Examination of witnesses (Questions 100
- 119)
MONDAY 18 MAY 1998
MR MICHAEL
C SCHOLAR, CB,
MR NEIL
HIRST and MR
RICHARD LAZARUS
100. But the fact that they were adjudged
to have failed largely after a lot of the restructuring came true,
that is an embarrassment to the Department and an indication that
the £121 million was not necessarily well spent, is it not?
(Mr Scholar) I think on the contrary, that the
reduction in the size of the nuclear liability I mentioned indicates
the success of the restructuring so far.
Mr Love
101. Mr Scholar, I am afraid I am going
to take you back to the issue of phasing and look at it in the
light of the duties of your Department and you as the Accounting
Officer to the Government of the day. Do you feel that you failed
in your duty to the Government not to raise the issue of phasing
with them at the time of this sale?
(Mr Scholar) No, because it was clear in Ministers'
minds that there was to be no phasing and we knew it was clear
in their minds that it was government policy that there should
be no phasing and it would have been academic to have raised that
question. If we had believed that there was a benefit to the taxpayer
in doing so, I would certainly have raised it.
102. Can I take the first of those two points?
Is it not part of the duty of the Civil Service to bring unwelcome
facts to the Government's attention, the ones that they may not
feel perhaps inclined to take into account, but it is certainly
the duty of a civil servant to make the Government or the Secretary
of State aware of them?
(Mr Scholar) Yes.
103. So even though they may well have been
inclined to sell AEA Technology in one go, it was surely your
duty to remind them of other alternatives?
(Mr Scholar) Well, it would have been if there
had been an advantage in doing so.
104. Does that not destroy your argument
about using the Government as a cover for not bringing this to
their attention?
(Mr Scholar) I do not think so. The Report makes
it quite plain that the judgment about phasing is a fine one to
make. Shares sometimes go down as well as up, and it is sometimes
possible to lose money from phasing.
105. Let me take that point because if you
look at Appendix 2 to this Report, it quotes all of the different
occasions on which the Committee of Public Accounts and the National
Audit Office brought to various departments' attention the attractions
and advantages of phasing and particularly the situation that
we are describing here where it was difficult to make a valuation.
Now, surely in the light of all of those decisions taken before
AEA Technology was sold, it was your duty, not you personally,
but of your Department, to bring those previous decisions to the
attention of Ministers at least to discuss the alternatives that
were available to them?
(Mr Scholar) Well, I accept that, as a public
authority with a requirement or the highest requirements of accountability
which we have, it would have been better if we had written a paper
and that paper had been on the file setting out the case against
phasing and I regret that we did not write such a paper.
106. Can I go on to the other thing that
you did not write which was any direction to your Minister to
cover yourself in the situation where there would be a loss to
the Exchequer. Was that never a consideration in your mind that
with all the difficulties in making a proper valuation, with the
fact that phasing was not being considered to protect the public
interest, that you could cover both yourself and your Department
by seeking a direction from your Minister?
(Mr Scholar) I think no question of a direction
arose because we did not believe that phasing would be to the
benefit of the taxpayer. We thought we were selling, and we were
selling a stock which was going to be difficult to sell. The opinion
in the markets and in the press at the time was that this was
going to be difficult to move. It was a nuclear stock, British
Energy had not done very well, and it was a company without a
track record, as I have explained before. So the view we took
was that if we phased the sale, if we held back some of the shares,
we would complicate the sale. It was not a large sale. It would
be an unnecessary complication and might make it quite difficult
to get the sale away. Certainly we believed that the effect of
holding back some of the stock would be to reduce the proceeds
we would get from the sale.
107. We are asked as a Committee to scrutinise
public expenditure in the light of the public interest. If we
try to envisage that in terms of an individual looking at the
way that the Government spends its money, do you think that a
person who sees that we gained, and I am taking very bold figures
now, but something in the region of £223 million from the
sale of AEA Technology with a cost of £121 million in restructuring
and a company that is now worth something in excess of £700
million, and that is less than two years after the privatisation,
do you think that that member of the public would think that value
for money had been attained in this process, and do you think
that this Committee should, therefore, think that value for money
has been attained in this process?
