and focus on investing in infrastructure. Issues that had arisen in the Transnet balance sheet included accounting protocols, operating revenue, and problems within SAA. Transnet had done well in some years due to asset value adjustment that gave it a balance sheet income, rather than an operating revenue. Having “cleaned up” the balance sheet, the Ministry had identified difficulties and was prepared to seek mechanisms to strengthen the balance sheet in order to pursue new investments.

The failure to identify risk soon enough, and the particular form of hedging used, had caused balance sheet problems for SAA, which had absorbed much funding from Transnet to eliminate the hedge book. Transnet, as the holding company, had to further convert loans into equity to maintain the accounting integrity of SAA. However, in terms of operational revenue, SAA was among the leading airlines in the world. Although the balance sheet needed to be strengthened, the overall economic situation was favourable for both SAA and Transnet. Thus, it was an opportune moment to invest in both entities and focus on improving performance.

Although there had been much speculation about the Transnet Board, the transition had been remarkably smooth from one Board to the next. The Board had appropriately taken responsibility for their shortcomings and stepped down, thereby acting in the best interest of the company. The Board was concentrating on focusing Transnet as a logistics company and improving efficiency. The rail sector would be modeled after the port sector in that the infrastructure company would be divided from the operations company. This would allow for the formation of partnerships with operating companies within the private sector while still assuring that all activities within these sectors were operative, as the private sector would not engage in all activities important to the economy due to issues of profitability. The Committee and the media were invited to see the Transnet facilities to better understand the situation “on the ground.”

The Government had rightly decided to keep Denel, as there was no doubt that important defense capacities had been created in aerospace, ammunition, artillery, and land-based vehicles. These capacities needed to be retained and built upon as they provided benefits like development, research, and technology. In addition, retaining this sector strengthened important components of the economy. However, it was doubtful that South Africa would ever have the capacity to build submarines.

In response to arguments that South Africa should privatise the defense industry, it was noted that most defense industries were public enterprises and it would be unwise to assume that the country’s defence needs would coincide with the interests of private companies. Nevertheless, partnerships would be formed with private companies wherever possible.

Denel’s balance sheet problems stemmed from declining Rand earnings due to the strengthening of the Rand and the fact that Denel had been expected to finance much of the research and development. It was necessary to find a mechanism by which to inject capital into Denel.

People will be added to the Denel Board over the next month to provide it with additional experience.

For various historical reasons, there were entities within Denel, SAA, and Transnet that were not part of the organisations’ core business. Such entities should be sold to achieve empowerment objectives and make the enterprises more efficient. This coincided with the key five-year objective to make stronger companies that provided better service.

Discussion
Mr I Davidson (DA) questioned if it was wise for Government to inject capital into Denel, given the large amount of capital Denel needed and the number of other service delivery obligations Government needed to fulfill. Minister Erwin reiterated that it would be a major loss to the economy to lose Denel and that it would be a mistake to assume that the private sector would provide the same capacity as Denel. He confirmed that the company was not bankrupt, despite whatever the CEO may have said. Denel was an important asset for the country and it was necessary to find an affordable solution to rebuild the company.

Mr Davidson brought up Telkom as an example of the difficulties inherent in public-private partnerships. He argued that Eskom could never be sold as an entire entity. Rather, it would have to be sold to various service stations. In such a case, competition was crucial. Minister Erwin noted that there were similarities between SAA and Telkom, in that both were large, global companies. He stated that selling off Telkom completely would have resulted in a loss of capacity. However, the private partner had helped Telkom and the role of the state had been reduced. He argued that it was always important to analyse the particular company and market and then set certain strategic objectives for the economy, one of which should be strong ICT (information-communication-technology) capacity. He argued that Eskom was the market for energy, stating that it was a success because it had a mixed profile of assets that allowed it to price competitively. Nevertheless, it was necessary to create new capacity that could be sold to the private sector. He stressed that it was desirable to bring in competition and private capital, both of which would happen in the next ten years.

Mr Davidson asked whether the division of the rail infrastructure sector from its operations sector entailed a situation similar to that found in France and Germany, where Government controlled the infrastructure while different service providers competed for freight and/or passengers. Ms M Ramos (Transnet, Chief Executive Officer) argued that separating infrastructure from operations allowed for a better understanding of costs and what needed to be done in terms of infrastructure. It also allowed for the possibility of bringing in additional operators, as had been done in the ports.

