Denel Briefing: Update on Implementation of its Turnaround Strategy; with Deputy Minister

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Public Enterprises

16 November 2022
Chairperson: Mr K Magaxa (ANC)
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Meeting Summary

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In this meeting, Denel updated the Committee on implementation of its turnaround strategy. Over the past few years, Denel has been heavily reliant on government to remain in business, with a debt facility of R5.9 billion guarantee being extended and funding of R2.9 billion for debt covering. This was acknowledged as possibly the last funding from government to the entity. For this, the entity's turnaround strategy is more crucial than ever.

Denel had, over the last four months, undergone strategic restructuring. The entity’s strategic intent of the turnaround plan is to reduce dependence on the fiscus to maintain critical strategic and sovereign capabilities. The success of the turnaround plan is premised on the timeous cash inflow of working capital to execute operations and the restructuring costs.

Committee Members said that the presentation needs to be understood for what it is – an organisational re-engineering of the business. However, the presentation is not clear on the role government will play in the turnaround strategy. The Committee alluded to a project where the arms deal manufacturer lost out on an R8 billion deal, notwithstanding the government as the shareholder, and could have offered a guarantee to secure the deal.
 
Members said it is important to make Denel profitable and look at other markets for profitability. Further, Denel must look beyond the Defence Force for opportunities in other new markets, such as on the African continent. The Committee expressed concern over Denel’s failure to mention the entity's efforts of exploring Africa and identifying the African Union as a potential market, as the continent is riddled with a lot of instability. Considerations were made on how the South African government and Parliament can assist Denel in penetrating the African markets.

The Committee said that the implementation of the turnaround plan needs to be monitored so Denel can achieve the desired outcome. Overall, the Members were satisfied with the presentation made by Denel on its strategic framework for turning around the entity.

 

Meeting report

The Chairperson opened the virtual meeting, welcoming the Members and all the guests in attendance. He then handed over to Denel for its presentation.

Briefing by Denel

Mr Michael Kgobe, Acting Chief Executive Officer, Denel SOC Ltd, delivered the first part of the presentation.

He said that Denel had undergone strategic restructuring over the last four months. Currently, the strategy is at its implementation stage. The intention and mandate of the strategic restructuring had been to (i) stabilise the business, (ii) sustain the existing business, and (iii) establish ways in which the business can be grown in the medium-to-long term. As it stands, Denel does not have the luxury of time. As a result, these plans ought to be implemented in the next 12-18 months. The strategy is clear. Strategic and decisive leadership will need to be shown, going forward.

On governance: The executive of Denel had socialised the strategy and approach with several critical instances, which include the following:
(i) The board that had approved the strategy;
(ii) Aligning the Armaments Corporation of South Africa (Armscor) board and the Department of Defence;
(iii) Establishment of a joint committee between Armscor and Denel, to regulate so that the entity's common interests merge with the national interests;
(iv) Intervention on revenue management and footprint of the organisation;

Denel is grateful for the allocations made during the Medium-Term Budget Policy Statement to implement Denel’s turnaround plan.

On financial reporting, there were some outstanding financial statements for 2021/22. These are set to be submitted at the end of November 2022, with the expectation and planning that the audited financial statement will be completed by the end of February 2023. The 2022/23 financials will be submitted by the end of February and audits thereof are to be completed by end of May 2023. By the end of the 2023 financial year, Denel will be on track with the financial reporting requirements.
 
A strategic restructuring and turnaround plan had three phases. The stabilisation of the business has been largely achieved, although it is a continuous process. This allowed Denel to forge forward into the stabilisation phase. There are six key objectives behind this plan, and there is a detailed intervention that addresses these objectives. The key objectives include:
-The reduction of costs and increase in revenue, as without these, the business will not be sustainable or able to move forward;
-Creating a performance drive organisation through talent and performance management;
-Creating a diverse customer base that focuses on tangible profitability;
-Improving procurement processes and contract management whilst driving optimal stock levels;
-Streamlining the planning and production processes to support the effective execution of maintenance;
-Entering into collaboration with key role players in the industry would enhance Denel's product offering.