(Mr Scholar) I think the Committee should think
so because I could provide for the Committee, with Mr Lazarus's
help, a number of stocks which have risen a similar amount during
that time and indeed, as I have explained to the Committee, if
you look at the relevant market indices for stocks of this kind,
the rise in this stock over this period has not been untoward.
So I do not think you can attribute that increase in value to
a failure on the part of the department to realise the proper
price for the sale.
108. Let me just take you up on that slightly.
You mentioned that there had been a 95 per cent increase in the
FT Index. If we half the value of the company on that basis it
is still over £350 million. If we assume that part of the
restructuring costs might not be due to the privatisation, there
is still a very substantial discrepancy in that the public, I
believe, would not understand, yet ministers were never confronted
with this. Is your department culpable in this waste of public
funds?
(Mr Scholar) I do not accept there has been a
waste of public funds. This has been a company which has been
very successful since it was floated and it has been successful
because of the skill of its management and in the decisions it
has made. Mr Maclennan asked me questions about that and I explained
why I thought that the company had been successful and had increased
its value over and above the value suggested by the index I mentioned.
Mr Lazarus cites other indices which suggests that perhaps it
has not been quite so successful in its own right. It has followed
the market more closely if you make different assumptions about
the nature of the company.
109. Can I take you to the valuation that
you gave to the company. You have explained the reason why you
chose a narrow range, although not being someone directly involved
in this I remain somewhat sceptical. However, I do not think you
have given us an adequate explanation as to why that narrow range
should not have been shifted either significantly or perhaps less
significantly up the price range so that rather than choose the
band that you did you would have chosen a band further up. Can
you explain why that was the case?
(Mr Scholar) Yes. When the range was first determined
in July 1996 we decided that it should be between 230 and 260
pence. That was the figure which we arrived at after taking advice
from Cazenove and Schroders. Subsequent to that market conditions
improved. The campaign for selling the stock was going well. Press
comment which had been rather mixed at first improved and so we
first raised the range from 240 to 270 pence and then, in a somewhat
daring manoeuvre, right at the end we raised it to 250 to 280
pence. So we actually raised it twice.
110. With the luxury of hindsight we may
not have thought that is as daring as you are suggesting to us
now. I would like to take you to figure 9 on page 35. Figure 9
gives the Cazenove valuation. On page 8 under figure 1 you give
the turnover, profitability and restructuring costs of AEA Technology.
I notice that there was £46 million-worth of restructuring
costs in 1995/96. Since that was done part-year presumably there
would be a full-year extrapolation that you could do in relation
to those restructuring costs which perhaps could have shown that
the company was likely to be more profitable than that included
within these figures. I know that when you are valuing companies
you are not in the job of protection, but was there not some very
good estimates that it was likely that the profitability of AEA
Technology would go up in future years?
(Mr Scholar) Yes. We had an estimate initially[6]
that the operating profits in 1996/97 would be £35 million,
which we revised downwards and it subsequently turned out to be
lower than that. They subsequently turned out to be £24 million.
They had grown somewhat from the 1995/96 level.
111. If you had put that into this multiplier
that has been used by Cazenove that would have given a valuation
very much in excess of the one that is quoted here even though
that valuation was at the higher end of the range that you finally
achieved.
(Mr Scholar) Various adjustments were made to
the mechanical valuation which was done by applying a PE ratio
to that 1995/96 profit figure, by the DTI after a discussion with
Treasury colleagues and with advisers. Inevitably that kind of
figure has to be a judgemental figure and it has to take account
of exactly the point that you are making, that the restructuring
costs were not going to go on forever.
112. The other question that springs to
mind is the £35 million predicted profit. Even though it
may well have been adjusted, presumably that was price sensitive
information. Was there any awareness in the marketplace that the
profits were likely to go up substantially in the year following
privatisation?
