Select Committee on Public Accounts Minutes of Evidence

Examination of witnesses (Questions 104 - 119)




  104.  We now welcome the representatives of the winning bidders, Mr Anderson, Managing Director of Porterbrook, Mr Jukes, Managing Director of Forward Trust Rail, formerly Eversholt Leasing and Dr Prideaux, who used to be Chairman of Angel and is now a Non-Executive Director. Welcome everybody. We normally have hard bitten permanent secretaries in front of us who know the procedure here-you have one sitting behind you actually. If you have any difficulties with procedure or any questions do not hesitate to interrupt and ask me if there is a problem for you. May I also ask you in answer to questions to be as brief as you can be within reason? If people want elaboration they will come back to you. For the purposes of pace in this meeting it would be helpful if you could be brief. As I ask questions I shall give you a reference in the National Audit Office report. If you have that with you it may help you, but I will normally give you the information anyway. I shall start with a question on paragraph 2.46 in the NAO report which shows that there was only one external bidder left in the final competition. Were you unduly negative to the various external bidders about the ROSCOs' future prospects, so discouraging external bids and leaving the way clear for you to buy the ROSCOs cheaply?
  (Mr Anderson)  No, not at all. We were represented by Hambros in every meeting we had with external bidders and we answered any questions they had. We tried to point out the ups and downs in the business as we were by law due to do.
  (Mr Jukes)  No, I do not believe we were at all. All parties had access to the same basic information. We presented what we had done with the company up to that point and answered questions on what we thought the prospects of the company to be. There were risk areas and certainly the Networker Express part of our transaction was a risk area. We made bidders aware of the risks in that area. That is the only specific which I would identify.

  105.  That was the only risk you identified.
  (Mr Jukes)  The only area in which our concerns were particularly high and events have borne out that concern.

  106.  Mr Anderson, what risk areas did you highlight to outsiders?
  (Mr Anderson)  We highlighted the design and endemic faults as being perhaps a problem; problems which may appear on the train which would be the responsibility of the ROSCO.

  107.  Others will no doubt come back to that question. Paragraph 2.63 shows that soon after privatisation GRS sold their right to part of Angel's income flows for an amount which was virtually the same as the total sale price paid to the Department-within £6 million of it. You were left with the remainder of the business which you sold later for £395 million, which you obviously got for £6 million. Why did your bid to the Department not include any value for the rest of the business?
  (Dr Prideaux)  It is fair to say that our bid fully valued the ongoing lease revenue after the end of the initial leases, despite some suggestions to the contrary.

  108.  What was the elapsed time between the GRS sale and your purchase?
  (Dr Prideaux)  About two years.

  109.  In paragraph 2.56 I see that your backers told the NAO they would not necessarily have been deterred from bidding if the Department had insisted on provisions for sharing in gains made from the on-sale of the companies, but that this might have reduced the sale price. What would your reaction have been to clawback provisions on the profits you made, after you had achieved a minimum level of profit?
  (Mr Jukes)  That is a very hypothetical question because a clawback was at no stage part of the terms which were on offer and to be frank I cannot remember an occasion when there was any discussion of the implications of a clawback for the way in which we might bid and the way in which we would value the company. I do not find it easy to give any quantified response to your question.

  110.  Let me break it down for you. Most management buyouts envisage a future onward sale, that is where most of the profitability for a management buyout is normally crystallised. In assessing this you will have made some judgements as to being able perhaps to improve the business, I do not know what your plan was, and sell it onwards at some point and therefore have an expected level of profitability. In a sense that would have been material to the way you assessed your bid price, would it not? Are you with me so far?
  (Mr Jukes)  Yes.

  111.  Had there been a clawback arrangement, clearly there would have been a reduction in that expected forward price. If the clawback had been set at a level that was well above where you expected to get a return, you would not expect much of a reduction. If, however, it had been set to take half of your expected return, you would have had a reduction. If you want to take it in pieces, let us start with what you expected to make on the sale when you bid.
  (Mr Jukes)  I do not think we had a specific number in mind. If I may run back to the process as it was in 1995, we were going through a very tightly timed bidding process, we assembled a large and quite complicated consortium which had to get an understanding of the business and of the risks and other issues associated with the businesses and we had to reach a point where we decided what number to bid. I remember a meeting on 27 September 1995 with the consortium members sitting round a table when there was a discussion about what number to bid. I understand fully the theoretical analysis of what return you expect but we came to a number with which the group was comfortable. Some were wishing to make it a little higher and others feeling that was top whack and maybe a bit beyond that for their comfort. We ended up with a number. In that number there was not hard and detailed analysis of what we expected to sell the company for in the future and when we expected to sell it and what was the return.