Chiefly, it is important to ensure that Denel invests in strategic partnerships that will ensure access to markets, access to new technology, and ensure risk-sharing financial models.

The new operating model for Denel is to streamline the business and ensure its efficiency and continuity. This will include migration to a shared services environment, common governance, policy, information technology, and business practices. There needs to be one interface, from six, with the customer market. That will be coordinated from a central system. 

Without the support of Denel, it would not be possible to support the National Defence Force in their mandate to the government in their capabilities, namely: (i) guided weapons, (ii) land, (iii) air, and (iv) integrated systems.

Mr Riaz Saloojee, Chief Restructuring Officer, Denel, said that Denel is the custodian and supplier of the ground-air-based Defence system for the South African Defence Force. From an engineering perspective, Denel is doing level four and five system engineering. Not many companies can create integrated weapons systems into one order user system that will give an air defence capability that secures the air space of South Africa. This is the environment that Denel is looking to diversify. It has engaged with various stakeholders to find ways of enhancing the security systems of various South African facilities such as border control systems, pipelines, etc.   

Currently, Denel is migrating the implementation plan into a new shared services environment. New capability systems are being established as underpinned by business excellence programmes where monitoring, evaluation, and testing of efficacies are executed. This includes relationship management with external strategic stakeholders.

On a day-to-day basis, this strategy is organised to control, tightly manage and evaluate the progress of this new turnaround strategy by:
-The Denel board of directors who are full-heartedly behind the plan;
-The Armscor Committee oversees how Denel can be supported to deliver the capabilities to the Defence Force;
-The Group Executive Committee, as led by the interim Chief Executive Officer;
-The Restructuring Committee as led by the Chief Restructuring Officer, and
-The Extended Executive Committee.

The management and leadership entities are executing the three critical focus areas. The three focus areas for Denel are the (i) internal focus area that looks at how the day-to-day running manages the on-time and on-budget execution of contracts to ensure no money is lost. The next one is (ii) the external focus area, which is concerned with managing and implementing the turnaround plan so that new revenue streams are established and new markets are penetrated. Last is the (iii) restructuring projects, which are looking to ensure the migration of the entity to new the new business model.

Chiefly, the turnaround strategy seeks to decrease dependence on the fiscus and government to maintain its strategic and sovereign capabilities. These need to be funded internally. Securing export revenue streams will assist the entity in maintaining these capabilities. Denel needs to be legitimised again in the eyes of the people and the country, and to gain the confidence of stakeholders about its future vision. Buy-in at all levels is critical. All stakeholders need to understand that Denel is a national resource and capability that needs to be maintained and secured for the future of the country, the National Defence Force, and South Africa’s independence and sovereignty.

The restructuring of Denel is admittedly prone to risks that could hinder the strategy’s success. This includes:
-Insufficient funding for the completion of the restructuring strategy;
-Continued brain drain and loss of critical skills, as no compelling employment offer can be made to the remaining core and scarce skills;
-Unavailable funding to allow Denel to take advantage of the R30 billion export opportunity pipeline;
-Insufficient working capital poses a risk of an insufficient liquidity cycle repeating itself, followed by an inability to fund critical capex and business improvement initiatives.

Ms Thandeka Sabela, Interim Group Financial Officer, Denel, presented the financial information. She said that, as of September 2022, Denel’s revenue had been flat, with a five percent improvement in revenue, accompanied by a gross profit of minus 75%. There had been a non-performance of on-time delivery to suppliers, which had led to penalties. It is for this that Denel is prioritising delivery and performance to clients, so that finances can be improved.

Costs are quite high at Denel, and they need to be managed. Their costs are currently running at 224% against the budget. The net profit has shown improvement, but there is a net loss from operations. The improvement is coming from the exercise of unlocking income from the non-core assets, and not from operational activities. The focus is to ensure the implementation of the structural changes of the turnaround plan, so that improvements may be experienced.

