Arms Dealer Takes Aim at Respectability : Transition: Efforts by notorious South African firm illustrate country’s struggle to overcome its image.

To many people here, the raft of indictments handed up last November by a U.S. grand jury against a key South African company appeared to be the end of an era.

The company was Armscor, the state-owned arms maker and arms merchant. For the second time it was being charged with receiving as much as $30 million in U.S. munitions between 1978 and 1989 in violation of an international arms embargo and with diverting some of the materiel to Iraq. The charges were particularly embarrassing for Armscor, because at the time it resembled a leopard deep in the process of trying to change its spots.

Since South Africa entered a period of political reform two years ago and took steps to rejoin the world economic community, Armscor has been telling the public that it is cleaning up its act. Long one of the world’s more notorious arms manufacturers and dealers, the company says it plans to convert most of its factories to civilian production. It has suggested that its secret missile range in the south of the country might be converted into a commercial-satellite launching center.

Although never admitting to violating international sanctions or arms embargoes, the company today goes out of its way to pledge that it will comply with global standards of acceptable conduct.

Armscor’s metamorphosis could be one of the most interesting indicators of South Africa’s change from a pariah state to a compliant neighbor, if only because the arms business is one of the world’s most unsavory enterprises. It is one at which South Africa deliberately turned itself into a first-class participant.

That was in 1977, when Armscor was formed within months of the U.N. arms embargo of South Africa. Its charge was to replace the military technology denied the country by the embargo, financing the process where possible by commercial sales. By 1988, Armscor was such a leading producer that it surmounted trade obstacles crippling most other South African businesses.

“Sanctions do not worry us,” said Piet Marais, then its chairman. “At the end of the day, if your product is good enough there will always be a buyer.”

Armscor was then and is now one of the country’s leading industrial enterprises. It is South Africa’s No. 1 exporter, its third-largest manufacturing firm and at its peak in 1990 the employer of 29,000 workers (and through subcontractors as many as 100,000 more).

Its staff was expert in developing and producing arms for the South African Defense Force and domestic security agencies. Some of its products are considered the best in their class.

But peace, including what passes here for racial peace, has been hard on Armscor. South Africa’s domestic defense spending peaked in 1990-91 at about $3.7 billion, as much as half of which may have gone to Armscor; this year, it is down to about $3.3 billion and may drop by an additional $300 million next year.

The result has been layoffs of as many as 2,500 employees and the prospect of tens of thousands more lost jobs among the 3,000 private companies that function as Armscor subcontractors.

“What we’re seeing is the whittling down of the military-industrial complex, in which there has been enormous investment over the past decade,” James Selfe, a security consultant to South Africa’s Democratic Party, said last year. “The cuts will have a huge impact on this sector of the economy.”

That is important because Armscor long has been a star of South Africa’s highly concentrated, state-subsidized industrial sector. In 1989, then-Defense Minister Magnus Malan said Armscor was exporting to 39 countries, which he refused to name. He said it had earned the government more than $700 million in foreign exchange since the arms embargo had begun.

In fact, Armscor was such a crucial foundation of the South African economy that the African National Congress, whose armed wing had often come under fire from the company’s output, warned publicly that it would oppose any effort to significantly pare Armscor.

“We are very suspicious about what the government is doing here,” said ANC spokesman Tokyo Sexwale, a former leader of Umkhonto we Sizwe, the ANC’s guerrilla wing, after a round of Armscor layoffs last October. “They want to ensure that a new, ANC-led government is not a strong one and are completely neutralizing Armscor as a force.”

Now military observers here are watching the spectacle of Armscor trying to cope with changing circumstances. In May, it rolled out its new look: a new subsidiary, known as Denel Ltd., to hold its 23 manufacturing and engineering divisions and steer them toward more civilian-oriented business.

Denel’s goal, said its managing director, Johann Alberts, is to reverse within five years Armscor’s traditional revenue mix of 70% from military and security products and 30% from civilian manufacturing. The old Armscor is to revert to pure procurement for the military and security forces.

To a great extent, this change is dictated by events. Just as domestic arms spending is down, Armscor’s external markets are shrinking. The South African-sponsored war in South-West Africa ended with that land’s metamorphosis into independent Namibia. Neighboring African countries that were customers, such as Zimbabwe, are too financially strapped to do much arms buying. Shorn of the need to sustain Cold War client states, Western aid donors are less likely than ever to finance the acquisition of new weaponry.

As for trading with unpopular regimes, as an agent of a country now striving for international respectability Denel will have to hew closely to worldwide arms embargoes, preventing it from pursuing customers blacklisted by the rest of the world.

