Select Committee on Public Accounts Minutes of Evidence

Examination of Witnesses (Questions 40 - 59)



  40. So you still do not know.
  (Sir Michael Scholar) No, nor shall we; not for some time.

  41. How long?
  (Sir Michael Scholar) It is hard to say. In any acquisition of this kind one expects the deal to unfold, its consequences to make their impact on the business gradually over time.

  42. Would the private sector go into a deal like this?
  (Sir Michael Scholar) Yes, I believe so.

  43. They would.
  (Sir Michael Scholar) Yes.

  44. Would you say now that the system has changed for the Post Office, that you are no longer competing in the market with your hands tied behind your back? That was always the argument, was it not?
  (Mr Roberts) Yes. Our hands are less tied behind our backs. We are obviously not a privatised company, we are competing with privatised companies. One of the things we have to try to do is to satisfy not only this Committee but people outside, that the way in which we do business and the way in which we deal with Government in this rather strange thing for a public sector organisation called commercial freedom is fair and reasonable and that is what we have tried to do. It is why we have been very keen at our end that there should not be this concern that somehow or other we are using past profits to invest in new companies and that that investment should come from borrowing, borrowing which is then charged at a proper commercial rate. I am sure you will excuse me, Chairman, but none of my competitors will be doing what I am doing today, which is coming to talk to you, having had an audit report of this kind and that is the difference.

  45. You are getting an easy ride, are you not?
  (Mr Roberts) It depends where you are sitting. It is a serious point and that is just another aspect which means we are in a slightly different position.

  46. In your judgement, do you believe that the expenditure of £289 million has been fully justified?
  (Mr Roberts) Yes, we do.

  47. You said earlier that the facts have not come to light yet. Have you done any research as yet to see whether in fact the UK postal service has benefited by the acquisition of German Parcel?
  (Mr Roberts) There are three things. First of all, you asked whether the private sector or commercial company would do it this way: they would do it absolutely the same way as we did it, which is to look at the value this company would create financially for the Post Office. We actually looked at its cash flows and assumptions over a 15-year period and we then evaluated it against the cost of capital for us, which is between eight and nine per cent, and because that was producing a positive return and is still continuing to produce a positive return it is adding value to the Post Office. Because you look at it over a long period of time, that is why we cannot yet say in great detail that it is giving us this much. The other thing is that the other part of the strategy was that by buying German Parcel it got us entry into a Europeanwide network called General Parcel. We have now been able to move further down that to take, last December, overall control of that overall network. If we look at the strategy in the Post Office over the next ten years, although I cannot prove it to you this afternoon, I do believe it puts us in a position to compete now very effectively with the Germans and the French who are both over here dealing with the UK-based parcels and in fact the second biggest competitor for us here in the UK is now the French Post Office.

Mr Griffiths

  48. This report is in essence about the Department's oversight of the acquisition. I am interested to probe you on the expertise which the Department undoubtedly has in looking at the financial state of companies of a very large nature and what led you to accept the Post Office's own estimates. There was a decision which in some circumstances is commendable, not to duplicate the expertise which Mr Roberts' organisation was utilising. What was your checklist of considerations on that?
  (Sir Michael Scholar) We had a group of staff dealing with the Post Office who had experience of privatisations, who had long experience of the Post Office. They did not have experience of mergers and acquisitions, or corporate finance experience, so they felt themselves a bit short when this proposition was put to them. They therefore consulted elsewhere in the Department, various people in the DTI, they consulted the Treasury as they were bound to do and they concluded that they ought to take on some extra help. An individual was mentioned to them, a Mr Bullock, who was a member of the Department's Industrial Development Advisory Board. He is a banker, he had experience of project finance and he could help the group in the Department, the Postal Services Directorate, to ask the right questions. They asked questions about the likelihood of the profits being generated, what the downside was, what the upside was, what the degree of probability was. He asked questions, they asked questions about the risks which were involved and they went into some detail about those risks. They also asked questions about how those risks could be managed and the upshot of that—I do not know whether it would be right to say it came from them—was a very considerable operation in minimising the risks of the acquisition through obtaining warranties, guarantees, bank guarantees and so on. There was quite a lengthy and elaborate process. As this has gone on, we have learned from this experience and have felt that we ought to beef up our own capability to deal with proposals of this kind and we have strengthened the postal services directorate in the Department and have also taken on a group of advisers after a competition in the usual way, a set of advisers to advise us when acquisitions of this kind come along at the present time or in future.

  49. What are the likely comparable types of acquisition that you would want to have that expertise for?
  (Sir Michael Scholar) If the Post Office were to come forward and put to us a proposition to take on, to acquire some comparable business, that kind of thing, we should certainly want to subject it to the kind of scrutiny we did in this case or in fact to a closer scrutiny. The Government's policy was changing as this proposition was made to us and the Department was changing. I believe we kept up with the game—we kept ahead of the game actually—but the game has changed. You will see from this report that there is a whole list of acquisitions which the Post Office has made. They had made two before this one and there is quite a long list since this one. We have had to get our act moving.