The CEO further stated that Denel had had the opportunity within the African aerospace, which had gone a long way in assisting Denel in communicating its message of a redefined entity. This had yielded encouraging engagements with customers of Denel. With a declining National Defence Force, Denel needs to have engagements that will allow exploration of export markets and grow that side of the business. Denel’s return to stability remains key.

See attached for full details

Discussion

Mr S Gumede (ANC) lamented his wishes to have Denel implement, on the ground, what they presented to the Committee. It seems there is a difference between what is presented and what is practical in reality.

Denel has made commendable strides in the consultative approach to engaging the unions, media, and other stakeholders. This had been effective as some agreements were entered into.

Denel’s strategic framework touches on pertinent issues but also seems to be open-ended, unless this is due to the current plan being for 18 months. It would have been good for the Committee to be presented with milestones so that the Committee could intensify its role as an oversight body.

Further, Denel appears to be too dependent on the fiscus, even though there had been mention of funding. It seems as though the money given to Denel by the state is stringent. Can Denel allay the concerns of the Committee, as to what the money given by the state will be used for?

The sustainability of Denel raises critical issues. It seems as though Denel is not ready to execute the programme if they do not have other funding sources. There seems to be a fluctuation of figures about the pipeline. Can Denel confirm the figure? He further went on to ask if Denel had other sources of funding.

On strategic partnerships, the Member proposed that Denel investigate and give the Committee a presentation. PUPs are an alternative to public-private partnerships premised on the idea that government departments work with each other. This significantly improves costs, as there will be no consultation costs usually charged by the private sector. These costs tend to be exorbitant.
 
The risks were mentioned but no strategies were mentioned on how they will be mitigated and addressed.

State Capture had infested Denel. What strategies have been employed to address State Capture, as it is a legacy issue? Many State-Owned Entities (SOEs) are weak in consequence management.

The Committee was said to be behind Denel’s success, and it hopes the entity will not be a letdown.
 
Mr F Essack (DA) requested that there be an expansion on the sale of non-core assets. What are these assets? How much can Denel guess and estimate will be realised from selling these assets in the next six to twelve months?

The issue of skills loss remains a huge concern for Denel. With the reputation of Denel, how confident is the entity in its ability to attract the quality skills required in the restructuring programme that lies ahead?

On supply chain matters: what is Denel’s turnaround time in paying its suppliers?

Ms R Komane (EFF) cautioned Denel on the importance of the implementation and monitoring of strategies as presented, lamenting that it is not useful to have strategies that are not implementable.

State Capture rears its head often at Denel. What consequence management had been implemented by Denel?

On debt management: how much has been paid? How much is owed? What is the plan for covering the outstanding amount?

Ms J Mkhwanazi (ANC) said that she was covered by Mr Gumede, particularly on the timeframes and the monitoring of the restructuring plan.

Mr N Dlamini (ANC) enquired about the role of government in the re-engineering of Denel. For instance, Denel lost out on an R8 billion project because it had no money, yet it had the government of South Africa as its stakeholder, which could have given guarantees for this. Government needs to understand its role in SOEs, and not focus on false accusations from the opposition that the entities are merely milking money from government. The inverse must be asked: if these SOEs were profitable, what would be the benefit for government? If government shares risks, it should be so for benefits alike.

There seems to be an obsession with the State Capture matter without getting into the bolts and nuts of it. It is important to identify the projects that had state capture at Denel to enable government to know well matters and projects that fall under State Capture.  

Through the presentation made by Denel executives, it is established that Denel needs to get new markets. How is Denel going to identify and exploit such markets?

Moreover, the presentation did not mention exploring Africa and identifying the African Union as a potential market. Whilst there is a lot of instability in the African continent, how can government and Parliament assist Denel in penetrating the African markets?

The presentation made mention of Denel possibly working with the South African Police Services (SAPS) and related state departments. How does the Public Finance Management Act (PFMA) enable these types of inter-governmental engagements, where opportunities may be realised for Denel? Denel was made to be of use to government at its inception. It would be self-defeating if such partnerships could not be realised. 

