Cape Town ­ The successful conclusion of arms manufacturer Denel's turnaround strategy, and its future long-term sustainability as a going concern, require additional state funding of R1,7bn, former CEO Shaun Liebenberg said in his last report before his departure from the group.

Finance Minister Trevor Manuel could announce the funding when he releases the government's medium-term budget policy statement in Parliament on October 21.

Denel directors believe the funds will be granted this year. The government has already recapitalised Denel to the tune of R3,5bn, leaving R1,7bn outstanding of the total R5,2bn *1 package it promised. The additional funding would be over and above the R1,3bn Denel plans to borrow this year on the basis of the government guarantee it received in July and August.

The group's annual report, tabled in Parliament last week, said Denel wanted the government to invest the balance of R1,7bn of the recapitalisation package so it could repay short-term borrowings and fund its working capital requirements.

The funds would also be used to buy new plant and equipment, on restructuring, technology upgrades and skills development.

"The balance of the recapitalisation is critical to the completion of the turnaround strategy of the company," Liebenberg said.

Without the money, Denel might not be able to continue operating, the annual report said.

Liebenberg stressed Denel also needed dedicated government support in terms of "privileged access" to state defence contracts. This was a key pillar of the group's turnaround strategy, but had largely been lacking. This was a very common international practice where local defence industries were favoured by governments and received up to 70% of defence expenditure.

"This support is lacking in the South African context, more so with the decline, in real terms, of the defence budget over the past years," Liebenberg said.

He said there should be greater visibility of defence spending and local industry participation in department planning, as well as longer-term contracts to assist the industry's cash flows, supply chains and resources.

"With such a small defence spend, SA can ill-afford to have disparity between the planning of its defence-related industry's capacity and department of defence's expenditure," Liebenberg said. "There is the imperative need for closer co-operation."

Denel chairman Sibusiso Sibisi said the declining defence budget created uncertainty in the industry. This was because defence contracts usually took years to conclude and could be delayed further, or even terminated, in times of budgetary constraints.

Denel's turnaround strategy started in 2005, and has succeeded in reducing its losses for the third successive year last year, to R347m from R549m in 2006-07 *2. Turnover last year rose 17% to R3,8bn. The strategy has involved Denel unbundling its subsidiaries and bringing in strategic partners who can offer capital, technical expertise and access to global markets.

The annual report said the cabinet had decided the Rooivalk attack helicopter should be certified to meet a revised functionality within existing allocated resources. The aircraft will have a scaled-down weapons system. The defence force considered the Rooivalk to be a viable option to support its peace operations.

With acknowledgements to Linda Ensor and Business Day.