Is Denel too strategic to fail?


Denel, once a promising conglomerate perceived as a potential major in the aerospace and defence (A&D) sector, is currently facing deep troubles.

Although the group made in 2015 its entry into the Top 100 Global Defence Companies list and managed the following year to reach 84th place, its defence revenues have since suffered a steep 39% decrease in 2018 to R4.9 billion. The company has since failed to fully pay its employees on several occasions starting late 2017, and its future now lies in the hands of a massive government bailout.
One reason behind such a downfall was the decision to create a Joint Venture with the Asian branch of VR Laser (armoured vehicles maker) as it decided to bet on the substantial increase of defence spending in the Asia-Pacific markets. The move was made in order to compensate for South Africa’s progressive decrease of its military budget, although the targeted company for such an expansion turned out to be a costly and unproductive acquisition. The firm in question was linked to the Guptas, an influential Indian family which was regularly accused of acting as a ‘shadow government’ in South Africa due to its links with former President Jacob Zuma. Following reports of the Gupta’s alleged attempt to steel contracts away from Denel’s subsidiaries, public pressure dramatically increased until Denel finally decided in August 2017 to exit the joint-venture, eventually wasting the R300 million it had invested as the project turned up to be entirely unproductive.
However, Denel’s issues actually have deeper roots. Its accounting culture was indeed quite poor, facilitated as it was by the government’s eagerness to extend credit lines. A report conducted by the post-Zuma administration also unveiled in August 2018 that Denel was plagued with “rampant corruption at the highest level of the organization” along with “major contracts running well behind schedule and significant cost overruns”. Pravin Gordhan, then the newly appointed minister of public enterprises, added that the group owed roughly R1 billion to its suppliers, many of which have stopped deliveries since.
Following the ‘too big to fail’ principle which regularly applies to A&D companies given their strategic importance, it soon turned out that the South African administration would try to save a company that was seen just a few years prior as a future national champion. Another important fact, as noted recently by local defence journalist Darren Olivier (African Defence Review), is that Denel sits on several billion rand’s worth of bonds which are mainly government guaranteed, meaning that it would have to be covered by the taxpayer in the event of a bankruptcy.
A turnaround plan, involving an intensive management renewal, was thus laid out as the year ended, although the group still decided to bet on further joint-ventures in order to secure foreign contracts. As expected, overall revenues decreased substantially over the 2017/2018 period. The appointment of new personnel thus started in December with the nomination of Daniel Du Toit, a former Directing manager at Saab Medav Technologies (military communications) as the group’s new CEO. This first initiative was followed in July 2019 with the appointment of Khohlong William Hlakoane as COO, and in early September with the arrival of new CFO Carmen Legrange which benefitted from a strong experience in advisory consulting, including a ten-years’ long term at Price Water House Coopers.
Several decisions were also taken from January onwards in order to restructure the company’s finances. As unveiled by Jane’s in February, Danie du Toit decided to renegotiate several ‘onerous’ contracts while also seeking equity partners in some of their core division in an attempt to raise more cash. Such moves however would not be enough stop the company’s drastic decline, and further decisions had to be taken, especially since Denel intended to ask the government for a recapitalization which would require several spending cuts in order to be effective. Several additional steps, including the implementation of a voluntary severance package program to reduce its staff costs and the negotiation of further orders from the Department of Defence, were therefore taken a month later as Denel intended to require nothing less than R2.8 billion from the government. Several subsidiaries, namely Spaceteq (satellites), Mechem (armoured vehicles) and Hensoldt Optronics, were also considered for partial divestment, along with a potential termination of Land Mobility Technologies’ (armoured vehicles) activities and a complete sale of PMP, a small-calibre ammunition maker. Overall Denel thus hopes to gather up more than R150 million with this divestment plan, as reported by Reuters in early September.
Daniel Du Toit has meanwhile stated on 10 September that Denel was now bidding for a R3 billion contract with an undisclosed customer, including a much-needed R1.5 billion in advance payment. The new CEO also boldly stated that he could raise more than R1.5 billion from several equity partnerships, a much higher number than the R150 million announced previously by Reuters. Most importantly, the government approved on 31 August the bailout plan, although it decided to only inject R1.8 billion instead of the R2.8 billion initially asked by Danie du Toit. The amount is still significant, and the implementation of new executives in order to re-orient the group’s business practices seems to be going in the right way. Further developments will be of high interest here, as Denel’s story is already full of teachings when it comes to the confrontation of economic and strategic responsibilities in a tense political environment.
Written by ADIT – The Bulletin and republished with permission.