Creating a Viable Denel Presentation to Parliament Joint Meeting of the Portfolio Committee on...

Creating a Viable Denel

Presentation to Parliament

Joint Meeting of the Portfolio Committee on Public Enterprises and the Select Committee on Labour and Public Enterprises

18 October 2005

2

Agenda

Group Overview

• Situation/Business Analysis

• Financial Update

• Strategy Update

3

2004/5 Group Income Statement versus Budget

2004/5 Actual Rm

2004/5 Budget Rm

Variance % to 04/05 Actual Rm

Revenue 3 784 4 252 (11)

Profit (loss) before tax*not final

(850)* (381) (203)

4

OUR CHALLENGE

• Becoming a profitable, commercially viable and dynamic entity

• Delivering consistent, real growth

• Attracting, developing, retaining and appropriately rewarding world class skills

• Achieving world class productivity

• Focusing on the areas where we can compete credibly

• Partnering with the state agencies to meet the defence needs of the country

• Developing partnerships/alliance ventures with true value add

‘Fixing’ Denel means . . .

5

• If we want to compete in the open market, we must behave like the best in the open market (systems, processes, governance, marketing, equipment, commercial culture etc.)

• We cannot achieve world class results and delivery with a ‘subsidy mindset’ – this mindset, will continue to support mediocrity in everything we do and are.

• Anything other than world class will not cut it!

‘Fixing’ Denel means . . .

6

WHO ARE WE ?

• We need to decide who we are and stick to the game plan

• This calls for a reality check, based on facts

• The mind-shift required for this process will take ‘courage’

7

SINGLE VISION – ANYTHING ELSE WILL NOT HELP

President and

Cabinet

Denel Executive

team

Portfolio Ministers – DPE,

DOD, Foreign Affairs, Finance

Denel Board

From: Misalignment amongst stakeholders To: Single vision and purpose

One team

• President and Cabinet

• Portfolio Ministers

• Denel Board

• Denel Executive team

8

KEY MESSAGES

1. Much of the global defence spend is inaccessible to independent contractors, making players highly reliant on their domestic markets. Furthermore, changes in the industry are forcing players to consolidate, build alliances and carefully focus their businesses

9

390

650

450

360*

1 850*

ALTHOUGH GLOBAL DEFENCE PROCUREMENT IS A $360B MARKET…

Total budget Defence procurement

OtherOperations and maintenance

Personnel

$b, 2010

*Budget breakdown assuming US FY2004 proportions

Source: US Department of Defence; team analysis

Estimated world-wide defence spending

10

. . . MUCH OF THE GLOBAL DEFENCE SPEND IS NOT DIRECTLY ACCESSIBLE TO INDEPENDENT CONTRACTORS SUCH AS DENEL

Total spend on products in which Denel participates

Rest of World

NATO excluding USA

USA

$b

*FY2000 awards

Source: Forecast International; World bank; team analysis

• Near impossible for independent contractors to serve USA and NATO countries

• Competition to serve remaining markets is intense:– Exports from major

US and European players

– Development of domestic industries (e.g., India, Israel)

– Political constraints and alignments

~55

~81

~170

~190

~34

~360

23% 9% 15%

ROUGH ESTIMATES

100%

Total military purchases

Spend on products in which Denel does not participate

47%53%

Contracts awarded by US Department of Defence*

US companies 89%NATO companies 11%Other companies 0%

NATO land vehicle example

National companies 76%Other NATO companies 22%Non-NATO companies 2%

11

1. Players dependent on captive markets

2. R&D is a core part of the revenue model

3. Scale is essential

4. Pure export businesses are seldom viable

Implications for defence contractors

Characteristics of the defence industry

MOST DEFENCE CONTRACTORS DEPEND ON A CAPTIVE DOMESTIC MARKET TO ACHIEVE THE NECESSARY SCALE

Source: McKinsey

Long business cycle

Development intensive

Strategic

12

THE GLOBAL DOMESTIC DEFENCE INDUSTRY HAS UNDERGONE SIGNIFICANT CHANGE OVER THE PAST DECADE, AND THE PACE OF CHANGE WILL INCREASE

Source: McKinsey

Changing nature of conflicts and shifting customer needs

Declining defence spend

• Lengthening product life cycles and reducing demand for new platforms

• Shift to smaller, more mobile weapons and increasing use of electronics

• Increasing consolidation to achieve minimum scale

• Smaller players forming global alliances and focusing on:

–Supply of systems, sub-systems and components to alliance partners

–Fulfilling maintenance and upgrade role for domestic customer

ImplicationsForces for change

13

DEFENCE BUDGETS HAVE DECLINED, MAKING IT HARDER TO COMPETE IN THE TRADITIONAL PLATFORM SALES BUSINESS

*Including USA?

