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Aug 24, 2012

Denel adjusts strategy and structure as turnaround continues

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In July, South Africa’s State-owned defence industrial group Denel announced it had made a small profit of R41-million during the 2011/2012 financial year (FY – which ended on March 31). This was the second year in which the group reported a profit, but, encouragingly for the group’s management, although this profit was lower than the previous year’s, it was achieved entirely by operations, whereas the FY 2010/2011 profit had been boosted by a large, one-off, accounting gain from the restructuring of a pension fund. Furthermore, all but one of Denel’s businesses made a profit. And the exception, Denel Aerostructures, cut its losses by 67%.

Course adjustments

Since mid-January, the Group CEO of Denel has been retired Brigadier-General Riaz Saloojee, who succeeded Talib Sadik. (Following his retirement from the South African National Defence Force – SANDF – in 2000, Saloojee spent ten years in the defence industry, rising to become head of Saab South Africa, before his appointment to lead Denel.) Saloojee is the Denel group’s third CEO since its turnaround was launched under Sadik’s predecessor, Shaun Liebenberg, some six years ago.

Liebenberg reorganised Denel into ten “business entities” and three “associated companies”, as the group designated them. The business entities were Denel Aerostructures (DAe), Denel Aviation, Denel Dynamics, Denel Integrated Systems Solutions (DISS), Denel Land Systems (DLS), Denel Overberg Test Range (OTR, previously known as OTB – its initials in Afrikaans), Denel PMP, Denel Industrial Properties, Denel Training Academy and Mechem.

DAe designs and manufactures major structures for aircraft airframes; Denel Aviation undertakes the maintenance, repair and overhaul of aircraft (both fixed wing and helicopters); Denel Dynamics designs and manufactures guided missiles and unmanned air vehicles (UAVs); DISS specialises in the integration of complex land-based air defence systems; DLS designs and manufactures artillery systems, armoured vehicle turrets, small arms and related systems and subsystems; OTR is an aircraft and missile test and evaluation complex; Denel PMP (PMP – which is by far the oldest entity within Denel and far predates the creation of the group itself, having been founded in 1931) manufactures small and medium calibre ammunition, brass and copper strip and drill-bits for mining; and Mechem specialises in demining and antismuggling technologies and operations. The Denel Training Academy is the group’s independently accredited instructional institution while Denel Industrial Properties owns and manages the group’s various properties.

The three associated companies are businesses which Denel shares with foreign strategic equity partners. They are Carl Zeiss Optronics (30% held by Denel, with the other 70% belonging to Germany’s Carl Zeiss group; however, Zeiss is selling its defence business, which includes its South African operation, to EADS Cassidian), Rheinmetall Denel Munitions (RDM – 49% held by Denel, 51% by Germany’s Rheinmetall) and Turbomeca Africa (also held 49% by Denel and 51% by France’s Turbomeca, itself part of the Safran group). It should be noted that Turbomeca Africa was created ten years ago, before the turnaround was started. Carl Zeiss Optronics designs and makes optronic imaging devices; RDM produces artillery shells, propellants and pyrotechnics and Turbomeca Africa manufactures parts for, and undertakes the maintenance, repair and overhaul (MRO) of aeroengines.

The turnaround strategy has evolved and adapted since then. Under Sadik, the entities and associated companies were grouped into four clusters – defence (Denel Aviation, Denel Dynamics missiles business, DISS, DLS, PMP and RDM), security (Carl Zeiss Optronics, Denel Dynamics UAV business and Mechem), certification and training (Denel Training Academy and OTB) and, on its own, DAe.

And, under the new CEO, further changes have been made. “We’ve gone through a very logical process. Your strategy predicts your structure,” explains Saloojee. “Originally, the ‘unbundling’ [creation of the business entities] was based on a concept of getting international partners [which resulted in the associated companies]. But there was a debate about whether that is in the interest of the country. There is a recognition that we can’t live in isolation from the world. But it is also recognised that certain capabilities should be sovereign. So certain capabilities should be in South African hands.” Moreover, international partnerships do not have to be equity partnerships.

The defence industrial and technological capabilities that should be sovereign have been identified by the draft Defence Review. They are the ability to develop and manufacture certain secure communications and electronic warfare (EW) equipment and other national security critical systems, to integrate and support secure communications and EW and other critical systems and equipment and to develop and support the necessary algorithms and software for such systems. In addition, the domestic industry must be able to manufacture critical munitions and batteries, manufacture high rate-of-use spares that cannot be stockpiled or obtained from multiple overseas sources, and support, repair and maintain critical systems and equipment.

Moreover, it needs to be able to provide equipment and systems optimised for most African (and especially Southern African) operating environments and the SANDF’s operational style and tempo. Such systems include long-range artillery, wheeled armoured vehicles, tough logistical vehicles and appropriate and effective communications systems.

It was this emerging consensus on the role of the local defence industry that led Denel – the country’s largest defence group – to further adjust its turnaround strategy, which, in turn, has affected its group structure. The loose clusters created under Sadik have now been reorganised and tightened into six divisions (the new structure came into effect on July 1).