  112.  What were the fundamentals you based the price on?
  (Mr Jukes)  Inevitably there was an assessment of the forward cash flows of the business and the risks associated with that.

  113.  A net present value of the forward cash flows.
  (Mr Jukes)  That was the way anybody looking at these businesses would approach a valuation.

  114.  The NAO report says that the money bid in each of these cases accounted for approximately a net present value of the guaranteed cash flows.
  (Mr Jukes)  That makes certain assumptions about the expected returns and the basis for financing the package.

  115.  If I may summarise your answer to me, you had no notion of what you were going to make out of this at the crystallisation stage of what happens at every management buyout but you based your bid on a net present value of the discounted cash flows forward, including the expected return on as yet unfixed contracts.
  (Mr Jukes)  That is correct. It is fair to say that the way in which venture capitalists look at these things does have built into it certain assumptions about the kind of return on the equity which they put into it. I do not believe that the returns which were assumed in our bid were inconsistent with normal assumptions of a venture capitalist which of course encompass acquisitions which are in the end unsuccessful in terms of onward sale as well as those which are successful.

  116.  There are not very many of those. In that case your calculation would not have had anywhere in it anything upon which a clawback provision would have had an impact since you were not valuing on an onward sale you were valuing on discounted cash flow which would not have been impacted by clawback.
  (Mr Jukes)  I am sorry, I do not think I agree. I believe the analysis encompasses, as you rightly said at the beginning, an assumption that in due course the company would be sold. The returns built into the cash flows or the assumptions about the returns built into the cash flows assume something about the returns to the ordinary shareholders as a result of an onward sale. That is true and if you built into that an assumption about clawback then that would certainly impact on the price.

  117.  I am sure others will come back to you on this. I just want to get very clear for you that what I am driving towards is what the impact of a clawback arrangement would have been on the pricing judgement you made. That is what I am after and that is why I am trying to get a straight answer about the valuation basis of each of these companies.
  (Mr Anderson)  We would have looked at it from a point of view of an internal rate of return. If you see the structure of our deal there was a substantial number of preferential shares in that deal which had a kicker of ten per cent per annum. On top of that then we had the equity which was fairly small. With the risks involved venture capitalists would have at least expected to have had a 35 per cent return on the equity, including the preferential shares, because you were talking about companies which were not really in a trading position. They were created but not in a trading position as such. If somebody had said they wished to take back 20 per cent of the profits, 30 per cent of the profits, we would have deducted that from our price. We made that clear to the National Audit Office when they asked us that question. How much that would have been would have been dependent on the whole scale of how you did the adjustments on clawback.

  118.  We will come back to the formula in a second. That gives me a clear idea. Did you have any assessment in your original judgement of price how much profit you would make or what the new price would be when you sold it on?
  (Mr Anderson)  No, but it is fair to say that we would have made an assumption that you cannot get people to put money up unless they can make in the range of 30 per cent; that is fact. The other thing you should take into consideration when you put some of these deals together is that you have to get the banking. The figure we put in for Porterbrook was the maximum amount of banking we could get. In the case of Andrew Jukes he maybe took a situation where he was looking and deciding a price. I put in exactly what I could get from the banking plus what Charterhouse would put up. That is where we landed on our price.
  (Dr Prideaux)  You have asked us two questions. First ours was of course not an MBO so it was not approached in the same way. In terms of the question of a clawback, it frankly was a hypothetical question. We had our work absolutely cut out to get the bid in and our backers satisfied and I have to say we spent no time at all looking at hypothetical questions. In terms of how the cash flows and the potential of the company was valued—

  119.  Let me stop you there a second. This Committee has to look back at the way policy was executed and make a judgement as to whether or not it was executed well and whether there are lessons which can be learned for the future. That means looking at what happened and what might have happened. That by definition is hypothetical. When Mr Jukes had trouble with that we broke down the argument into its component parts and asked how he valued it. We can do it that way. We can go through the details of valuation if you like. There are two ways to do this. What I want to try to get from you is your judgement on the basis of what you know about the mechanism you used to value the system when you were making your bid.
  (Dr Prideaux)  I will give you an undetailed but as accurate an answer as I can on clawback, which is that it would have reduced the value bid because it would have reduced the potential upside to all the backers in GRSH. I cannot tell you by how much because it was not a question we ever addressed. Otherwise I think I would be risking misleading the Committee.

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