Mr Davidson questioned the need for Government to own SAA given its successful operations. Minister Erwin asserted that the only potential buyer of SAA was another large airline, which would not rationalise their fleet to meet the needs of South Africa. South Africa’s economy needed a carrier that provided a reasonably comprehensive service. Therefore, there was no strategic logic in selling SAA to another operator, although ways to bring in private capital would be explored. While the Ministry was committed to Initial Public Offerings (IPOs), which would allow individuals and institutions to partake in the capital, the basic controlling interest would remain with the State.

Advocate Z Madasa (ACDP) asked if the separation of infrastructure from operations would benefit the African continent. Minister Erwin noted that a more efficient South Africa was better for the continent. However, the Ministry was not pleased with the way Government interacted with Africa. The interactive approach was too fragmented and thus, a more coordinated approach, in which helping Africa also entailed helping South Africa, needed to be established.

Advocate Madasa questioned whether mechanisms had been established to monitor the Boards. Minister Erwin emphasised the importance of clearer mechanisms for contact to establish better working protocols. He noted that it was the Boards’ responsibility to manage their respective enterprises and that Government’s issues with such enterprises should be addressed through the Boards.

Mr T Louw (ANC) argued that it was important for Members to know public enterprises’ mandates in order to better understand their role as legislators. He stressed the importance of public enterprises in stimulating the economy.

A Member (ANC) questioned why Government should sell thriving enterprises, such as SAA, and retain those that were making loses. He noted that Denel had to engage in open tenders and, therefore, often lost to foreign tenders. Minister Erwin said that the issue of tenders was complicated and had much to do with the kind of equipment under discussion. A balance between production by Denel and tenders needed to be found. However, Government would continue to control the arms trade.

The Chairperson asked for clarification on the new oversight role envisioned for the Department. Minister Erwin stated that the Department needed to learn from what had been done thus far in Government. The Department was in the process of refocusing their work, which would help them to achieve their objectives. Divisions within the Department would be created to deal specifically with analysis and risk management, governance and policy, and corporate finance, strategy, and structure. More emphasis would be placed on working with state-owned enterprises in order to better identify risks.

Ms Ramos argued that hedging should not be thought of as a means to make money, unless one was a bank or a hedge fund. Rather, companies should hedge to protect themselves from certain risks that had been identified and defined. The SAA Board had adopted an interim hedging strategy that addressed cash flow at risk since 54% of SAA’s revenue was in foreign currency. SAA’s “plain vanilla” hedging strategy dealt with basic hedging instruments that were easy to price and understand. Such a strategy was important in determining the amount of loss that could be endured and when to get in and out of various situations.

Mr Madasa asked if the banks had taken responsibility for their part in the hedging deal. Ms Ramos asserted that, in any company, the Board and the management had to take responsibility for hedging strategies. Banks sold products regardless of their risk to the buyer. For this reason, Transnet had opted for simple products that could be easily understood and met the business strategy. Minister Erwin agreed that management was responsible for hedging since it was their responsibility to mitigate risk.

Mr Davidson asked when the Ministry would know the extent of capital injection that was needed in Denel and Transnet. Minister Erwin stated that the Ministry would present Cabinet with their financial proposal at the end of October. The proposal would outline what could reasonably be achieved in the coming years. The Ministry would report back to the Committee in November, after having met with Cabinet.

Mr Davidson expressed his concern over certain “back and forth” decisions that had been made within SAA recently. Ms Ramos explained that such apparent indecisiveness resulted from the complexities inherent in acquiring a new fleet, as management had to determine whether to make straightforward acquisitions or to adopt a leasing programme. In most cases, the company had opted for operational, rather than financial, leases.

Mr K Minnie (DA) questioned whether it would ever be possible to sell international routes serviced by SAA while maintaining control of the airline as such. Minister Erwin was uncertain whether tendering routes would be a successfully strategy.

The Chairperson urged the Committee to think about important issues such as hedging and the different forms that privatisation could take.

The meeting was adjourned.