Examination of Witnesses (Questions 40
MONDAY 12 FEBRUARY 2001
SCHOLAR, KCB AND
40. So you still do not know.
(Sir Michael Scholar) No, nor shall we; not for some
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
(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.
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 thatI do not know whether it
would be right to say it came from themwas 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 gamewe kept ahead of the
game actuallybut 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
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
(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 preferas I
wouldto 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 suspiciousI
think quite wronglythat 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.
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.