South Africa special: Forward march

South Africa has set out to restructure its defence and aerospace industries in a bid to create a modern, consistently profitable sector. But will it work?

A decade after it returned to the international fold, South Africa's defence and aerospace industrial base is engaged in what is likely ultimately to become its biggest-ever structural overhaul, with government and business leaders united in the desire to ensure the sector can be sustained profitably beyond the current bow-wave of defence modernisation projects.

The overhaul is set to include a raft of industrial mergers along specific capability lines, primarily fuelled by efforts to return Denel, South Africa's dominant defence supplier, to profitability after devastating financial losses in 2005, as well as stepped-up efforts to secure international investment and collaboration.

Denel management announced plans last year to break up the company into a series of self-contained businesses, joint ventures and strategic alliances, over which the parent Denel group would effectively operate as a holding company. The South African government, as Denel's primary shareholder, approved the strategy in February and has agreed to fund recapitalisation for a three-year transition period.

The first result of this "get-well" effort has been the creation of an aero­structures joint venture between Sweden's Saab and Denel Aviation, with a soon-to-be finalised deal expected to link Denel's optronics interests with Zeiss of Switzerland.

Missiles, unmanned air vehicles and rotary-wing aviation are likely to proceed next. Turkey's attack helicopter programme, a decision on which is imminent, is playing a significant role in discussions on the rotorcraft sector, with two major alternative strategies being explored by Denel and South Africa's Advanced Technology and Engineering (see P30). Those same two companies are also eyeing a UAV business tie-up (Flight International, 26 September-2 October).

Additional impetus for the wider industry overhaul is also emerging in the form of South African government plans for a revised defence industrial policy, potentially in the form of a strategic framework similar to that just rolled out by the UK.

Addressing the opening of last month's African Aerospace and Defence (AAD) exhibition at Ysterplaat airbase in Cape Town, South African defence minister Mosiua Lekota flagged plans to more closely align future South African National Defence Force (SANDF) requirements with existing domestic industrial capabilities.

He said that, in conjunction with the Department of Public Enterprises, "we have embarked on the transformation of the defence and defence-related industries. We have started with a review of the policies guiding the defence industrial complex of South Africa.

"The alignment of defence acquisition policy is critical to support the development of the local defence-related industries. Acquisition policy should be linked to capital expenditure planning and technology strategy and transfer. Perhaps the emphasis should shift to considering programmes and projects - prioritised according to our overall development agenda - rather than the old-fashioned concept of tailoring our needs to our budget."

Requirement shifts

Lekota also used the speech to flag possible shifts in future SANDF capability requirements in response to ongoing changes in the broader African security environment. "These include total war theatre and force projection at the one end of the spectrum, to search and rescue and environmental protection on the other end. Clearly the frequency of operations in terms of peacekeeping, humanitarian assistance and logistic-related missions are increasing and will dominate the future SANDF's operational role, resulting in requirements for different products and services," he said.

That shift needs "to be fully understood by the domestic industry", he said. "In turn the local defence-related industry requires forward information on what the SANDF will purchase to plan production."

The new policy would aim to allow "industry to work in partnership with the defence force, plan production and develop the required technology. It is also important that defence research and evaluation expertise within various state organisations is rationalised and duplication is avoided to facilitate alignment with technology strategy and the increased transfer of technology to the local defence-related industry," Lekota said.

Further development of the domestic aerospace industry has to be a goal of overall defence spending plans, the minister argued. "Without a strong service industry to maintain, repair and upgrade our aerospace and defence purchases, we would be wasting our money. The aerospace industry opens up huge opportunities for us and has been identified as one of our priority areas," he said.

As currently structured, South Africa's defence and aerospace industry largely reflects arrangements that have been in place since the end of the apartheid era. An initial overhaul occurred at the start of the current decade, involving both new starts and foreign equity investments linked to the SANDF's sweeping modernisation programme involving multiple strategic defence package awards between 2000 and 2002. These resulted in acquisition deals for 28 Saab JAS39 Gripen fighters, 24 BAE Systems Hawk 100 trainers, 30 AgustaWestland A109 and four Super Lynx Mk64 helicopters, plus new warships.

Offset requirements tied to the packages, comprising direct defence industrial participation (DIP) and more generic national industrial participation (NIP), have in turn played a major role in sustaining industrial capabilities over the past five years. The offsets also helped draw in direct financial investment from the likes of BAE Systems, Saab and Thales, with these now playing critical roles in the current restructuring efforts.

The DIP component is credited with opening up new opportunities for South African companies in the global aerospace supply chain, says Sipho Thomo, chief executive of Armscor, the national armaments acquisition agency. But he also says that South African industry cannot rest on its work to date if the sector is to be guarantee its own future viability.