Source: Forecast International; IISS, McKinsey A&D practice; team analysis

Defence Budget% of GDP

1985

3.1 3.1 3.3 3.76.0

1998

2000

2003

5.12.2 2.2 2.6 2.8

7.14.1 4.1 3.2 3.2

USA

NATO*

Rest of World

General shift from platforms to services

2002

1985

1998

2000

2003

2002

1985

1998

2000

2003

2002

• Lower budgets are increasing systems’ life requirements, driving growth for upgrades and services (e.g., leasing)

• Military is increasingly outsourcing maintenance to drive efficiency and focus on front-line

• Reduced budgets, coupled with lower threat levels and dearth of breakthrough technology results in fewer new systems sales

14

SIMILARLY, SHIFTING MARKET REQUIREMENTS ARE DRIVING A MOVE TO MORE MOBILE TECHNOLOGIES

Source: Forecast International; McKinsey A&D practice

Major market shifts

• Long-term shift from heavy vehicles and large calibre to lighter vehicles, smaller calibre weapons and reconnaissance technologies

• Network-centric warfare, C4I set to shift growth from large hardware to components, software and integration businesses

Historic environment

Open range battlefields

Old military structures

Military block scenarios

Current and future environment

Increased importance of urban battle-grounds

New missions – peacekeeping, out-of-area

New scenarios – terrorism, drug wars

Shift to mobile weapons and electronic technologies

15

DECLINING DEFENCE SPEND AND INCREASING R&D COSTS HAVE DRIVEN CONSOLIDATION OF PRIME CONTRACTORS ACROSS ALL SECTORS

Source: McKinsey A&D practice

In 1992, the US Defence Department encouraged manufacturers to merge in order to cope with drastic budget cuts:

“By 1996, American defence budget expenditure on equipment procurement and R&D will fall by over 40%, from 117 to 68 billion dollars”

1992: Over 30 companies 2005: Five consolidated groups

• Lockheed Martin• General Dynamics A/C• Martin Marietta GE

Aerospace• Loral • Computer Affiliated Svc. Inc.• L-3 Communications**• Rockwell Aerospace• McDonnell Douglas• Hughes Space• Continental Graphics• Jeppesen• Flight Safety Training• Raytheon• BAE Corp Jets• E-Systems• Texas Instruments (Def.)• Hughes Defense• General Dynamics• Bath Iron Works• NASSCO Holds.• Gulfstream • GTE Gov't Sys• Primex• Galaxy Aerosp.• Motorola IISG• GM Defense• Veridian• Northrop Grumman• Grumman• Westinghouse ESD• Logicon• Litton• Aerojet EIS• Newport News Ships• TRW• XonTech

US AEROSPACE EXAMPLE

16

SMALLER PLAYERS ARE FOCUSING ON SPECIALISED ROLES, OFTEN AS PART OF A BROADER ALLIANCE

Pre-requisites to succeed Examples

Global prime contractor

• General Dynamics

• Boeing• EADS• Denel today

• Privileged relationships• New system platforms paid in full by domestic user• Export sales are heavily promoted by domestic

government

Domestic systems developer

• Indian Ordinance• Norinco (China)• Armscor (pre 1990)

• Extensive local demand and funding• Focus initially on low complexity, high strategic value

items and critical support services

Specialised contractor

• Samsung Techwin (Korea)

• Singapore Technology

• IAI/EMI

• Technological edge or low cost production capabilities • Managing partners through alliances • Access to domestic defence spend

Sub-supplier

• Grintek• Denel Optronics

• Technological edge or low cost production capabilities • Managing partners through alliances • Access to domestic defence spend

Contract manager

• US munitions industry

• Commercially viable contract with the state• Efficient management of operations

17

Focus

Political support

Alliances

Excellent execution

• Specific products or roles in the value chain with defendable positions

• Large domestic demand and guaranteed access to domestic programmes

• Reliable multi-year R&D funding to retain a technological edge in an increasingly globalised market

