South Africa’s Denel Forced Into Strategic Shift
Back in July 2005 it was apparent India’s sanctions against Denel and possible disqualification from a $2 billion artillery contract could have a major effect on the South African defense firm as a whole. In August 2005, those sanctions came to pass, barring Denel from a contract it was likely to win and accelerating efforts already underway to radically restructure the firm.
CEO Shaun Liebenberg launched that shift in late 2005 with some frank discussion of the global defense market, and the position of small-medium players like Denel in it. At DSEI 2005 in London, UK, the outline of this new strategy was already apparent. Many of the products Denel is known for will no longer define the firm. But could it find a way to stanch the bleeding and survive in a globalized market?
And how has it done since?
- Denel’s Position
- Denel’s New Strategy
- Updates and Key Events [updated]
The new CEO was frank about Denel not being viable under the current model. According to Liebenberg, global prime contractors succeed due to privileged relationships with their domestic customer who largely fund and promotes the development of new system platforms.
“Changes in the defence industry have forced consolidation and the forming of alliances worldwide… Although Denel has an enviable range of products, we no longer have a captive domestic market or the scale to succeed as an independent systems integrator and exporter of such a broad range of products…”
“Our analysis of the international defence environment shows much of global defence spend is not directly accessible to independent contractors like Denel,” Liebenberg explained. “The US Department of Defense in recent years has awarded contracts almost exclusively to US and NATO companies. These companies supply most other markets, too. Developing nations like India, Brazil and Israel have strong domestic industries to serve their own customer, whilst giving intense competition to other independents.”
Denel’s product range drives the full scope of its ambitions home. If anything, it’s surprising that the reckoning hasn’t come sooner.
Indigenous efforts in the missile field alone include the A-Darter (intended as a Sidewinder 9X/ ASRAAM/ AA-11 Archer contemporary), Ingwe and Mokopa anti-armor missiles (think TOW2 and Hellfire/Brimstone competitors), and Umkhonto-IR ship based anti-air missile. The firm also has a full line of optronics; 3 UAV projects (including a reconnaissance UAV, a high speed stealth UAV, and a target drone); a full-fledged new-generation attack helicopter project in the Rooivalk (Eurocopter Tiger/ AH-1Z/ Mi-28 contemporary); the Umbani bomb kit (a kit that converts ordinary bombs to something approaching a JSOW); world-class artillery systems in the G5, G6, and accompanying base bleed ammunition; vehicle turrets, a full line of military small arms; plus C4ISR products, licensed production of other helicopters, aircraft maintenance, and more.
Some products, like its artillery, are genuine world-beaters coping with a shrinking market for their specific product range. On the other hand, many of these expensive development projects were substitutable at home, and non-viable abroad from the get-go. Little wonder the new CEO has concluded that local defense spending clearly won’t suffice, even with some 45% of Denel’s business still deriving from the domestic market.
Worse, much of South Africa’s recent domestic spend has taken place in areas falling outside Denel’s product range, like fighter jets and naval systems. Denel’s involvement was limited to sub-contracts on the SA Navy’s corvette weapons suite, some workshare on the Gripen, Hawk and Agusta helicopter programs, and the hope of additional workshare as part of the Airbus A400M military transport. Liebenberg clearly understood, and stated, that some non-viable businesses would have to be made viable or exited entirely.
Denel’s New Strategy
Liebenberg believed that his company’s capabilities are attractive to global prime contractors for partnering. Liebenberg said Denel meets the pre-requisites to act as a specialised contractor that could slot into the value chain of the global players, because it has a technology edge or low cost production capabilities in several niche areas, plus good systems integration experience.
As such, he intends to pursue a strategy that focuses Denel business on being a domestic prime contractor, whilst becoming a specialized contractor or sub-supplier to other international defense contractors.
In keeping with Denel’s new strategic direction, formally announced by CEO Shaun Liebenberg in August 2005, the Group is showcasing some of its niche defence and aerospace systems at DSEI 2005 this week in London, UK.
Denel’s advanced LCT-30 combat turret will be part of the South African Army’s new generation infantry combat vehicle. Denel also hopes to interest more customers in its sophisticated sub-systems, like its ‘Eagle Eye’ target location binocular, Denel’s NATO certified LH-40C eyesafe laser rangefinder already in use with some European armies, the ‘Kenis’ infrared thermal imaging camera, and the Goshawk electro-optic stabilized airborne observation system. Denel is also supporting Zeiss Optronik of Germany with periscope equipment for a number of foreign navies.
Yet Denel hasn’t given up on all of its bigger projects. Its Umkhonto IR surface-to-air missile, selected by the South African and the Finnish navies, remains on offer now that performance testing and live firings have concluded successfully [DID: Sweden would eventually buy them too, as a partial offset for the SAAF's new Gripen fighters]. In the artillery department, its ‘Arachnida’ electronic targeting and combat management is already in service on the UK’s light artillery guns and was exported in quantity to a Middle East customer, and Denel’s world-class artillery ammunition is currently being evaluated in the NATO environment as well as in the United States. In 2007, Denel announced a strategic alliance with Germany’s Nitrochemie to develop a new generation of modular propellant charges for 105mm and 155mm artillery, and 2008 saw Germany’s Rheinmetall take a majority stake in Denel Munitions.
