Research group Forecast International says a new assessment of the South African defence-related industry shows that the industry is on a sound footing that will sustain it in the face of potential uncertainty in the domestic defence market resulting from this year’s general elections.
FI`s researchers say the SA defence sector has been engaged in an ongoing structural transformation for the past two years under the aegis of state-owned holding firm Denel.
In accordance with mandates attached to government recapitalisation efforts valued at $455 million, Denel has proceeded with “restructuring necessary to achieve solvency and profitability.” The plan for restructuring the SA defence sector hinges on leveraging the existing technical strengths of core business units with equity partnerships involving foreign defence enterprises to develop high value-add niche defence enterprises and cement integration into the global defence industrial supply chain.
Forecast International adds that it has identified the formation of equity-for-access partnerships between SA and foreign defence enterprises as the key element in this restructuring plan. “These partnerships entail foreign defence enterprises acquiring controlling or majority stakes in specialised South Africa enterprises, which in turn gain exposure to international defence tenders and receive investment in management, logistic networks, and tech transfers,” it says.
“Since the South African Ministry of Public Enterprise opted to divest from unprofitable domestic defence enterprises and relax regulations on foreign investment in the defence sector in late 2005/early 2006, 10 major acquisitions involving foreign defence enterprises targeting South African enterprises have occurred.
“These equity-for-access partnerships have provided South African firms with greater capital and the opportunity to apply technical advantages in high-growth defence market sectors such as electronic warfare, aerostructures, avionics, unmanned systems, and tactical communications,” FI adds in a summary of the report sent to the media.
“As the dominant entity in the South African defence sector and the enterprise most targeted by foreign equity-for-access acquisition deals, Denel serves as a bellwether for the success of the restructuring plan.
“Since early 2006, Denel has sold 20% of it aerostructures division at a price of R66 million to Saab to form the Denel Saab Aerostructures joint venture; 70% 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% 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, the restructuring plan has begun yielding results: 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.
“The improving balance sheet, increasing focus on international markets, and greater focus on foreign capital and tech transfers will be integral for the SA defence sector in the event the March 2009 general elections result in a disruption of domestic defence spending.
“In the wake of the 1994 general elections, defence spending declined by 39% – from $3.41 billion to $2.1 billion – in 1999.
“While the upcoming elections are not anticipated to yield the paradigm shift in the South African political environment experienced in 1994, it is likely to be characterized by a high degree of political volatility as power is transferred from centre-right to the decidedly left elements of the African National Congress.
“Moreover, the potentially volatile political transition coincides with a reorganization of structure and strategy of the South African military`s procurement agent, Armscor. Amid the rising uncertainty associated with the domestic defence market, the SA defence sector`s strategy to discard self-sufficiency in favour of an industry structure optimised to increase access to the global defence market appears to be a key step in the right direction,” FI adds.