• Consistent, active support from government for export sales

• Integration into a network of OEMs and sub-suppliers to gain market access, skills and minimum scale

• World class capabilities and productivity

Captive market

Privileged Access

Commercial orientation

LOOKING AHEAD, SUCCESSFUL PLAYERS WILL REQUIRE BOTH PRIVILEGED ACCESS AND A COMMERCIAL ORIENTATION

Source: McKinsey

18

KEY MESSAGES


2. Denel is facing a funding crisis, and there is significant risk associated with the current financial projections

19

DENEL CURRENTLY OFFERS AN IMPRESSIVE PRODUCT AND SERVICE PORTFOLIO. . .

Source: Denel; team analysis

20

. . . AND THERE IS SIGNIFICANT RISK ATTACHED TO FUTURE PROJECTIONS

*Order cover = confirmed orders budgeted sales

Source: Business Unit 5 yr plans; team analysis

183 0

1 713

447 802

6 5225 920

5 0614 551

3 813

0

1 000

2 000

3 000

4 000

5 000

6 000

7 000

2006 2007 2008 2009 2010

Denel overall order coverRm; confirmed orders at March 2005

Order cover*: 45% 18% 9% 3% 0%

Benchmark order cover

for new financial

year: > 80%

Projections

Orders

21

KEY MESSAGES



3. Denel is not viable under the current model. It no longer has the domestic market and scale to succeed as an independent systems integrator and exporter of a broad range of products

22

DENEL CURRENTLY LACKS THE BASIC PREREQUISITES TO BE VIABLE UNDER THE CURRENT MODEL

Source: McKinsey

Current Denel position Rationale

• Denel no longer has critical level of domestic spend

• Denel is sub-scale for its current product portfolio

• Denel is largely trying to play as a vertically integrated and independent global prime contractor in many of its businesses

• Political support for Denel has been inconsistent

• Denel productivity and delivery performance lag global requirements

Strong

Weak

Focus

Political support

Alliances

Excellent execution

Captive market

Privileged Access


23

0

2 000

4 000

6 000

8 000

10 000

12 000

14 000

1985 1990 1995 2000 2005

. . . but Denel did not participate in this recovery

DENEL HAS LARGELY LOST ITS CAPTIVE DOMESTIC FUNDING BASE . . .

0

2 000

4 000

6 000

8 000

10 000

12 000

14 000

1985 1990 1995 2000 2005

Total Denel revenue*

Denel exports & commercial

*Pre-1992 figures estimated from Armscor and defence industry data

Source: Denel financials; SA Reserve Bank Quarterly bulletin; Central Economic Advisory; SIPRI; SA budget review; Armscor; team estimates

Rm, Real 2005

RSA defence spend recovered since 2000 . . .

Total SA defence spend

Denel local defence sales

ESTIMATES

• Recent spend increase not in areas where Denel has capabilities

• Spend levels will decline by 2010

24

320

1 500

1 900

4 200

9 200

17 800

Revenue from home market* sources$m

. . . AND NO LONGER HAS THE MINIMUM DOMESTIC MARKET DEMAND TO REMAIN AN INDEPENDENT PRIME CONTRACTOR

*Defined as domestic and alliance markets

Source: Hoovers; team analysis

CompanyTotal business revenue$m

Share of business from home market*%

760

2 100

2 400

5 300

14 900

19 200

42

71

81

79

62

93

=X

General Dynamics (USA)

BAE systems (UK)

Rheinmetal (Germany)

SAAB (Sweden)

Israeli Aircraft Industries (Israel)

Denel (South Africa)

25

DENEL’S PRODUCTIVITY REMAINS SIGNIFICANTLY BELOW THAT OF INDUSTRY BENCHMARKS

Source: Company reports; Hoovers; team analysis

Aerospace revenue/employee benchmarksUS$ 000/employee, 2003

320

310

245

225

220

180

140

70

67

Boeing

EADS

Lockheed

Bell Helicopter

Denel

SAAB

BAE

IAI

Augusta Westland

Land Systems revenue/employee benchmarksUS$ 000/employee, 2003

135

55

175

225

250

265

285

555

Krauss Maffei Wegmann

Rheinmetall

United Defence

Alvis Hagglund

Denel

Giat

General Dynamics

Diehl VA Systems

26

DENEL MUST THEREFORE FOCUS ON SUPPLYING SUB-SYSTEMS AND COMPONENTS TO THE GLOBAL PRIME CONTRACTORS

Pre-requisites to succeed Examples

Global prime contractor

• General Dynamics

• Boeing• EADS• Denel today

• Privileged relationships• New system platforms paid in full by domestic user• Export sales are heavily promoted by domestic

government

Domestic systems developer

• Indian Ordinance• Norinco (China)• Armscor (pre 1990)

