Creating a Viable Denel

1. 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

4. OUR CHALLENGE • ‘Fixing’ Denel means . . . • 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

5. ‘Fixing’ Denel means . . . • 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!

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 From: Misalignment amongst stakeholders To: Single vision and purpose Portfolio Ministers – DPE, DOD, Foreign Affairs, Finance President and Cabinet • One team • President and Cabinet • Portfolio Ministers • Denel Board • Denel Executive team Denel Executive team Denel Board

8. KEY MESSAGES • 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. ALTHOUGH GLOBAL DEFENCE PROCUREMENT IS A $360B MARKET… $b, 2010 • Estimated world-wide defence spending • Total budget • Operations and maintenance • Personnel • Other • Defence procurement * Budget breakdown assuming US FY2004 proportions Source: US Department of Defence; team analysis

10. 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% • 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 û û . . . MUCH OF THE GLOBAL DEFENCE SPEND IS NOT DIRECTLY ACCESSIBLE TO INDEPENDENT CONTRACTORS SUCH AS DENEL $b • ROUGH ESTIMATES û • Total military purchases • Spend on products in which Denel does not participate • Total spend on products in which Denel participates • USA • NATO excluding USA • Rest of World 100% 53% 47% 23% 9% 15% * FY2000 awards Source: Forecast International; World bank; team analysis

11. Implications for defence contractors • Players dependent on captive markets • R&D is a core part of the revenue model • Scale is essential • Pure export businesses are seldom viable MOST DEFENCE CONTRACTORS DEPEND ON A CAPTIVE DOMESTIC MARKET TO ACHIEVE THE NECESSARY SCALE • Characteristics of the defence industry • Long business cycle • Development intensive • Strategic Source: McKinsey

12. Implications • 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 THE GLOBAL DOMESTIC DEFENCE INDUSTRY HAS UNDERGONE SIGNIFICANT CHANGE OVER THE PAST DECADE, AND THE PACE OF CHANGE WILL INCREASE • Forces for change • Declining defence spend • Changing nature of conflicts and shifting customer needs Source: McKinsey

13. DEFENCE BUDGETS HAVE DECLINED, MAKING IT HARDER TO COMPETE IN THE TRADITIONAL PLATFORM SALES BUSINESS • Defence Budget • % of GDP • USA • General shift from platforms to services • 1985 • 1998 • 2000 • 2002 • 2003 • 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 • NATO* • 1985 • 1998 • 2000 • 2002 • 2003 • Rest of World • 1985 • 1998 • 2000 • 2002 • 2003 * Including USA? Source: Forecast International; IISS, McKinsey A&D practice; team analysis

14. SIMILARLY, SHIFTING MARKET REQUIREMENTS ARE DRIVING A MOVE TO MORE MOBILE TECHNOLOGIES • Major market shifts • Historic environment • Current and future environment • Open range battlefields • Increased importance of urban battle-grounds • Shift to mobile weapons and electronic technologies • 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 • Old military structures • New missions – peacekeeping, out-of-area • Military block scenarios • New scenarios – terrorism, drug wars Source: Forecast International; McKinsey A&D practice

15. DECLINING DEFENCE SPEND AND INCREASING R&D COSTS HAVE DRIVEN CONSOLIDATION OF PRIME CONTRACTORS ACROSS ALL SECTORS • US AEROSPACE EXAMPLE • 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 • 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” Source: McKinsey A&D practice

16. SMALLER PLAYERS ARE FOCUSING ON SPECIALISED ROLES, OFTEN AS PART OF A BROADER ALLIANCE • Pre-requisites to succeed • Examples Global prime contractor • Privileged relationships • New system platforms paid in full by domestic user • Export sales are heavily promoted by domestic government • General Dynamics • Boeing • EADS • Denel today Domestic systems developer • Extensive local demand and funding • Focus initially on low complexity, high strategic value items and critical support services • Indian Ordinance • Norinco (China) • Armscor (pre 1990) Specialised contractor • Technological edge or low cost production capabilities • Managing partners through alliances • Access to domestic defence spend • Samsung Techwin (Korea) • Singapore Technology • IAI/EMI Sub-supplier • Technological edge or low cost production capabilities • Managing partners through alliances • Access to domestic defence spend • Grintek • Denel Optronics Contract manager • Commercially viable contract with the state • Efficient management of operations • US munitions industry

