Presentation

to

Portfolio Committee

on

Public Enterprises

Funding

and

Governance Challenges

21 October 2020

INDEX

1. Strategic Relevance

2. Capabilities

3. Critical Governance & Regulatory Processes

4. State Of Business

5. Towards a Renewed Denel

6. Denel Future State Update

7. Risks to Future Sustainability

2

STRATEGIC RELEVANCE

3

The Defence Review, 2015 which is the blue print of Government’s defence policy, classifies Denel as a

national security asset, with the prime purpose of designing, developing, manufacturing and supporting

defence materiel.

In addition, Defence Review expects Denel to:

• Take custodianship of assigned sovereign or strategic defence capabilities, technologies and

abilities, inclusive of those that may be at risk, and the loss thereof would threaten South Africa’s

required defence capability.

• Design, develop, manufacture and support of important capabilities which may not be

commercially viable.

The National Defence Industry Council identified the financial liquidity challenges facing Denel as having

the potential impact of:

• Compromising South Africa’s national security;

• Collapsing the entire defence industry irretrievably;

• Exposing RSA to a mass exodus of skilled personnel in sensitive defence domains to countries

that are not necessarily aligned to our country’s national interests;

• Loss of critical defence capabilities, including sovereign and strategic capabilities.

Hensoldt (Pty)

Ltd (30%)

Rheinmetall

Denel Munition (Pty) Ltd (49%)

Barij Dynamics

LLC (49%)

Pioneer Land

Systems LLC(49%)

Business

units

Associated

companies

Strategic equity partnerships

• R&D and intellectual property development investment of

R550m• Contribution

through Rooivalk in peace-keepinginitiatives

• Knowledge-based value added skills development

• Partnerships with global OEM’s and extensive SADI supply chain

• Exports – foreign currency earnings

• Advanced high technology manufacturing

• Transformation

progressing: 61% ACI

1600 Associated Company Employees

Jobs: 3 032 DenelEmployees

DENEL CAPABILITIES

ArtillerySecurity and

border control

Naval Aerospace InfantryTraining and

other

155mm G6 self-propelled Guns

155mm G5 Towed Guns

105mm Leo Guns

Charges and Propellants

Laser Range Finders

Seeker 200 and 400 UAVs

Light Weapons

Ammunition

MEDDS

Casspir Vehicles

Surveillance Equipment

Mine Clearing

20mm Guns

Umkhonto Missile

DPS-35 Guns

Ammunition

Periscopes

Inflight testing

Aerostructures

Aircraft MRO

Manpower supply

Air-to-Air Missiles

Precision Guided Bombs

UAV Systems

Ejection Cartridges

Aircraft Bombs

Engines and Gearboxes

Stabilized Gimbals

Space

Artisan Qualification

Engineering Training

Mine Clearing Training

Mining Drill Bits

Rocket Motors

Warheads

Energetic Materials

Anti-Armour Missiles

Active Missile Protection

Air Defence Systems

Combat Vehicles

Vehicle Turrets

Machine Guns

Ammunition

Anti Materiel Rifles

Automatic Grenade Launchers

Casspir Vehicles

Pyrotechnics

Laser Range Finders 5

CRITICAL GOVERNANCE & REGULATORY PROCESSES

6

T0 4-12 weeks 3-9 months 9-24 monthsCRITICAL STATUTORY PROCESSES

Denel GroupInternal Governance – ITAC, PPPFA,

PFMA, National Treasury Act

Transactions Approval

Within Threshold

Denel Board Denel GovernanceTransactions Approval

above Threshold

Department of

Public

Enterprises

Confirm Compliance (dti Policy,

DIRCO Policy, PFMA, National

Treasure Reg., PPPFA, S&MFA)

Approve all Transactions

that are material and

significant

National

Conventional

Arms Control

Council

(NCACC)

Authorizes the export of Arms and

establishment of Armaments

Companies in SA and Manages

governance aspect ito International

Arms Control Treaties

Statutory Entity for All arms

related transactions

Department of

Defence (DoD)

Oversees capability and technology

retention in order to provide National

Security

Oversees and participates

through the National

Defence Industrial Council

(NDIC)