• Extensive local demand and funding• Focus initially on low complexity, high strategic

value items and critical support services

Specialised contractor/local prime

• Samsung Techwin (Korea)

• Singapore Technology

• IAI/EMI

• Technological edge or low cost production capabilities

• Managing partners through alliances • Access to domestic defence spend

Sub-supplier

• Grintek• Denel Optronics

• Technological edge or low cost production capabilities

• Managing partners through alliances • Access to domestic defence spend

Contract manager

• US munitions industry

• Commercially viable contract with the state• Efficient management of operations

X

X

27

KEY MESSAGES




4. To succeed, Denel should pursue a strategy based on prime contracting in the domestic market and the export of systems and components though selective equity partnerships and alliances with global prime contractors

28

. . . THE FIVE INDUSTRY SUCCESS FACTORS SHOULD FORM THE FOUNDING PRINCIPLES OF THE FUTURE DENEL

1. Secure privileged access to a guaranteed minimum proportion of RSA defence development and procurement spend

2. Partner with the state agencies – joint business planning and export marketing responsibilities

3. Focus on growing the commercially viable businesses where Denel has real technological leadership; other businesses ring-fenced or operated under management contracts

4. Secure scale through 2 – 4 equity business partnerships with major global players

5. Raise capabilities and productivity to world class levels; exit businesses where this cannot be achieved

Source: Team analysis

What this means

Focus

Political support

Alliances

Excellent execution

Captive market

Privileged Access


29

OUR PRIMARY OBJECTIVE SHOULD BE TO SECURE EQUITY BUSINESS PARTNERSHIPS ACROSS THE GROUP

Denel

ILLUSTRATIVE

Aerospace and technology

Aviation Munitions

Source: Team analysis

Land SystemsFacilities managed under contract

Disposals

Businesses • DAS (Missiles)• Optronics

• Aviation ISS Aviation aero-structures

• Naschem• PMP• DLS Western

Cape

• DLS Lyttelton • OTB

30

Equity business partnerships

Teaming across programmes

EQUITY BUSINESS PARTNERSHIPS SHOULD BE PURSUED OVER TEAMING ARRANGEMENTS WHEREVER POSSIBLE

Source: McKinsey; team analysis

• Shared destiny – real incentive for partner to make Denel a success

• Deep, permanent synergies – restructure businesses to focus on complementary capabilities

• Real scale – market reach and smoothing across business cycles

• Temporary synergies – limited to programme funding and risk sharing

• Retention of full ownership of business

• Denel will have to:– give up those

capabilities where it does not have a distinctive edge

– share control over its businesses

• However, this is better than an ongoing struggle to secure export and breakeven revenues

Implications

31

HOWEVER, WE WILL HAVE TO EVALUATE OTHER MANAGEMENT MODELS WHERE EQUITY BASED ALLIANCES CANNOT BE SECURED . . .

Source: McKinsey

Preferred model

Model description Denel pre-requisites

• Denel and major global systems integrator partner jointly own the underlying asset

• Denel plays prime contractor role on domestic contracts

• Access to domestic contracts and/ or;

• World class capabilities/ products/ technologies

Equity based alliances

• Businesses 100% owned by Denel• Businesses in strategic alliance with major

players, but without equity stakes• Denel focuses on a sliver of the value

chain that complements that of partners

• Minimum captive market to break even

• World class capabilities/ products/ technologies and/ or;

• Low cost production

Independent alliance partner

• Businesses 100% owned by Denel with no on-going relationships to any global players

• Sufficient domestic scale and/or export market access to succeed on own

Domestic supplier

• Denel manages businesses on behalf of the state, with clear incentives to deliver optimal performance