17. LOOKING AHEAD, SUCCESSFUL PLAYERS WILL REQUIRE BOTH PRIVILEGED ACCESS AND A COMMERCIAL ORIENTATION • Privileged Access • 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 • Captive market • Consistent, active support from government for export sales • Political support • Commercial orientation • Specific products or roles in the value chain with defendable positions • Focus • Integration into a network of OEMs and sub-suppliers to gain market access, skills and minimum scale • Alliances • Excellent execution • World class capabilities and productivity Source: McKinsey

18. KEY MESSAGES • 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 • 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 • Projections • Orders Benchmark order cover for new financial year: > 80% • Denel overall order cover • Rm; confirmed orders at March 2005 • Order cover*: • 45% • 18% • 9% • 3% • 0% * Order cover = confirmed orders budgeted sales Source: Business Unit 5 yr plans; team analysis

21. KEY MESSAGES • 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 • Denel is facing a funding crisis, and there is significant risk associated with the current financial projections • 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 Strong • Current Denel position Weak • Rationale • Privileged Access • Denel no longer has critical level of domestic spend • Captive market • Political support for Denel has been inconsistent • Political support • Commercial orientation • Denel is sub-scale for its current product portfolio • Focus • Denel is largely trying to play as a vertically integrated and independent global prime contractor in many of its businesses • Alliances • Denel productivity and delivery performance lag global requirements • Excellent execution Source: McKinsey

23. DENEL HAS LARGELY LOST ITS CAPTIVE DOMESTIC FUNDING BASE . . . • ESTIMATES Rm, Real 2005 • RSA defence spend recovered since 2000 . . . • . . . but Denel did not participate in this recovery • Recent spend increase not in areas where Denel has capabilities • Spend levels will decline by 2010 • Total SA defence spend • Total Denel revenue* • Denel exports & commercial • Denel local defence sales * 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

24. . . . AND NO LONGER HAS THE MINIMUM DOMESTIC MARKET DEMAND TO REMAIN AN INDEPENDENT PRIME CONTRACTOR • Share of business from home market* • % • Revenue from home market* sources • $m • Total business revenue • $m • Company • General Dynamics (USA) • BAE systems (UK) • Rheinmetal (Germany) = X • SAAB (Sweden) • Israeli Aircraft Industries (Israel) • Denel (South Africa) * Defined as domestic and alliance markets Source: Hoovers; team analysis

25. DENEL’S PRODUCTIVITY REMAINS SIGNIFICANTLY BELOW THAT OF INDUSTRY BENCHMARKS • Aerospace revenue/employee benchmarks • US$ 000/employee, 2003 • Land Systems revenue/employee benchmarks • US$ 000/employee, 2003 • General Dynamics • Boeing • EADS • Krauss Maffei Wegmann • Lockheed • Rheinmetall • Bell Helicopter • United Defence • BAE • Alvis Hagglund • SAAB • Diehl VA Systems • IAI • Augusta Westland • Giat • Denel • Denel Source: Company reports; Hoovers; team analysis

26. DENEL MUST THEREFORE FOCUS ON SUPPLYING SUB-SYSTEMS AND COMPONENTS TO THE GLOBAL PRIME CONTRACTORS • Pre-requisites to succeed • Examples • X Global prime contractor • Privileged relationships • New system platforms paid in full by domestic user • Export sales are heavily promoted by domestic government • General Dynamics • Boeing • EADS • Denel today • X Domestic systems developer • Extensive local demand and funding • Focus initially on low complexity, high strategic value items and critical support services • Indian Ordinance • Norinco (China) • Armscor (pre 1990) Specialised contractor/local prime • Technological edge or low cost production capabilities • Managing partners through alliances • Access to domestic defence spend • Samsung Techwin (Korea) • Singapore Technology • IAI/EMI Sub-supplier • Technological edge or low cost production capabilities • Managing partners through alliances • Access to domestic defence spend • Grintek • Denel Optronics Contract manager • Commercially viable contract with the state • Efficient management of operations • US munitions industry