ArmscorArmscor manages the utilization of IP

owned by the DoD

Licencing agreement for

transaction involving DoD

owned IP

South Africa

Reserve Bank

(SARB)

Authorizes all in- and outflow of

currency and considers movement of

IP out of the RSA

All international

transactions

National Arms Control Process

Denel Governance

Denel Governance

National Regulation

DOD IP Framework

Agreement

National Regulation

Defence Capability Review

7

STA

TE

OF

BU

SIN

ES

SPeople

• Transitionary Values

• Committed workforce but low morale

• Staff turnover ratio 9.3% (296 exits

from Apr-Aug 2020)

• Salary dispute - Organised Labour

instituted court action for inability to

honour full salary commitment due to

cash flow constraints

• Inability to attract STEM, commercial

Stakeholders

• Limited Defence budget to fund sovereign

capabilities

• Reduced order pipeline

• Change in Banker’s Policy – move away

from military solutions

• Engagements with state agencies re: past

governance breakdowns

Organisation

• World-class design & development

• Poor programme execution & risk

management

• Majority of divisions are loss-making

• Devolve authority to Divisions

• Governance & Risk Management

• Fix balance sheet – liquidity

• Reputation management

Strategic

• Alignment on Denel’s Future State

• Divestment of non-core capabilities

• Sustainable industrialisation through

SEP’s

• 7 Workstreams launched

• Right-size resources to revenue

• Fitch Downgrading, excluded Sovereign

Support

STATE OF BUSINESS (ii)

8

• Closure of loss-making LMT subsidiary, LMT Products (Pty) Limited (was in business rescue (BR) – process

concluded and BRP managed to secure a buyer, thus saving jobs; Denel awaits pay-out of a dividend once the

shares are transferred. Saving another annualised R48m in support costs.

• Overdue creditors reduced by more than 80% (vs 2018/19) and payment plans for the remainder in place.

• Cumulative cost savings in excess of R1bn since April 2018, driven mainly by 27% reduction in employee

numbers.

• State Capture issue – ongoing cooperation with the Commission, scheduled hearing dates 26th to 31st October

2020 and 9th to 13th November 2020.

• Hensoldt: Inability to meet conditions by 30/9/20 resulted in lapsed sale of shares

• COVID-19 Impact:

o Revenue delays due to Arms Control Authority not issuing contracting permits on time.

o Supplier delivery impacted negatively.

o Employee disruptions - health, travel and business interruptions

o To date – 60 positive cases recorded, with 55 recoveries and two active cases. Sadly, three employees

succumbed to the virus.

o Ongoing awareness campaigns

STATE OF BUSINESS (iii)

9

• Human Capital:

o Our headcount as at 31 August 2020 was 3032.

o Some 296 employees have left the company from April to date.

o Inability to pay full salaries (R391m) and statutory obligations has led to low staff morale, lawsuit

due to be heard on 3rd December 2020 and threat of lawsuit by the Pension Fund (Denret).

o Relations with organised labour has been strained due to inability to honour contractual

obligations in terms of salary payments to a point where Solidarity and UASA took us to court.

o Threatening to take us to the CCMA for failure to pay full salaries in some of the Divisions for

August and September.

o Engagements with organised labour are ongoing.

o Recruitment process of the permanent Group CEO is underway.

STATE OF BUSINESS (iv)

10

• Hoefyster Programme Status:

o Technical alignment on compliance against the Armscor specification is achieved.

o Positive feedback from the SANDF following a successful Badger Section Variant Preliminary

Operational Test & Evaluation.

Way Forward:

o Stakeholders to support acceptance and approval of the development baseline for Section

Variant

o Support and expedite the contract amendment for Phase 2 (Production) to align the contract

with current realities (budget and schedule), this amendment has far reaching commercial

implications across the industry (both local and foreign).