  50. You mentioned risk in an earlier answer. Has the goodwill payment of £233 million been justified by the subsequent performance?
  (Sir Michael Scholar) We think it has been justified by the subsequent performance. As we have made our appraisals since the acquisition, the positive net present value which we saw in the first case continues. The acquisition has the capability of a considerable amount of growth within the organisation and has led to further acquisitions which have begun to put flesh on that strategic framework which I was referring to in answering the Chairman's questions earlier.

  51. Are you checklisting what you have been told these acquisitions will bring in benefits according to a timescale, according to generation of business, amount of business they are taking? How have they been checklisted? Could you perhaps give us an example?
  (Sir Michael Scholar) As far as the risks are concerned, we looked at a range of risks: the risk of disruption to the business through change of ownership; the risk of losing key employees who have been running the business so successfully to date; the risk of finding that their historic cost base had been understated and the Post Office will face with much higher costs than they had expected; the possibility that there would be big capital requirements they had not anticipated when they made the deal; the possibility that the profit data they were working on proved to be overstated and the profits were lower than they thought; a whole range of other risks, for example, that the outfit would not be able to cope with the Year 2000 change. They went through this whole thing in a very, very detailed way. I am very glad to say one could go through that checklist and say on one thing after another that that risk has proved not to be a worry, or it has only proved to be a worry in a very small way and that was addressed by the terms of the agreement to purchase, so that there was actually some compensation for a small shortfall in the volume that the business experienced and so on.

  52. The financial year in which this took place, 1999, in terms of your financial year, which months did that cover?
  (Mr Roberts) The first year we settled the deal in January and it covered the last quarter of our reporting year and then the first nine months of our next year. They were on a calendar year basis; we are on an April to March basis.

  53. What were your overall finances separate from that deal like then? What surplus had you generated?
  (Mr Roberts) In the year 1999-2000, for reasons Sir Michael just mentioned, we had a particular write-off to do with a big computer project called Horizon, which meant we actually had a post-tax loss. We had an operating profit before that of something like £250 million.

  54. The year after?
  (Mr Roberts) The year after is the year we are in, 2000-2001, which we do not report on until June.

  55. If it had been in any other year, would you have had to go to the Government to cover the £289 million costs?
  (Mr Roberts) It is a question of what you mean by "cover". We are under instruction to borrow the money from the Government to cover the cost of any acquisition and that is something we want to do. The only other way we could do it would be to draw on the reserves which the Post Office has built up and we do not want to do that, nor are we allowed to do that. Whatever the acquisitions, we always have to go to Government and we have to borrow the money from them. That then assures people that the rate we are being charged is a commercial rate.

  56. How do your Board members feel about that?
  (Mr Roberts) I think they would prefer—as I would—to have greater freedom to try to raise money in the commercial markets. That is where we are, given the Government's policy, given the Government's statement in the White Paper and the new framework which has been set for us.

  57. What would you do to convince this Committee that the preferred approach of the Board was a better one?
  (Mr Roberts) The issue is that while we borrow from Government people outside are always going to be slightly suspicious—I think quite wrongly—that we are not being charged a commercial rate. There is no substitute for borrowing from a commercial lender because you know it is going to be a commercial rate. We could all sit here, as both Sir Michael and I have done, and say we are pretty satisfied that via the Treasury, who are not noted for their generosity, we are getting a commercial rate, but there is no substitute for actually going to borrow from the same bank as one's competitors are borrowing from.

Mr Love

  58. Is it possible for you ever to have a proper commercial rate when there is always the backing of Government for any final losses you make? The only way you could get a proper commercial rate on the market would be if you were fully independent. Is that not correct?
  (Mr Roberts) That is almost inevitable. The point I would want to make is that the Post Office has been independent of Government in having any call on Government for over 20 years, so we do have some element of track record of not going back to Government to bail us out. Inevitably that is right, the suspicion will always be there, even if the fact is not, that somehow or other, because we are part of Government, there is this Government backing. From my point of view in trying to run the organisation, it is as much a disadvantage as an advantage. We have not had to call on it and we try very hard not to get into the position where we do and I would see it as a failure if we did. Inevitably in trying to convince people outside, there is always this feeling that because you are part of Government somehow you are getting a more favourable deal.

  59. We are also aware of the significant contribution the Post Office has made to Government coffers over the last few years, but we shall not dwell on that. When reading this report it tells me that this particular deal was done with some speed. It was also done with a lack of complete information about the deal. The report also tell us that there is a spread of possible values, according to the Post Office, of £109 million on a £289 million deal. Did not all of that together raise any concerns in the Department's mind?
  (Sir Michael Scholar) Obviously looking at an acquisition of this scale one is concerned to reduce the amount of risk to the greatest degree possible. We did go about that in a very professional way. We went through all those headings of risk which I mentioned in answering Mr Griffiths' questions and to each of these risks various probabilities were attached. If you take a worst case, you get a very poor result. If you take a best case you get a very, very favourable result and we tried to look at both of those. The range was considerable. It would have been nice to have had longer, but in the commercial world, you often do not have that luxury and the Post Office told us and we had no reason to doubt this, that if we took longer over the deal, if we held up the deal, it would go to somebody else; somebody else would buy it. There was a great deal of activity in the market, looking for partners in Germany. This was an attractive partner and the partner, German Parcel, wanted the deal to be concluded before the end of December for tax reasons, so we had to get a move on; the Post Office had to get a move on and we had to get a move on.

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