It’s going to be a long road ahead for Denel, as it always is in major corporate restructurings. Jack Welch, widely considered to be the gold standard of modern-day CEOs, offered his take on the restructuring/ crisis process in a Wall St. Journal article that covered the aftermath of Hurricane Katrina. The circumstances are different, but the process is universally applicable.
In a way, however, the scale of the problem is blessing to Denel. The very overreach that has landed the firm in such trouble has also made it sufficiently important to South Africa’s defense infrastructure that allowing the firm to fail will be seen as a last resort option. Given the roster of projects it has successfully brought to fruition, it’s also clear that Denel has some very talented engineers and personnel on hand.
Strong government support, a solid share of South Africa’s production allocation for the A400M global project, and success in its alliance efforts could yet steer the South African firm back to health. Yet the international defense market is becoming a difficult place for small-mid size firms without an in-demand flagship product. Unlike Apollo 11, failure is an option.
Updates and Key Events
July 22/09: A Denel release suggests renewed efforts to step up exports – even as it makes the importance of the Hoefyster IFV project, and the continued primacy of South African defense spending, clear:
“In 2005 Denel Land Systems was a company “in anticipation.” Inheriting an overdraft of R400m and a loss of R180m year-on-year, DLS was insolvent for all intensive purposes. Despite this however, the strategic and technical value of the company remained evident… Having technical expertise and an artillery capability among the best in the world does not automatically equate to sustainability however… All product lines manufactured by DLS were reviewed as a result, with non-core products such as hunting rifles immediately being exited. We simultaneously applied for recapitalisation funding, which was used to repay an overdraft and give DLS a “clean start”
Despite this however, DLS needed a catalyst for growth and sustainability. With over 70% of its business coming from the local market and notably from the SANDF, it was critical that DLS secured a sizable defence contract… we were conscious of the business and strategic value this type of contract would enable… The Hoefyster project has provided just the required impetus. With a total contract value of R8.3bn and the demand phase in activation already worth R1bn, the contract’s full effects are not confined to DLS, but also being felt by 60 local contractors – a glimpse of the scale of impact the company can have on the local economy.
While Hoefyster proved a critical element in ensuring DLS broke even during the financial year 2008/09… we have started visiting previously interested international parties and looking for new ones in the Middle East, Far East, South America and Africa. To step into these international markets however, strategic partners will be critical in ensuring access. As such, our focus has seen us already engage with a number of key players so as to establish supplier contract relationships.”
July 16/09: Denel Group CEO Talib Sadik discusses the organisation’s revised growth strategy in a corporate release, and offers an update on turnaround progress made to date. Since the turnaround began in 2006, Denel has inked strategic equity partnerships with Carl Zeiss, Rheinmetall Defence and Saab:
“While acknowledging the Group still faced challenges, most notably the continued posting of losses by Denel Saab Aerostructures and securing further recapitalisation, Sadik maintained it was important to acknowledge the milestones that had already been achieved. These included the improved relationship with the South African Department of Defence, enhanced risk management and programme execution, and the significant performance of and turnaround seen in some of Denel’s fully-owned (100% shareholding) businesses… Turbomeca Africa has continued to grow its profits year-on-year. We have also seen Carl Zeiss Optronics’ sales per person has increased from R0.8 million to R1.6 million since its restructuring, and are expecting Rheinmetall Denel Munitions to post its first profits in the new financial year,” explained Sadik. He added that Carl Zeiss Optronics has shown a 100% increase in revenue over a two year period, while Rheinmetall Denel Munitions’ order cover is in the region of 70%.”
Overall, losses are continuing at a declining rate, from R 1.56 billion in the 2004/05 financial year to R 347 million in 2008 (q.v. Sept 9/08 entry). Despite the net loss, Denel Group’s gross profit has grown from -6% in 2006/07 to 16% in 2008/09, while revenue per employee across the Group has more than doubled from R 353,242 in 2006 to R 745,460 in 2009. R&D has grown to R 1.12 billion in 2009 driven largely by development of the A-Darter 5th generation air-to-air missile, the Badger/Hoefyster 8×8 IFV, and subcontracting work on the A400M military cargo aircraft.
Denel’s order book has seen the most growth, from R 3.75 billion in 2006 R 16.05 billion (including confirmed contracts) at the end of 2009. The May 2007 IFV win played a large role in that increase, by adding R 8.3 billion to the order book.
