Is Denel a perfect candidate for rescue/restructuring or is it a poisoned chalice?

Jonathan Faurie
Founder: Turnaround Talk

In a recent discussion with a BRP, the conversation naturally gravitated towards the prevalence of companies becoming financially distressed seeking either business rescue or some form of informal restructuring to save their business.

While it is undeniable that the Covid-19 Pandemic has disrupted the business models of many companies significantly, the BRP pointed out that many of the companies that face financial distress today would have faced this distress absent Covid. The seeds of the challenges that they face were planted long ago and have now taken root.

While a lot of attention has been given to the SAA and Comair business rescue over the past two years, the Denel business rescue is one that could serve as an important case study in the years to come.

Mistiming the market
At one stage, Denel was at the cutting edge of innovation with products, such as the Rooivalk, garnering a lot of interest from international buyers.

The Chinese believe that once should never spend more than 10 years without going through significant disruption. If we apply this to the business world, we can find many cases where this has proven to be true. Think of Kodak, Nokia, Blackberry, and Block Buster Video. All of these companies were market leaders in their respective fields but failed to see the evolution of the industry.  To their credit, the first three companies pivoted at just the right time to avoid complete ruin. Block Buster did not survive the disruption within its market.

The same occurred with CNA, and this is where the sentiments echoed by the BRP at the beginning of the article become relevant. Online consumerism and direct wholesalers muscled CNA into irrelevance. There was simply no market for the stationary giants operating model.

The same can be said for Denel. In a world where diplomacy is the preferred method of conflict resolution (taking the Ukraine War and the decades long conflict in the Middle East out of the equation), is there a demand for innovation when it comes to defence products?

It doesn’t help that the company is also facing a major backlash from its involvement in State Capture and the awarding of contracts to the controversial Gupta family.

Rebuilding the company
Following the company’s financial distress, Denel pointed out that the company cannot meet its loan repayments. This is a tune that South Africans, and Government, has heard all to often from State Owned Entities.

Public Enterprises Minister, Pravin Gordhan, has acknowledged the company’s plight and told Bloomberg (in a February Interview) that Government is fully committed to rebuilding the company.

“Our next job is to rebuild Denel,” he said. “How this will be done in refloating Denel has still to be determined.”

A News24 article points out that according to Finance Minister Enoch Godongwana’s national budget tabled in Parliament last month, Denel had been allocated R3 billion to settle interest payments.

This amount is inclusive of the R2.9 billion announced during the medium-term budget policy statement in November 2021. Previously, News24 reported the JSE suspended Denel bonds due to its failure to submit annual results for the 2021 financial year.

Denel needs to rethink its operating model
Photo By: Denel

Seeking restitution
When companies suffer the level financial distress that Denel found itself in, one of the major parties that are impacted by this are its employees.  This is something that Denel has suffered with over the past few years. Gordhan is adamant that the R3 billion allocated to Denel will not be used for salary payments.

On 22 March, News24 reported that Denel employees have finally received some financial relief.

The article points out that a group of 14 current and former employees of Denel were paid almost R4.7 million on 18 March from an attached RMB bank account of the state-owned arms manufacturer.

The group of employees had the bank account attached and frozen after Denel failed to comply with a court order to pay their unpaid or partially paid salaries dating back to May 2020.

The article adds that the North Gauteng High Court in Pretoria granted the order in January this year. Denel did not oppose the application and was ordered to pay within 10 days, by 3 February because of the breach of its contractual obligations to pay its employees.  

Last year Denel’s interim group CEO William Hlakoane told MPs the company’s balance sheet showed it was technically insolvent, with a negative cash flow of around R600 million, and that it owed a total of over R600 million in unpaid salaries, as well as some R900 million to suppliers.

Multiple challenges
It is clear that Denel faces multiple challenges:

  • The market in which Denel operates is changing significantly;
  • The company has a major cashflow problem which has now snowballed into a massive financial challenge;
  • The company has lost trust due to its role in State Capture; and
  • The company has a disgruntled workforce which does not trust the company. 

What is the way forward for the company? There needs to be an independent probe into the company’s financials and the company’s cash management system to determine whether there was any financial mismanagement or if the company’s financial distress is purely a result of changing market dynamics.

Management that can take the company forward also needs to be put in place. While facing major challenges, Eskom CEO André de Ruyter has been outspoken about the problems within the utility which have been cause by the company and the blame culture that exists within it. While many may say that this is expected of De Ruyter, we need to admit that talk like this means that he his trying to instil a culture of accountability in the company that will address internal challenges.

Finally, Denel needs to look beyond the four walls of the company. If its core strength is in innovation, this can benefit airlines who are looking to convert a portion of their fleet into cargo planes. When faced with the possibility of the global supply chain crisis that the world is currently facing, Amazon invested in its own cargo aircrafts to ensure that they don’t have to rely on courier companies in certain markets. Surely there are other companies who are also eager to cut out the middleman? This is the market where Denel needs to play in.

There are opportunities for growth
Photo By: Canva

Once bitten twice shy
The question is, who wants to take charge of this? It is clear that the company is in need to restructuring which falls within the realm of BRPs and restructuring professionals.

But BRPs and restructuring professionals have done this dance before. Who wants to work with a State-Owned Entity? Not only are there conflicts with the Companies Act and the Public Finance Management Act, the SAA BRPs were stonewalled by Government on more than one occasion. What should have been a rescue that would have been completed in X number of months became significantly longer as politics became a challenge.

There is no doubt that Denel is in need of the specialised services that can be offered by BRPs and turnaround professionals. One of the core values of business rescue and restructuring is preserving jobs. Given the challenges that Denel already has in this department, and the already alluded to possibility if political interference, the question becomes: is Denel a perfect candidate for rescue/restructuring or is it a poisoned chalice?