"Denel Restructuring and Announcement of preferred Strategic Equity Partners"
Cape Town, 12 October 2000
It is with great pleasure that I am able to announce the details of yesterday's Cabinet decisions concerning Denel restructuring. The decisions are grouped into three packets:
As we are all aware, the last two years has witnessed a rapid reshaping of the International Aerospace Industry, marked by consolidations and mergers. This was due mainly to the decrease in defence spending in the world and rising costs of developing defence system platforms, e.g. Fighter Aircraft. This has resulted in the forming of very large defence companies in the world and has created a very competitive defence market. Although Denel is a small player in comparative terms, it enjoys a strong share of the competitive edge in a number of niche areas. It has increasingly turned its attention to the international export market for military and commercial requirements that has matched the decrease in domestic procurement. Increasing R+D, the termination of GEIS, market consolidation, increasing trends towards offset and industrial participation, and international exposure has led to increased pressure on Denel to reorganise, restructure and reposition itself accordingly.
In short, the restructuring priorities of Denel have included a combination of strategies to ensure internal reorganisation, renewed focus on financial and executive management, and, critically, discussions to secure appropriate strategic equity partners primarily for our aerospace and ordnance groups and some of its divisions.
It was with careful analysis of these external factors, Denel's own niche capabilities and strengths, and an assessment of real benefits to the South African economy that Cabinet has approved the selection of the following preferred strategic equity partner and equity partners for Denel aerospace and ordnance groups and some of its divisions, namely:
I will now deal with each of these decisions separately.
BAE SYSTEMS has been selected as the preferred Strategic Equity Partner for Denel Aerospace at the group level inclusive of all Denel aerospace divisions, with the exception of Houwteq. Negotiations between BAE Systems and Denel will aim to produce joint business plans that will be presented to Government before the shareholders agreement is signed between the two parties. Notwithstanding ongoing discussions with SAA Technical, DATAM will remain consolidated and BAE Systems will be given an opportunity as the equity partner to secure transport aircraft maintenance business for DATAM to the required levels. Depending on the outcome of BAE Systems discussions, DATAM's future will then be decided upon.
Government is of the view that the bulk of the technology, R+D, productive capacity and assets of Denel Aerospace are militarily-critical technologies to the country as a whole and thus envisage that BAE Systems would become a minority share partner in Aerospace. Previously announced figures have indicated a possible share of 20%, but we would view this as a negotiating point and will not fix a limit at this stage.
You will recall that Denel recently received a number of workshare contracts from BAE SYSTEMS and Saab, which form part of their combined Defence Industrial Participation programme linked to Government's purchase of Hawk and Gripen aircraft for the SA Air Force. However, Denel's restructuring and the selection of a strategic equity partner was deliberately ring-fenced and separated from the Government's strategic defence procurement programme. Both of these processes are of vital strategic importance to South Africa and as Government, we could not afford to let either process prejudice the outcome of the other, for this reason we decided to keep them separate.
However, when it came to evaluating prospective strategic equity partners for Denel's aerospace and ordnance divisions, we were able to identify a greater number of commercial and industrial synergies with BAE SYSTEMS that give strategic benefits to Denel and the State as Denel's major shareholder, compared to other groups and companies we approached.
Allow me to elucidate the strategic commonalities between Denel and BAE SYSTEMS. Denel is South Africa's largest state-owned systems, defence and aerospace company with a diverse industrial capability and advanced technological skill with an extensive infrastructure, marketing in over 70 countries internationally. It's annual export sales are worth R1, 269 billion to date. Denel arguably is the largest contributor to South Africa's income through the export of value-added manufactured goods.
BAE SYSTEMS, a global systems defence and aerospace company with home markets in nine countries around the world and annual sales worth R120 billion. It is listed on the FTSE 100 and was created through the merger of British Aerospace and Marconi Electronic Systems in November 1999, in a move that expanded the group's combined industrial capability and more importantly, its breadth in terms of international market position.
Unlike most other regional and international manufacturers, Denel, like BAE SYSTEMS, is a broad-based defence and aerospace business with a full range of products and capabilities for the land, sea and air markets. Government views a Denel-BAE SYSTEMS partnership as a long term strategic relationship between complimentary and well matched companies, it will facilitate further growth of South African Aerospace and defence exports and stimulate new investment in South African and its engineering and technological skills base. We are able to complement each other's niche capacities in interesting ways and which the two companies have already identified.
