Forecast International,
NEWTOWN: A recently completed assessment by Forecast International concludes that an effective industry restructuring plan geared toward divesting non-core assets and a corresponding surge in acquisition activity on the part of foreign defense enterprises is expected to sustain the South African defense sector in the face of potential uncertainty in the nation’s domestic defense market resulting from the March 2009 general elections.
Under the aegis of state-owned holding firm Denel Pty Ltd, the South African defense sector has been engaged in an ongoing structural transformation for the past two years. In accordance with mandates attached to government recapitalization efforts valued at $455 million, Denel has proceeded with “restructuring necessary to achieve solvency and profitability.” The plan for restructuring the South African defense sector hinges on leveraging the existing technical strengths of core business units with equity partnerships involving foreign defense enterprises to develop high value-add niche defense enterprises and cement integration into the global defense industrial supply chain.
Forecast International has identified the formation of equity-for-access partnerships between South African and foreign defense enterprises as the key element in this restructuring plan. These partnerships entail foreign defense enterprises acquiring controlling or majority stakes in specialized South Africa enterprises, which in turn gain exposure to international defense tenders and receive investment in management, logistic networks, and tech transfers.
Since the South African Ministry of Public Enterprise opted to divest from unprofitable domestic defense enterprises and relax regulations on foreign investment in the defense sector in late 2005/early 2006, 10 major acquisitions involving foreign defense 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 defense market sectors such as electronic warfare, aerostructures, avionics, unmanned systems, and tactical communications.
As the dominant entity in the South African defense 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 percent of it aerostructures division at a price of ZAR66 million to Saab to form the Denel Saab Aerostructures joint venture; 70 percent 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 percent 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 percent between 2007 and 2008 and decreased at a compound annual rate of 74 percent 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 South African defense sector in the event the March 2009 general elections result in a disruption of domestic defense spending. In the wake of the 1994 general elections, defense spending declined by 39 percent – 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 center-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 defense market, the South African defense sector’s strategy to discard self-sufficiency in favor of an industry structure optimized to increase access to the global defense market appears to be a key step in the right direction.
Forecast International, Inc. is a leading provider of Market Intelligence and Analysis in the areas of aerospace, defense, power systems and military electronics. Based in Newtown, Conn., USA, Forecast International specializes in long-range industry forecasts and market assessments used by strategic planners, marketing professionals, military organizations, and governments worldwide.
