South Africa’s state asset manager has quietly bought up almost 90% of cash-strapped arms manufacturer Denel’s bonds in the past 12 months, data from the country’s main securities depositary showed.

The previously undisclosed funding by the Public Investment Corporation (PIC), which manages R2 trillion ($140 billion) of investments for the government, sheds new light on the precariousness of Denel’s financial position.

It also shows the extent of state support for Denel at a time when private investors say they are reluctant to lend to the weapons company because of its previous management’s involvement in a corruption scandal.

Faced with a critical election next year, President Cyril Ramaphosa is fighting to keep struggling state-owned companies like Denel and power utility Eskom afloat.

But he also wants to preserve South Africa’s last investment-grade credit rating, the loss of which could trigger large capital outflows. Ramaphosa recently ruled out for that reason a request by Eskom for the state to take on R100 billion of its debt.

A senior lawmaker in the biggest opposition party, the Democratic Alliance (DA), said the purchase of Denel debt by the PIC amounted to a bailout by stealth.

“This is a state bailout, irrespective whether it is a grant from National Treasury or a PIC investment via bonds,” said Kobus Marais, the DA’s shadow minister for defence. “Denel must be sustainable on its own.”

The PIC only held around R350 million of Denel bonds in March 2017, but from December last year it started to dramatically increase those holdings, data from South Africa’s Central Securities Depositary analysed by Reuters showed.

As of December 14 this year, the PIC owned R2.8 billion of Denel bonds, out of the company’s total issuance of R3.15 billion. The PIC purchased the bulk of that debt via private placements in December 2017, September 2018 and this month.

It bought almost R2.5 billion of debt — issued to refinance older borrowing — in September alone. That same month, Denel was unable to pay senior staff in full because of what it called “liquidity challenges”.

Two former Denel executives told Reuters that many banks and large private investors had refused to lend to Denel since December 2017, citing governance concerns. They said that by September 2018 the company did not have enough cash to meet maturing debt repayments, putting it at risk of default.

Asked about the PIC’s purchases of Denel’s bonds, the arms company’s spokeswoman said: “Denel has been successful in raising sufficient funds from the bond markets to ensure that it is in a position to honour its obligations. … It will soon become profitable and operationally sustainable.”

She declined to comment on whether Denel would have defaulted without PIC support.

The PIC’s current holdings of Denel’s debt are held on behalf of the Unemployment Insurance Fund and Compensation Commissioner, two funds the state uses to pay benefits to unemployed, sick or injured people.

“State-owned entities, in which the PIC is invested on behalf of its clients, service their interest payments as required and to date there have been no defaults,” the PIC said in a statement to Reuters, confirming that it owned R2.8 billion of Denel bonds.

A spokesman for the National Treasury, which is the ministry responsible for the PIC, said the state asset manager took its own investment decisions.

Debt woes

Denel, a cornerstone of South Africa’s once-mighty defence industry, has been plagued by years of mismanagement.

It recorded a R1.7 billion loss — its first in eight years — in the financial year that ended in March, and has struggled to pay suppliers and employee salaries for much of the past year.

Defence industry officials have said Denel requires new equity partners to survive in the long term.

Saudi Arabia, the world’s third-largest defence spender, has approached South Africa about partnering with Denel as part of efforts to establish its own defence industry, but the South African government has yet to respond to the offer.

Contributing to Denel’s woes was its involvement in an influence-peddling scandal involving associates of former President Jacob Zuma that made investors wary of its debt.

Denel’s most recently maturing debt — R290 million owed to sole investor the City of Johannesburg — was due to be repaid on December 11. Johannesburg’s mayor told Reuters on December 10 he was still unsure if the city would be repaid.

“I made it clear to them I wasn’t going to roll the debt over,” Mayor Herman Mashaba said.

A source in the public enterprises ministry, which oversees Denel, told Reuters earlier this month that ministry officials were working closely with Denel to help it refinance its debts.

Denel, which relies almost entirely on short- and medium-term bond issues for its funding needs, issued a new R290 million bond on December 11, the proceeds of which were used to repay the City of Johannesburg.

The PIC bought the whole issue, securities depositary data showed.