The Rooivalk Attack Helicopter will be part of the portfolio of the new aerospace company and the Rooivalk option analysis between the Minister of Defence, Armscor, and the SAAF will be completed shortly to inform the negotiation between the two companies. The Rooivalk represents South Africa's ability to develop systems level platforms of world quality and brings an intrinsic value to the partnership that we would prefer to see moving forward.
At this point let me turn to outline the proposal for Denel's Airmotive division of Aerospace. We have identified Snecma/Turbomeca as the preferred equity partner for Airmotive. As a result, the incorporation of Airmotive will proceed as a matter or urgency. There is no conflict of interest between BAE Systems operating as the SEP at the group level, and Turbomeca at the division level, as former does not have the equivalent capacity in the area of expertise. Similarly, cooperation between the two companies within Europe is well established and productive.
Denel Airmotive is responsible for the maintenance and repair of engines and components for the majority of the aircraft in the South African Air Force. The emphasis of the maintenance work has shifted to helicopter engines, including work on civil helicopters flying in Africa and civil engines subcontracted to Airmotive by Turbomeca who have licensed Airmotive to do the work. Airmotive has developed with SNECMA and the French Air Force a support and logistics program for the Atar engines flying in the Mirage and Cheetah aircraft, allowing Airmotive to give the SAAF a more cost effective service and benchmarking against the worldwide fleet of engines. As a result of this Airmotive was recently granted the licence for worldwide support on the Atar 09C and 09K50 engines outside the French Air Force.
Airmotive and SNECMA also had a joint development program for the Atar engines, enhancing the performance and giving the engines longer life between overhauls. This was SNECMA's first collaboration program outside of France and will give Airmotive a lucrative export opportunity over the next 5 to 8 years.
Airmotive's major manufacturing activity is the manufacturing, assembly and maintenance of accessory gearboxes for SNECMA, Turbomeca and Rolls-Royce and all the gearboxes for the Rooivalk. Resulting from Airmotive manufacturing the Topaz engine (which is a licensed derivative of the Makila engine) for the Oryx helicopters, Airmotive has established itself as the only turbine engine manufacturer on the African continent, manufacturing engine parts for SNECMA, Turbomeca and Rolls-Royce.
Airmotive needs an equity partner in the Aero engine and gearbox business. Although the industrial participation programs will bring work for the next 5 to 7 years, to remain competitive enough to be a player in the international markets with a sustainable workload and job opportunities (proprietary), technology transfer is required from the original equipment manufacturers (O.E.M.'s). The SNECMA group, which includes Turbomeca, is the main engine development and manufacturing company and maintenance facility in Europe. Their product range covers military aircraft and helicopters as well as civil helicopters and civil aircraft engines (of which the most important engine is the CFM-56 engine for the Boeing 737 and Airbus 320 range). They are also involved in joint venture companies with Rolls-Royce of the UK and General Electric of the USA in these market segments.
The Turbomeca division of SNECMA is the largest manufacturer of helicopter engines in the civil market worldwide and the largest in the military market outside the USA, with a market share of 30%. Turbomeca has 8 subsidiary companies and 31 repair facilities throughout the world and supports a philosophy of backing up all maintenance facilities, ensuring total market coverage and optimised customer support. Manufacturing of all their engines takes place in France.
Airmotive will become the maintenance facility for the African continent for helicopter engines, and the second source manufacturing facility for the Makila engines (Oryx and Rooivalk in the SAAF) and the Arrius engines (A109- LUH for SAAF) and parts for other engines as backup for the French factories of Turbomeca and SNECMA.
The nature of Airmotive's work, its mix of commercial and military application, identifies it as not having the same significant in militarily- critical technologies as the rest of the aerospace group. Hence, in this instance, government is prepared to negotiate the cession of a majority share to Turbomeca in a manner that is satisfactory to both parties.
With reference to the Ordnance Group within Denel, Cabinet has decided to invite BAE Systems to engage in discussion with a view to being a potential SEP at the group level, excluding Swartklip and Mechem. The international ordnance companies are still in a state of flux, but we are confident that, with the discussions we have already had, we will be able to speed up the process of concluding an agreement on Ordnance, again to the satisfaction of both parties.
The cabinet has, however, decided to invite Pains Wessex Defence to enter into discussions with them to take an equity share in Swartklip and to sell an equity share to a Black Empowerment Group.