9

STATE OF BUSINESS (v):

SOVEREIGN & STRATEGIC CAPABILITIES FUNDING GAP

Capability 2020/21 2021/22 2022/23 2023/24 2024/25

Denel Land Systems

Artillery Main Weapon 20 17 17 17 20

Ballistic Simulation 6 3 3 3 6

Fire Directing and Control 27 24 24 24 27

Gun Command and Control 20 18 21 21 24

Ammunition Handling and Gun Control 20 17 17 17 20

PMP

Medium Calibre Ammunition 14 15 16 17 18

Small Arms Ammunition 52 56 59 63 67

Denel Aeronautics

Component MRO 22 22 22 22 22

Engineering & Continued Airworthiness 13 13 13 13 13

Aero Engines 16 16 16 16 16

Denel Dynamics

Missiles - Sovereign Capability 433 410 312 186 132

OTR

Capital replacement 40 24 80 32 35

Total 683 635 600 431 400

STATE OF BUSINESS (vi)

12

• DEBT (DMTN Programme, JSE-listed)

– PIC rolled UIF bonds of R2,488bn for a further 12 months and Sygnia (R15m).

– NT & DPE supported DENEL to pay its quarterly interest of R51m to all investors and capital

redemption amounts for two of our five investors, namely Vunani (R132m) and Aluwani (50m).

– This was released from the MTEF-allocated funds of R576m and hence R271m remains.

• STAKEHOLDERS

– Interactions have increased; closer interaction through SecDef with DoD, Armscor & SANDF;

– DPE and NT weekly & monthly meetings continue; and

– Inter-Ministerial Task Team to resolve Hoefyster under leadership of Deputy Minister of DoD.

• FUTURE DENEL – Denel Future State submitted to DPE Shareholder; awaiting response

• SUPPLY CHAIN RECOVERY PROJECT – Inventory analysis for optimal cost recovery, Reducing

Supply Vulnerability. COVID-19 related spend YTD R3m.

• ASSOCIATES – Barij Dynamics (previously Tawazun); RDM (49%); Hensoldt (30%)

Shareholder Agreements being reviewed to assess Return on Investment KPIs and realisation of

value through reciprocal business opportunities. Some of these have not been reviewed since the

SEPs were concluded.

STATE OF BUSINESS (vii)

13

• Unaudited loss of R1.8bn in

FY2019/20, due to significant

decline in revenue and poor

programme management

• Denel’s equity significantly below

levels (R4bn) required by

investors and SOC’s assets

predominantly funded by debt

• Equity level decreased

substantially despite equity

injection of R1.8bn disbursed in

FY2019/20

• Received R305m of the R576m

allocated to Denel in FY2020/21

MTEF cycle (use for debt ONLY)

- Redemption payments – R183m

- Interest – R123m

Amount remaining – R271m

STATE OF BUSINESS (viii)AGSA AUDIT FY19: FINDINGS

14

Area of Focus FY2018/19 FY2017/18 FY2016/17 FY2015/16 FY2014/15 FY2013/14

Annual Financial

Statements

Disclaimer

(various

matters)

Disclaimer (various

matters)

Unqualified

(material

uncertainty

on going

concern)

Unqualified Unqualified Unqualified

Predetermined

Objectives

Disclaimer Disclaimer Unqualified Unqualified Unqualified Unqualified

Compliance Disclaimer Disclaimer Unqualified Unqualified Unqualified Unqualified

External

Auditors

AGSA Nkonki Chartered

Accountants,

Appointed, started

audit then replaced

by AGSA in

04/2018

Sizwe

Ntsaluba

Gobodo

Sizwe

Ntsaluba

Gobodo

Sizwe

Ntsaluba

Gobodo

Sizwe

Ntsaluba

Gobodo

TOWARDS A ‘RENEWED’ DENEL – REFLECTING BACK

15

2,404 2,471

2,153

2,550

3,346 3,616

-

500

1 000

1 500

2 000

2 500

3 000

3 500

4 000

2020 2021 2022 2023 2024 2025

Revenue CP 2020/21 - 2024/25

• Declining local budget and decline in defence

spending (Armscor reduced by over 40%)

• Non-alignment and expectations from key

stakeholders

• Unsustainable cost structure vs revenue

• Unsustainable debt

• Poor programme management

• Poor working capital management (stock, debtors &

cash)