(Mr Scholar) There was a prospectus which set
out for the whole marketplace what could be said about the profits.
113. And that figure was indicated?
(Mr Lazarus) No, it was a qualitative comment
and there was plenty of brokers' comment, but generally speaking
the analysis in the market came relatively close to the outturn
number.
(Mr Scholar) Which was £19 million.
114. It was actually £19.8. So there
was at least some indication that the continued restructuring
would deliver benefits in future years.
(Mr Scholar) I think opinion in the market in
this case, as in other privatisation cases, would assume that
there would be some benefit in future years from both restructuring
that had happened and further restructuring that would probably
be available.
115. Yet none of that was taken into account
in the valuation figure and the range of valuations that you did.
Can I take you to figure 10 which is the book-building exercise
that was carried out and the paragraphs that follow. There is
some indication that there was within the marketplace some willingness
to consider a figure higher than the one that eventually emerged.
Would you agree with that?
(Mr Scholar) A fifth of those who indicated[7]
that they would be interested in making a bid said that they would
do so at 270. There was strong price resistance in the marketplace
from a number of quarters to any price above 265 a week before
the sale. I reviewed the press coverage in those weeks and it
was quite clear that 260 to 270 was regarded generally as a full
price, with one or two commentators seeing some potential for
perhaps a ten per cent premium. Nobody before the sale expected
a larger premium than that.
116. There was a rush right at the end of
this process. The department must have considerable experience
of those brushes with privatisations. Did that give you no indication
that a higher figure than you finally went for in the marketplace
would have been available to you?
(Mr Scholar) We understood that a number of potential
buyers had capped their bid at 280. We subsequently found that
five institutions declined to bid at 280. We investigated at great
length and discussed a great length with Treasury colleagues and
advisers whether it would be wise to go above 280 and we decided
that it would be dangerous to do so and that we would be likely
to end up with lower proceeds if we did so. So we made the decision
to go for 280.
Mr Love: Sadly, a
wrong one. Thank you.
Mr Davies
117. This does seem very unfortunate because
to the layman it appears the department have given Schroders a
strategy to set a price for the sale. They have made a decision
to fill with added value a company they are selling by putting
£121 million of restructuring in and then in a situation
where the advisers on price and some of the other changes are
permitted to buy below par prices and face an enormous appreciation
and make enormous profit on behalf of their clients. Do you not
feel slightly embarrassed by all this? Do you think my brief potted
rendition of the situation is fair?
(Mr Scholar) I do not think it is fair because
I believe that the restructuring had to be done in any event.
That was accepted by the Treasury. It was a common view. I believe
that if the restructuring had not taken place there would have
been a great deal of waste of public money as people were employed
in doing a task which the government did not want them to do and
still would not want them to do.
118. Can I just take you through some of
the issues one more painful time. On the issue of phasing you
said that the government in 1995 said they wanted a clear break
in terms of privatisation and therefore that was taken to mean
no phasing was possible. That was your interpretation. It clearly
is the case that one could have rapidly privatised an industry,
particularly this one over a period of weeks or a slightly longer
period even though there was a certain immanence in terms of the
General Election. In other words, you could have sold the whole
lot off before the General Election in chunks. Would you accept
that?
(Mr Scholar) No. It was not a matter of interpretation.
We knew that it was the government's policy to make a clean break
and sell it in one go. If I could quote Lord Fraser in the House
of Lords in July 1995. He said: "Full commercial freedom
means the freedom to take risks and to reap rewards. That is not
consistent with a degree of public ownership."
119. What was at issue is not the retention
of public ownership, it is profit maximisation of the sale. Accepting
that the government at the time wanted to sell it off, it is still
consistent with that quote that they could sell it off in chunks.
(Mr Scholar) I do not think it is consistent with
the quote which said, "That is not consistent with a degree
of public ownership."
6 Note by Witness: in 1995. Back
7
Note by Witness: In the first week of marketing. Back
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