Jan 19/09: In its analysis of the South African defense industry, analyst firm Forecast International sees Denel’s efforts paying off. In accordance with mandates attached to government recapitalization efforts valued at $455 million, Denel has proceeded with restructuring. Forecast International believes that amid rising uncertainty around the domestic defense market, the sector’s decision to discard self-sufficiency in favor of an industry structure optimized to increase access to the global defense market appears is looking like a good strategy. It adds:
“Since the South African Ministry of Public Enterprise opted to divest from unprofitable domestic defense enterprises and relax regulations on foreign investment in the defense sector in late 2005/early 2006, 10 major acquisitions involving foreign defense enterprises targeting South African enterprises have occurred… Since early 2006, Denel has sold 20 percent of it aerostructures division at a price of ZAR66 million to Saab to form the Denel Saab Aerostructures joint venture; 70 percent of its optronics division was acquired by Carl Zeiss Optronics in exchange for phased investment in Denel’s European logistics network; and Rheinmetall AG acquired a 51 percent stake in Denel Munitions in return for the provision of financing and advising on the business unit’s restructuring.”
While Denel has yet to operate at a profit, operating losses declined nearly 37% between 2007 and 2008, and decreased at a compound annual rate of 74% since restructuring efforts were initiated in early 2006.
Sept 25/08: State-owned Denel (Pty) Ltd’s Chairman of the Board Dr Sibusiso Sibisi announces Talib Sadik’s appointment as Group CEO for a period of three years. Mr Sadik was appointed as Group Financial Officer of Denel in 2006, and has been an executive member of the Board of Directors since that date.
Sept 9/08: Denel’s Acting Group CEO Talib Sadik, announces that for the fiscal year that ended on March 31/08, the Denel Group increased gross revenue to R 3,894 million (2007: R 3,310 million) and posted a net loss of R 347 million (2007: R 549 million). Of the total turnover 56.8% was from domestic sales (2007: 47.5%) and 43.2% from export sales (2007: 52.5%). Sadik:
“We managed to improve the loss for the past year through focusing on core businesses, phasing out of legacy contracts, savings in operating costs and profits on the sale of non-core assets… Better contract negotiations including higher advance payment receipts towards the year-end and improvements in our debt collection process helped us to achieve the healthy cash situation.”
Sept 1/08: The finalized deal involving Rheinmetall and Denel Munitions comes into effect. Denel release [PDF].
June 1/08: Denel Group’s CFO Mr Talib Sadik becomes interim CEO of Denel.
Feb 8/08: Germany’s Rheinmetall Group signs an agreement with Denel (Pty) Ltd, indicating its intention to take a majority equity stake in Denel Munitions. The deal is finalized on Sept 1/08. Read “Rheinmetall Buying Majority Stake in Denel Munitions” for more.
July 25/07: Denel’s Group CEO Mr Shaun Liebenberg, announces a net loss of R 549.1 million for the past year ended March 31/07 (2006: R 1,363.4 million) on turnover of R 3,268.1 million (2006: R 2,773.2 million). Gross profit rose to R 754.0 million (2006: loss of R131.1 million). His statement adds:
“Incremental sales by Denel Land Systems and Denel Munitions to clients in South America, Europe and the Middle East added to the increased turnover… At year-end Denel received a number of large contracts, notably the R8.3 billion ‘Hoefyster’ – the biggest in Denel’s 15-year existence, and the A-Darter air-to-air missile contract worth approximately R1 billion… BAE Systems awarded Munitions a contract worth R300 million over three years to supply brass cups, which are used in the manufacture of small calibre ammunition. Denel Optronics, in which German firm Carl Zeiss Optronics has acquired a majority holding, received a BAE Systems contract worth R200 million to produce 450 units of its unique pilot helmet tracker system for use in the Eurofighter-Typhoon jet.
…The agreement signed with Saab in Sweden in June 2006 regarding the establishment of a new aerostructures company, led to Saab AB (publ) taking an initial minority equity stake and operational management control, with Denel retaining an 80% holding… At the close of the financial year Denel and German company Carl Zeiss Optronics GmbH agreed on an equity partnership for Denel Optronics. Denel was to retain a minority share with Carl Zeiss Optronics taking a majority holding of 70%. The effective transaction date was after year-end, with final share transfer on 20 July 2007. The company now trades as Carl Zeiss Optronics (Pty) Limited.”
May 17/07: Denel wins the $1.2 billion, 264-vehicle contract for the South African Army’s new generation “Hoefyster” infantry combat vehicle program. The goal is to produce an 8×8 wheeled APC in the 25 ton class, designed as a family of vehicles that can be equipped with various turret and on-board options. It is described as the biggest single contract in firm history. The vehicle will not be Denel’s, however, but Patria Oyj of Finland’s popular AMV.
April 2007: Denel’s missile/UAV subsidiary Denel Dynamics announces a joint development agreement with Brazil’s Ministry of Defence and Forca Aerea Brasileira for the A-Darter short range air-air missile (SRAAM), signed as a government to government agreement via South Africa’s Armscor. The original contract was apparently signed in July-August 2006, but the formal cooperation launch was announced at the 2007 Latin American Aerospace and Defence exhibition in Brazil.