• Lack of appropriate commercial & contracting skills

• Sub-optimal relationship with SEPs

TRANSITIONAL PERIOD - WORK STREAMS

16

1. Alignment

2. Business Development

3. Communication

4. Financial Sustainability

5. People

6. Programme Execution

7. Strategy

17

RENEWED DENEL: FUTURE STATE

CAPABILITIES TO RETAIN / FIX / GROW

and consider PARTNERSHIPS

Land Systems

• Infantry Systems

• Artillery Systems

• Infantry Weapons

Vehicle Systems

• Armoured Vehicles

• Mechatronics

Aeronautics

• Military Aircraft & Engine – MRO

• Systems Integration and Upgrades

• Rooivalk Helicopter

Dynamics

• Missiles

• Precision Guided Munitions (PGM’s)

• Unmanned Aerial Vehicles (UAVs)

• Integrated Systems Solutions (ISS)

• Cyber Solutions

Pretoria Metal Pressing (PMP)

• Small & Medium Calibre Munitions

RECAPACITATE / UPGRADE

Overberg Test Range (OTR) • Test & Evaluation Facilities

EXIT / DIVEST

Aerostructures

LMT Products (Vehicles) – sold through BRP

LMT Holdings

Spaceteq

Hensoldt Optronics

Gear Ratio (DVS)

Mechem (DLS)

Properties

CURRENT DENEL ASSOCIATES

Rheinmetall Denel Munitions• Large Munitions

Barij Dynamics (UAE)• Precision Guided Munitions (PGM’s)

• Achieve financial sustainability in

short term.

• Supported by a competitive coherent

internal or accessible capability

system.

• Have acceptable market access or

have secured long-term strategic

funding.

• Consideration must be given to meet

sovereign/strategic capability requirements.

KEY CORE / NON-CORE

BUSINESS CRITERIA

Rationale for seeking potential

investors includes the following:

• Market penetration

• Technology injection

• Raising capital

• Retaining / sustaining strategic and

sovereign capability for the SANDF in

a scenario of declining budget

• Job retention / growth of STEM skills

PARTNERSHIP VALUE

CRITERIA

The assessment of Denel’s business areas against the requirements, market and industry

resulted in a need to reshape and redirect Denel with the following key initiatives and criteria:

KEY RISKS TO FUTURE STATEOperational

• Recall of advance payments received on Hoefyster:

o Received R2.8bn in advance payments, of which R1.935bn relates to the Hoefyster project.

o Denel has c. R800m in stock & WIP against this prepayment; cannot repay if contract is cancelled/executed

at negative margins.

• Loss of critical staff:

o Non-payment of salaries has led to the loss of key technical staff in some divisions.

o Challenge remains in retaining core skills capabilities and delivery to clients.

• Liquidity constraints and working capital:

o Average working capital requirement of c.R370m p.m. to ensure operations run smoothly.

o Covid-19 impact further delayed strategic actions of turnaround – e.g. Hensoldt sale suspended, NCACC

permits outstanding and exports not being shipped.

o Lenders Group unwilling to advance funding for projects and maintain status quo; application for bridge

funding declined - funds be repaid by recapitalisation funds; all funding be government-guaranteed.

o Debt providers, creditors and employees for inability to pay full salaries to ALL employees since April 2020.

o Liquidity in first 12 months further negatively impacted by outstanding legacy obligations of R866m that still

require payment but make no contribution to the financial recovery of the company. Creditors at R715m (30

Aug 20), R537m is over 120 days.

18

KEY RISKS TO FUTURE STATE

Strategic

• Strategic Equity Partnerships:

o Negotiation, stakeholder alignment and PFMA approval may not be achieved in time to stop

untenable decline in Denel

o Geo-Political considerations / uncertainties may cause unusual delays in approval process

o Denel’s proposed value propositions may achieve less investment value than expected

• Reputation:

o Denel’s tainted reputation in the local and global market create a significant barrier to re-entry

o Key supplier reluctance to be in Denel’s redeveloped supply chain – extra cost / upfront payment

• Alignment Issues:

o Key customers especially DoD / Armscor: Hoefyster, Sovereign Capabilities

o NCACC for marketing and export permit approval

19

THANK YOU