The Denel Swartklip Divisions core business is in the manufacture of Pyrotechnic products. Pains Wessex Defence is a British pyrotechnic manufacturer and part of the Chemring Group plc. It also manufactures pyrotechnic and a wide range of countermeasures products and is a global player. They sell their products in over 60 countries worldwide. Pains Wessex Defence will add value to Swartklip for all shareholders through technology transfer, skill development, market access, increased workload in the factory, investment and sharing of R&D costs in developing new products. This will also increase Swartklip's competitiveness and sustainability.
Fourthly Cabinet approved the selling of Denel's Mechem Division to the CSIR for just over R10m. Mechem has been struggling for some time now to make its way financially. However, a great deal of its work, although military related is located mainly within the research and development arena, and would fit more comfortably within the CSIR environment. The major area here is the well-known demining and vehicle development capacity of Mechem. The weapons and explosive business units of Mechem, will however be relocated within Denel Ordnance.
Mechem remains one of the critically important centres of excellence within the defence related industry family. It is world renowned for its demining work, and this factor has played an important role in ensuring that the option of closing Mechem down was never considered seriously by government.
The Airmotive Sand Foundry started life in 1975 as the Telcast Foundry to supply high integrity, ie high tolerance and high metallurgical properties, castings for the defence industry. The Sand Foundry produced light alloy castings and concentrated on engine and gearbox castings. Decline in defence requirements forced a change in technological application in 1996 to cheaper and environmentally friendly "green sand" processes that did not use chemicals. However, the tolerance levels of the final product are significantly lower. The market for the products shrank considerably. In effect, the foundry operates as sand foundry that is now dormant, the commercial investment foundry that operates below scale, and the aerospace investment foundry that produces casting work requiring a high-technology facility capable of accurate alloy preparation, vacuum melting and casting. It is working well, with a number of long-term contracts being executed for Rolls Royce and Snecma.
Thus, the decision is to separate the activities of the dormant sand foundry and the commercial investment section from the aerospace investment foundry. The former two will be sold as a going concern, and discussions are taking place with international and local interests. The aerospace section remains intact and within the Denel fold.
I will shortly appoint a high-powered negotiating team or teams with the necessary technical expertise and practical know-how to manage the negotiations relating to the possible sale, strategic equity partnering or transactions involving the Aerospace Group, Airmotive, Swartklip and Ordnance. International consultants who will operate within clearly defined mandates will assist the teams and they will need to report to government on progress and the manner in which the mandate is honoured. Government is committed to maintain the highest integrity in this process.
A great deal of work has already gone into the various proposals and I am encouraged by the commitment of the parties I have identified to execute the negotiations as speedily as possible. Thus I expect the negotiation phase of the processes to be completed within the current financial year, or by the end of March 2001. My request to Denel is to begin discussions immediately with the prospective partners with a view to completing the work as soon as possible.
I am not going to speculate today about the financial side of the transactions, or to indicate government's initial estimates of the value of the proposed equity shares. Those figures are subject to a whole range of interlocking and diverse arrangements that will need to be reflected in the shareholders agreements that are agreed upon in each instance. Government will ensure that we secure the greatest value possible out of what we know are going to be complex discussions.
The question of job creation prospects and possible retrenchment has also been addressed. Denel has engaged, and continues to engage with labour, through the NFA structures and the RTCC within Denel, over this sensitive issue. Government re-emphasises our commitment is to ensure maximum job retention, and to confirm that the joint business plans that will be submitted contain very clear evidence of job creation possibilities within the new entities.
Lastly I would like to take this opportunity to thank the Denel Board and management for the manner in which they have undertaken this complex task. The employees of the company deserve enormous credit for there perseverance during this difficult time to reposition Denel. I also want to thank my staff in the department for there relentless effort in this process. The shifts in what has been called the ownership jigsaw within the European defence industry over the last two to three years are phenomenal. The teams that have had to analyse and assess the developments have always been hunting a moving target. And it continues to move, almost on a weekly basis. However, we believe that the time is now ripe to take advantage of the new developments for the longer-term viability and success of South Africa's domestic defence related industries. We trust also, that the announcements today will go some way to encouraging further rationalisation here at home.
This is a big day indeed for Denel, and I believe for the equity partners as well as they embark on an important process of showing confidence in South Africa and in our continent in an area whose lifeblood is high-tech research and development, in a highly competitive world. My congratulations to all preferred and invited potential equity partners for Denel, I am looking forward to a constructive process between all parties.
Chantal Dhoda
College Hill Investor Relations
Tel: +27 (0) 11 447 3030
Fax: +27 (0) 11 447 6910/1
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