• Denel not responsible for retaining leading edge development capabilities

• State responsible for profits/losses and on-going reinvestment

Manage assets under contract

32

. . . WHICH WOULD IMPLY A MIXED SET OF MANAGEMENT MODELS ACROSS THE GROUP, AND THE DISPOSAL OF NON-VIABLE BUSINESSES

Denel

• Aerospace– DAS– Optronics– Aviation

Equity based partnerships

Independent alliance partner*

Facilities managed under contract

• Restructured munitions business**

• OTB• Restructured

munitions business ***

Possible business examples

Disposals

• Non-core business

• Non-strategic, non-viable business (e.g. DLS artillery)

Domestic supplier

• Scaled down DLS Lytttelton

ILLUSTRATIVE

33

KEY MESSAGES




4. To succeed, Denel should pursue a strategy based on prime contracting in the domestic market and the export of systems and components though selective equity partnerships and alliances with global prime contractors

5. A process is underway to evaluate alliance opportunities and drive internal improvements across all business units

34

Key PerformanceIndicators

Key PerformanceIndicators

Performance Contracts• Upside• Clear Downside

23 September 2005: Establish Change Management Project Office

Design FormatDesign Format

3 WeeksReview with each

Business Unit (formulate a template)

Items:• Linked to Strategy• Actionable• Measurable• Simple• Few• Credible• Dynamic• Forward-Looking

Peer ReviewSign Off

Populate with Plan

Populate with Plan

4 Weeks• Workgroups • Populate• Methodo-logy• Balanced

Scorecard• Review and

Test

Change Management Project Office

MonthlyCycle Review

MonthlyCycle Review

MonthlyCycle Review

MonthlyCycle Review

MonthlyCycle Review

MonthlyCycle Review

“Balcony Vision”Interventions Progress/Remedies• Strategy• Operational• CapabilityReporting• Board Review/Considerations/Options• Change Program Tracking “Traffic Lights”• Identify Resource Bottlenecks• Identify Recurring Trends• Manage Facilitation (CAPEX/Personnel)

Roll upRoll up

Board Reporting Period

Support CEO to track/control/prioritise/position change strategy project issues

Turnaround and Operational Draft Budget - November 2005

Turnaround and Operational Draft Budget - November 2005

2006/7Budget and

Recapitalisation

2006/7Budget and

Recapitalisation

JOH-DEM001-20050601-JvW-P1

66

CERTAIN CONTRACTS MUST BE SECURED WITHIN THE NEXT 6-12 MONTHS, OR DENEL WILL EXIT THE BUSINESS

Business configuration Implications

Retain full DLS Lyttelton capabilities

• Long term future of artillery capabilities post 2010 not certain

• Investment required to recapitalise

Resize for MRO and small arms only

EXIT

• Loss of systems capabilities• 300 jobs lost• Small, but possibly viable

business

• Loss of all domestic development, production and support capabilities

• Hand MRO operations to SANDF

Yes

No

Resize around MRO, small arms and MCVsystems integration

• Exit large calibre turret business• Employment ramp-up to produce

Hoefyster• Business future secured for next

5-10 years

Yes

No

Yes

No

Source: Discussions with management team; McKinsey analysis

Most realistic outcome

STRATEGIC ROADMAP / LytteltonSTRATEGIC ROADMAP / LytteltonSTRATEGIC ROADMAP / LytteltonSTRATEGIC ROADMAP / Lyttelton

INTEGRATIONINTEGRATION OVER CAPACITYOVER CAPACITY SCENARIOSSCENARIOS

NOT NOT SUSTAINABLESUSTAINABLE

“Cut the obvious overheads”

ORDNANCE

EMIRATES

Saving:

± R20m pa


“Maintain capability but cut unutilised

labour”

Saving:

± R20m pa

Medium Road:

Artillery Development in Partnership

Low Road: Maintenance, Turrets

& Small Arms

CLOSE

Sales Risk

Capability and Image Risk

PA

RT

NE

RS

HIP

PA

RT

NE

RS

HIP

LO

CA

L F

OC

US

LO

CA

L F

OC

US

Right Size

LAND SYSTEMS LYTTELTON

LAND SYSTEMS LYTTELTON

High Road:

Artillery Leader

Investment

Equity partner

Project partner

CU

RR

EN

T S

TA

TU

S

650

610 520

450

300

520


Right Size

400

6 – 12 Months

12 –

18

Mo

nth

s18

– 2

4 M

on

ths

Thank you

Creating a Viable Denel Presentation to Parliament Joint Meeting of the Portfolio Committee on...

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