“There are two key drivers which influence the new structure we’re putting in place.” says Saloojee. “One, to make sure we optimise our cost base and do away with the duplication that was creating huge overhead costs and which came from the previous [Liebenberg] model. Second, to cluster certain capabilities. On the one campus [in Kempton Park] we’ve now clustered Denel Aviation, our Training Academy and our solutions provider. We’ve also optimised DAe and consolidated support structures. At Irene [south of Pretoria] we’re integrating our UAV capability and our integrated systems solutions capabilities into Denel Dynamics, which gives us high-end solutions for technologies and systems. You can consider our Irene campus as our systems integration facility. We’ve integrated our land systems solutions at Lyttelton [southwest of Pretoria] – DLS and Mechem. It made sense to cluster all our landward capabilities into one facility. PMP will be a standalone company because of its unique site [west of Pretoria].” OTR is also standalone, again because of its unique site near Bredasdorp on the southern coast of the Western Cape province. “All these are divisions of Denel, much more integrated, with lines of responsibility flowing throughout the organisation.” To sum up, these divisions will use the names Denel Aerostructures, Denel Aviation, Denel Dynamics, Denel Land Systems, Denel OTR and Denel PMP.

The associated companies, in which Denel is a minority shareholder, are naturally outside of this structure and will develop autonomously. The takeover of Carl Zeiss Optronics by EADS Cassidian does not faze Saloojee. “Denel has certain pre-emptive rights,” he points out. (This also applies to the other associated companies). “Any changes in strategy, structure and so on will require our approval. Moreover, Cassidian is very focused on the defence and security business. The Carl Zeiss group was not. The defence business was small for them. So the Cassidian takeover could be an opportunity for us. It could give us greater access to more markets,”

Facing the future

The Denel group now has two main areas of effort. One is to ensure that potential orders are converted into actual contracts. The other is to optimise its cost base, to a level appropriate for a company of its size. “These are the main focuses for the next 18 months,” he affirms.

In addition, Denel must look to the future, in technological terms. It must rejuvenate its current products and make sure it invests adequately into research and development and into “new integrated solutions”.

The group also has to explore new market segments. For example, using its system integration capabilities to move into the decision-making support sector, by developing decision support systems and command and control systems, for both military and civilian missions.

Marketing must also be improved and targetted on the most promising markets. “Denel has a good brand name,” highlights Saloojee. “It is well known throughout the world. And some divisions, like Denel Dynamics, Mechem and PMP, are even better branded than the Denel group. The clustering of our entities will allow a much more dynamic branding initiative, but there will be no fundamental change in branding.”

With North America and Europe still mired in recession, the group is seeking to target those parts of the world that are still economically dynamic – or, at least, less affected by the downturn. These include the Middle East, South East Asia and Latin America, where Denel already has a presence. And, of course, Africa. “We’ve got to have a much more robust African strategy,” he asserts.

South Africa’s and Africa’s leading aerospace and defence exposition, Africa Aerospace and Defence (AAD) 2012, which will take place next month, is going to be put to good use by Denel. “We’re very excited at the moment, leading up to AAD. We see it as an opportunity to showcase Denel and launch the new strategic perspective for the company,” he enthuses. “Hopefully, at the show we’ll be announcing new strategic relationships that we’ve managed to secure over the past six months.”

Rare capabilities

“For a country that is a developing country, we have certain key defence technologies here which not many other countries have,” stresses Saloojee. “Also, not many companies in South Africa – or in the developing world – have the technological skills that Denel has. We need to develop and defend the capabilities that support the SANDF and develop skills in South Africa. We also contribute significantly to enhance foreign policy and regional and international security, by working with [South Africa’s] strategic partners.”

However, the company has not been very good in explaining to South Africans its value to the country. “It’s very critical that we position Denel within civil society so that people can understand the value that we bring to the country,” he argues. “South Africans should be proud of Denel. It’s a national asset that needs to be looked after and developed. A defence industry by its very nature is a strategic industry. You’ve got to deal with it as a strategic industry. There is no defence industry that doesn’t enjoy significant support from its government. It’s during difficult times that you need support from government. There needs to be clear recognition of the relationship between Denel, the DoD [Department of Defence] and the SANDF. It’s almost a tripartite alliance!”

At last month’s Denel results presentation, Public Enterprises Minister Malusi Gigaba observed that the government was “committed to the turnaround of Denel. Additional support is being considered carefully. ... It is my view that Denel will remain a State-owned company. I am happy with the performance of the company so far. But there’s clearly a lot of work to be done.”

From the point of view of Denel, on the domestic front there is a need for better planning of defence expenditure and clarity on the funding flow, as well as better understanding of key projects. Ad hoc planning and funding is completely inadequate. There needs to be certainty and integrity in the business plan. There is now an understanding in the DoD and SANDF that such a long-term business model is needed and that it should be allowed time to consolidate.

Internationally, there is huge pressure in markets due to the global recession. But defence expenditure is still increasing, as a percentage of gross domestic product, in many developing and emerging countries. In Africa in particular, there is a realisation that peace and stability are essential for economic development, which is an imperative for the continent. African countries need technologies and systems that will allow them to create safer environments.

“One mustn’t be naïve,” cautions Saloojee. “There will be difficulties in the future. There are long-lead times. Projects will move to the right [be delayed]. There will be defence cuts. We need to be able to deal with the eccentricities of this business. It needs strong leadership and a clear idea of strategy. But I’m quite optimistic about the future of Denel.”

There is a recognition that certain defence industrial capabilities should remain in South African hands
 

Edited by: Creamer Media Reporter
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