Speaking to Flight International at AAD, Thomo said key aerospace sector capabilities Armscor wants to see put on a more sustainable basis include avionics, engines, maintenance, communications, and weapons and weapons interfaces. Past areas of South African self-reliance such as airframe manufacture are no longer seen as being strategic. "We can buy an airframe from anyone," Thomo says, "but things like avionics and weaponry and communications we feel are some of the things that need to be maintained in our industry for ourselves."

The South African aerospace industry's re-entry into the global marketplace in the mid-1990s was "late", Thomo says, and has placed the development of strategic relationships with major international defence and aerospace companies at the forefront of long-term sector planning: "We have discovered that unless you have got some sort of partnership with other people you are not going to be able to make any headway in terms of selling your products."

The two dominant partners are BAE Systems and Saab, both of which have been playing key roles in South Africa's defence industry structure for almost five years. Thomo describes both offshore firms as playing an important role in sustaining existing aerospace capabilities. "We welcome them from the point of view of resuscitating and keeping our industry alive."

Saab's initial engagement came via a joint shareholding and later majority ownership of Grintek, South Africa's primary electronic-warfare systems house, but in June it expanded to include joint ownership and management of the new aerostructures joint venture with Denel. That secured South African regulatory approval on 16 September, with Saab to hold 20% and Denel the remainder. Saab is managing the entire operation however, effective from 1 October this year, and a complete takeover is not ruled out by either side, though not in the short to medium term.

New venture

The new venture will take on Denel's existing obligations on the Hawk, Gripen and helicopter programmes for the South African air force, as well as work on the multinational Airbus Military A400M airlifter programme as part of South Africa's firm eight-aircraft order placed in May 2005. Its forecast first year turnover is flagged at R200 million ($26.3 million), although both Denel and Saab have indicated expectations for rapid growth by targeting global supply chain work. A key business advantage, both firms argue, will be on South African labour rates compared with rival firms in Europe and the USA.

Speaking at AAD, Saab executive vice- president Ken-Ake Jonsson said that the major customers for the venture would be "the big aircraft customers, Airbus and Boeing. If we can develop that in a successful way, that would lay the ground for an interesting business for South Africa in the future, where the major customers are outside South Africa and that means we will create a lot of exports from this country."

The settling-down process for the venture is assessed by Saab as requiring a total capital investment of R350 million. Jonsson said the capitalisation is required "to make the business profitable", with each partner to split the overhead on the basis of their respective shareholdings. For Saab that translates to a capital injection of R65 million over the first two years.

Denel chief executive Shaun Liebenberg says the new investment outlays will cover "putting in new equipment, tooling, scaling up and enhancing our furnace capabilities. We need to upgrade the facilities we need drastically to look at new processes and systems."

The partners want to stabilise the venture within 12 months, Liebenberg says, to prepare it for an anticipated bow-wave of work opportunities being driven by international requirements in the civil and military markets. "We are already talking to a number of players about taking on some of that volume that is required from a capacity point of view around the world. We have the capacity but we need to get our structures and our systems right," he says.

The link with Saab could also allow for a wider consolidation involving the Pretoria-based Aerosud, says Liebenberg.

He says that while Aerosud and Denel Aerostructures are targeting different segments of the global supply chain, "if we are open, and there is a lot of dialogue with the major customers in that area, Airbus, Boeing and all the other players, we can certainly carve an environment where we can work collaboratively in certain areas but keep the business entities separate."

He adds: "The issue in terms of medium- to long-term formal collaboration has been mooted. We have said that once we have got Saab on board, and we can create a certain basic level of stability, we should start looking at that discussion."

Planning for the future of Denel's missile business is largely following a different path, with the South African government pursuing multinational linkages as the basis for future weapons development, primarily through a three-way relationship involving India and Brazil. The first effort links South Africa and Brazil on an advanced version of Denel's A-Darter within-visual-range air-to-air missile, while later projects may include a new- generation beyond-visual range missile based on the Denel R-Darter.

Multinational ventures, Liebenberg says, are "critical" to Denel's future in the missiles sector. "We cannot fund the development of these products and we also would never be able to absorb sufficient production capacity to make a programme like this work on our own. Typically, the USA would develop a product like this, they have massive budgets. But between India, ourselves and Brazil and maybe another player or so, we collectively can all contribute to that so that we can develop a world-class weapon.

" To be brutally honest, if we do not get two or three or four countries contributing to this overall process, we cannot afford to do it. That is part of this reality check that we need to go through."

In parallel to the government to government efforts to secure an effective resource base, Denel has been talking to potential industrial investors, again led by Saab. The core challenge in that sector, Liebenberg says, is finding a partner of sufficient size to allow Denel to bring real value to the relationship. "We are in discussions with a number of people. The funding and the future of A-Darter is an important future step. We have some good traditional missiles that we are selling well around the world, but we are looking to secure our future on next-generation programmes and we can't do it on our own."

Source: Flight International