Denel was further cautioned on downsizing and disposing non-core assets carelessly, as they may prove to be critical for the core existence of the entity. In so doing, perhaps Denel should list these non-core assets and list how the entity has used them. Why were these acquired, if the entity can survive without them?
 
Ms C Phiri (ANC) commended Denel on how their presentation inspired hope for the future. Will the entity make any profits from assisting other government entities?

Ms J Tshabalala (ANC) enquired about the functionality of Denel. Is the entity functioning, currently? What are they doing on a day-to-day basis?

If South Africa was to go to war, would Denel have the capacity to protect South Africa? How much will the new plan for Denel cost? Who will fund the project – is it National Treasury? If National Treasury declines the funding, where is Denel looking for funding? How far is the negotiation process for recapitalisation of the company? Lastly, on the issue of workers: what is the staff complement, currently?

The Chairperson commended Denel on the consistency of the presentation, and the entity’s commitment to ensuring an extensive improvement in the entity. An enquiry on the extent taken by Denel in taking all its stakeholders on the process of implementing its turnaround strategy was made. Are all parties, including unions, on board and sharing similar sentiments as the board and executive?

Moreover, the recommendations made by this Committee after its site visit to Denel in 2019. There was a recommendation made by the Committee Members on diversification. To what extent is Denel trying to consider said recommendation?

Responses from Denel

Mr Kgobe highlighted the importance of implementing the strategy, whilst acknowledging and emphasising Denel’s commitment to implementing the presented strategy. The process is not going to be open-ended; it will be in tranches of 18 months and three-year timeframes.

Regarding the programmes: Denel has not lost any programmes and contracts. The entity had merely been unable to meet its commitments due to liquidity challenges and skills drainage. The execution is the crux of the matter that needs to be attended to.

Denel had a database plan and intervention with its Human Resource Management on past employees interested in returning to Denel, once the salaries issues have been resolved. The plan has not yet been finalised; it is in the consolidation phase.

On Denel's dependence on the fiscus: had the entity not received assistance from the government for recapitalisation, it would have remained impossible for the entity to even conceptualise a turnaround strategy. Therefore, recapitalisation will lay the basis for the rejuvenation of the organisation.

Denel had secured revenue in the pipeline. Currently, it is sitting with an order book of secured orders to the value of R12 billion. The liquidity crisis had prevented and caused delays in Denel's ability to perform its obligations.

Whilst public-private partnerships are important, Denel’s current emphasis is on profitable PUPs. Issues around the Public Finance Management Act need to be addressed, as there are issues that constrain and limit the way Denel can contract.

The identified risks have a management and mitigation process, which is part of the day-to-day process.

Ms Thandeka Sabela stated that the R2.9 billion received is for debt relief. As it stands, in Denel's book, there is a note for R100 million, which is due for redemption by September 2023.

All payment of staff members have been dealt with, and all staff members are paid what is due to them. Denel continues to pay salaries, whilst implementing the turnaround plan.

On supply chain management, Denel's focus is to bring back the trust of suppliers and ensure they are paid on time. Denel recognises that it will be unable to carry forward its mandate without suppliers.

The sale of non-core assets is for properties that have not contributed to Denel’s core business and will not contribute in the future. These sales will be undertaken if the sale does not impact Denel’s objective.

Mr Saloojee confirmed and admitted that African markets have been previously neglected by Denel, and the entity is currently having strategic partnerships on how this can be improved, and ensure that it takes part in stabilising the continent.

On Denel’s capabilities to protect the country, the entity’s responsibility is not to protect the country – that is the mandate of the National Defence Force. Denel’s role is to empower and equip the Defence Force to fulfil that mandate. If the Defence Force does not have enough budget and cannot contract Denel to fund these capabilities, it directly affects the entity’s adaptability to contribute to the defence of South Africa and its people.

Denel’s executive thanked the Committee for supporting Denel as a strategic capability, going forward. It assured them of the commitment to making Denel an efficient and operable entity.

The Committee considered and adopted minutes from the previous meeting.

The meeting was adjourned.
 

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