(For all that, there is no proof thus far that Armscor “ever breached an existing embargo,” said Helmoed Romer-Heitman, the South Africa correspondent for Jane’s Defense Weekly; even its known sales of arms to Iraq took place at a time when President Saddam Hussein was being enthusiastically supplied by other Western arms merchants.)

There may be more overt pressure to get out of the arms business. The South African press reported earlier this year that U.S. officials pressured Saudi Arabia to cancel negotiations for as many as 200 G-6 self-propelled howitzers, Armscor’s most successful military product.

At $3 million per cannon, the deal would have been worth at least $600 million. Spare parts, ammunition and training contracts might have tripled its value, and, as a satisfied customer, Saudi Arabia might have sent more business Armscor’s way. In South Africa, the pressure was seen as not entirely based on U.S. arms-race scruples.

“The Americans are trying to shut down as many arms industries as they can around the world because they’re competition for U.S. companies,” Romer-Heitman said.

U.S. officials declined to comment on his point.

Still, a key question is whether Denel will be able to compete. South African businesses expanding globally from their highly protected and monopolistic domestic markets have had uneven success in the highly competitive world of European and U.S. business.

“Denel management themselves say they’re not used to competition,” Romer-Heitman said. “There’s a learning curve--short but steep. They’ll get a bloody nose here and there.”

Denel may have some other special burdens. For one thing, the firm will have trouble if it inherits Armscor’s corporate culture along with its plants and personnel. As an arm of the police state buttressing apartheid, Armscor has traditionally been secretive and arrogant.

Further, over the years it has played a role in some of South Africa’s most embarrassing moments. In 1989, a South African diplomat was caught in Paris trying to offer Armscor products to Protestant guerrillas from Northern Ireland in return for a British surface-to-air missile stolen from an Ulster military base.

In 1984, four Armscor executives were arrested for arms smuggling within hours of their arrival in London. They were permitted to go home temporarily but skipped bail and never returned to London for trial. One of the “Coventry Four” resurfaced when indicted last November in the U.S. fraud and smuggling case; he still is an Armscor executive, prompting the South Africa Sunday Times to headline its article on him, “Metelerkamp an old hand at being caught.”

Armscor also was linked to South Africa’s worst air disaster, the 1987 midair explosion of a South African Airways Boeing 747 that killed 159 people. Records unearthed by the Weekly Mail newspaper suggested that the company had used the aircraft to transport secret cargoes of explosives for years. Suspicion was strong after the crash that the disaster was caused by fireworks or explosives in the cargo hold. But an official inquiry established only that there was a fire before the crash, without identifying the blaze’s cause. Armscor executives called the Mail’s allegations false and “malicious.”

The company’s most delicate period--and possibly its most financially successful--may have been in mid-1990, after Iraq’s invasion of Kuwait. South African officials insisted they were observing the arms embargo against Hussein from August, 1990, along with most of the rest of the world. But in October, the country’s exports of “unclassified” goods--a category made up mostly of arms--hit a record $900 million.

Government officials later acknowledged that arms had been sold to Iraq before the Gulf War but insisted the sales ended before the embargo. The possibility remained that South Africa continued to receive payments from Iraq after August for already delivered arms.

For their part, Denel executives pledge to comply with global standards of conduct. “Denel is sensitive to the international political environment and will behave in a responsible and dignified manner,” said Paul Holtzhausen, its head of corporate communications, in response to one of a series of written questions from The Times. (Denel executives would not agree to be interviewed.)

Another untested area is how well Denel’s military products will continue to compare with rival items. Many may remain top-class, including Armscor’s world-leading antitank missiles and howitzers. Their night-vision equipment, radios and small-arms equipment are also among the tops in the world.

But some arms experts say much of Armscor’s arsenal is of limited application around the world, having been chiefly developed for the wide-open African bush where the South African military was deployed; most of its vehicles are wheeled rather than tracked, for example.

Moreover, “they’re not as sophisticated as everyone thinks,” said a military observer in Pretoria. The world embargo has prevented South Africa from gaining the technology it needs to build turbine engines, so it could never develop a competitive jet fighter. Its most ambitious attempt at a high-technology product, its Rooivalk attack helicopter--roughly equivalent to the U.S. Apache--has been close to cancellation because of a dearth of orders.

Although the firm has begun trying to market its armored personnel carriers and other equipment as “crowd-control equipment”--its truck-mounted water cannons and riot vehicles are mainstays of the domestic security forces--much of the rest of its production line cannot be easily converted to civilian use, Alberts acknowledged at the Denel introduction.

Any attempt to directly compete with state funds against established civilian companies would cause a political storm in South Africa. But Denel’s Holtzhausen said Denel will have “no access to government funds” and will finance its operations “on the open market.”

But as Romer-Heitman said: “All of the industries in this business are already feeling the pinch from defense cutbacks. Every one of them will be in trouble if they can’t change.”