27. KEY MESSAGES • 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 • Denel is facing a funding crisis, and there is significant risk associated with the current financial projections • 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 • 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 • Privileged Access • What this means • Captive market • Secure privileged access to a guaranteed minimum proportion of RSA defence development and procurement spend • Partner with the state agencies – joint business planning and export marketing responsibilities • Focus on growing the commercially viable businesses where Denel has real technological leadership; other businesses ring-fenced or operated under management contracts • Secure scale through 2 – 4 equity business partnerships with major global players • Raise capabilities and productivity to world class levels; exit businesses where this cannot be achieved • Political support • Commercial orientation • Focus • Alliances • Excellent execution Source: Team analysis

29. OUR PRIMARY OBJECTIVE SHOULD BE TO SECURE EQUITY BUSINESS PARTNERSHIPS ACROSS THE GROUP ILLUSTRATIVE Denel Aerospace and technology Aviation Munitions Land Systems Facilities managed under contract Disposals • Businesses • DAS (Missiles) • Optronics • Aviation ISS Aviation aero-structures • Naschem • PMP • DLS Western Cape • DLS Lyttelton • OTB Source: Team analysis

30. EQUITY BUSINESS PARTNERSHIPS SHOULD BE PURSUED OVER TEAMING ARRANGEMENTS WHEREVER POSSIBLE • Equity business partnerships • Teaming across programmes • Implications • 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 Source: McKinsey; team analysis

31. HOWEVER, WE WILL HAVE TO EVALUATE OTHER MANAGEMENT MODELS WHERE EQUITY BASED ALLIANCES CANNOT BE SECURED . . . • Preferred model • Model description • Denel pre-requisites Equity based alliances • 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 Independent alliance partner • 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 Domestic supplier • 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 Manage assets under contract • 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 Source: McKinsey

32. . . . WHICH WOULD IMPLY A MIXED SET OF MANAGEMENT MODELS ACROSS THE GROUP, AND THE DISPOSAL OF NON-VIABLE BUSINESSES ILLUSTRATIVE Denel Equity based partnerships Independent alliance partner* Domestic supplier Facilities managed under contract Disposals • Possible business examples • Aerospace • DAS • Optronics • Aviation • Restructured munitions business** • Scaled down DLS Lytttelton • OTB • Restructured munitions business *** • Non-core business • Non-strategic, non-viable business (e.g. DLS artillery)

33. KEY MESSAGES • 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 • Denel is facing a funding crisis, and there is significant risk associated with the current financial projections • 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 • 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. 23 September 2005: Establish Change Management Project Office Peer Review Sign Off • “Balcony Vision” • Interventions Progress/Remedies • Strategy • Operational • Capability • Reporting • Board Review/Considerations/Options • Change Program Tracking “Traffic Lights” • Identify Resource Bottlenecks • Identify Recurring Trends • Manage Facilitation (CAPEX/Personnel) Design Format Populate with Plan Roll up Board Reporting Period • 3 Weeks • Review with each Business Unit (formulate a template) • Items: • Linked to Strategy • Actionable • Measurable • Simple • Few • Credible • Dynamic • Forward-Looking • 4 Weeks • Workgroups • Populate • Methodo-logy • Balanced Scorecard • Review and Test Monthly Cycle Review Monthly Cycle Review Monthly Cycle Review Turnaround and Operational Draft Budget - November 2005 2006/7 Budget and Recapitalisation Key Performance Indicators • Performance Contracts • Upside • Clear Downside Change Management Project Office Support CEO to track/control/prioritise/position change strategy project issues

36. LAND SYSTEMS LYTTELTON LAND SYSTEMS LYTTELTON STRATEGIC ROADMAP / Lyttelton INTEGRATION OVER CAPACITY SCENARIOS Project partner Sales Risk Right Size 450 650 CURRENT STATUS 12 – 18 Months “Cut the obvious overheads” “Maintain capability but cut unutilised labour” Equity partner Medium Road: Artillery Development in Partnership PARTNERSHIP Investment 520 610 520 High Road: Artillery Leader CLOSE 400 6 – 12 Months Low Road: Maintenance, Turrets & Small Arms Saving: ± R20m pa Saving: ± R20m pa LOCAL FOCUS Capability and Image Risk 18 – 24 Months Right Size 300 NOT SUSTAINABLE NOT SUSTAINABLE NOT SUSTAINABLE

37. Thank you