Memorandum submitted by QinetiQ (15 January
2003)
INTRODUCTION
1. The purpose of this paper is to assist
the HCDC in its investigation of the QinetiQ PPP by putting on
record the Company's position on some of the key issues. The paper
is structured in nine sections, each addressing an area in which
concerns have been expressed:
— Role and positioning of QinetiQ
— Benefits of a strategic investor
— Compliance and firewalls
— Employee incentivisation
ROLE AND
POSITIONING OF
QINETIQ
— Will QinetiQ retain a "technical
authority" role for MoD?
— Will QinetiQ operate at arm's
length from MoD?
— Will QinetiQ be treated like any
other contractor?
— Does QinetiQ recognise a responsibility
for the national good beyond that of making money for its shareholders?
2. As a private company with many private
shareholders, QinetiQ's role is to create value for its shareholders
within the constraints of its constitution. QinetiQ's constitution
has been formed to ensure that key national interests are protected
that might not naturally be fostered as an ordinary commercial
business.
3. QinetiQ's constitution contains provisions
for a Golden Share (which has powers to prevent undesirable shareholders),
for security restrictions, for legitimate areas of activity, and
for a Compliance Regime. Most of these are covered in specific
questions below.
4. It follows that QinetiQ expects to be
treated as a commercial company, but one in whose integrity and
independence customers can have confidence due to its specific
constitutional constraints.
5. QinetiQ does not expect to have any "technical
authority" role as such, but will continue to offer MoD customers
technical advice. It will be up to customers to choose to buy
from QinetiQ or any other supplier at arm's length. QinetiQ will
want to draw MoD customers' attention to the advantages in terms
of assurance that they can draw from its constitutional framework
(which otherwise limits QinetiQ's commercial opportunities).
BENEFITS OF
A STRATEGIC
INVESTOR
— Why a Strategic Investor rather
than an IPO?
— Why is a Strategic Investor of
benefit to the company, employees, customers, or the tax payer?
6. QinetiQ wanted the freedom to develop
its business and this is facilitated by access to private capital.
There is no long-term future for business restricted to UK defence
technology. Technology is inherently trans-sectoral and global
in its application. If QinetiQ is to retain its position in the
front rank of technology companies it needs to be able to invest
and develop in markets outside defence and outside the UK. It
would not have been appropriate to put at risk taxpayers' money
in such a venture.
7. The introduction of private capital benefits
each of the stakeholders in different ways.
8. The company has been given the freedom
to grow and prosper in the commercial world with the funding necessary
to develop the business. This means that QinetiQ can find new
customers to ensure growth of jobs and the protection of work
at its 63 sites around the country.
9. QinetiQ employees will be given the opportunity
to take a stake in the future of the business by participating
in the employee share scheme (see below). They will also be part
of a business whose objective is to grow, develop and increase
in value. They will no longer be restricted by perceptions of
restrictions on size of the public sector, and will be able to
benefit from the fruits of their own labour.
10. Customers will benefit from QinetiQ's
ability to stay at the forefront of innovation and technology
advances. Commercial customers will be able to gain advantage
from the unlocking of years of military research and development,
while military customers will profit from the increased speed
of technological development which these days stems from the commercial
market.
11. The taxpayer will benefit from the value
of the receipt received by the MoD and from relief from the liabilities
the company has taken on. In addition, by retaining a majority
shareholding (62.5% the MoD will ensure that it is able to capitalise
significantly on QinetiQ's future prosperity and growth.
WHY CARLYLE?
— Given the number of world class
UK private capital firms why was Carlyle chosen?
12. Carlyle is a good match for QinetiQ
because its experience enabled it to understand and commit to
the QinetiQ business plan. Owing to its heritage, QinetiQ has
an exceptionally wide range of technology offerings. Most private
capital firms prefer simpler, more tightly focused companies.
In selecting Carlyle, the MoD has recognised the benefit of QinetiQ
having a global investor with deep knowledge of a range of industry
sectors, global markets and routes to market, who has a proven
ability to identify and commercialise strong IPR.
13. Carlyle will bring QinetiQ access to
further capital, global expertise and cross-industry contacts.
Its global team of 60 venture professionals will play an important
supporting role in helping QinetiQ capitalise on its wealth of
intellectual property with access to global finance and technology
contacts and global know-how. To date, Carlyle has invested more
than a third of its funds in one of QinetiQ's core growth markets
(IT and Telecoms)—and this equates to a lot of knowledge
and contacts.
INTELLECTUAL PROPERTY
— How was DERA's Intellectual Property
distributed?
— What protection is there for companies
who provided DERA with IP in its role as part of Government?
— What is to stop Carlyle migrating
valuable IP to its US affiliates or other US companies?
14. Intellectual property is comprised of
data, computer programmes, documents, and technical notes. Prior
to the split in DERA the RASP process audited all IP held in the
QinetiQ part. The MoD Memorandum has explained the RASP process
which was designed to ensure that QinetiQ owns only the rights
to the intellectual property that it has actually developed itself
over the years or that which it has expressly acquired through
commercial contracts. Where the MoD funded this work it will continue
to have free user rights to this IP when it is needed for defence
purposes.
15. Intellectual property belonging to other
organisations, including defence companies, cannot be used by
QinetiQ without its owners' express permission, except for the
purpose for which it was given. This means that QinetiQ has access
to the data when it has need of it to fulfil an MoD contract,
following which QinetiQ must return the data when the contract
is finished.
16. QinetiQ's own intellectual property
remains the sole property of the company and may not be transferred
or sold to any other organisation including Carlyle or any associate,
without the permission of the Board. All transactions with related
parties must be at arm's length. QinetiQ will remain a British
company and the Government, as a majority economic shareholder,
will be the main beneficiary when new technologies are commercialised
by QinetiQ.
COMPLIANCE AND
FIREWALLS
— How is QinetiQ to remain a trustworthy
source of technical advice to MoD if it is also actively commercialising
its technology?
— How are companies which do business
with QinetiQ to know that their secrets will not be passed to
MoD?
17. The MoD has carefully structured QinetiQ
so as to give it assurance that it can rely on the company for
important and independent technical advice. The measures include
the Golden Share which allows them to prevent share ownership
by undesirable holders; vetting of members for security and approval
of the Compliance Committee Chairman of the Board; and a Compliance
Regime which restricts the categories of work QinetiQ can perform
in the UK Defence Equipment food chain.
18. The process the company uses to implement
the Compliance Regime (which is overseen by the Compliance Committee)
does not seek to make distinction between manufacturing and non-manufacturing
work. Instead the company's rule is that all work in the UK Defence
Equipment food chain, other than that direct for the MoD, must
be cleared through the Compliance Regime.
This means that specific, documented permission
must be received from the MoD before the work can be undertaken.
19. There are occasions when the MoD sees
it as in its interest for QinetiQ to engage with Defence Companies
in technology transfer before or during a procurement contract
for which QinetiQ is separately giving technical advice. In these
circumstances the company establishes separate teams with robust
firewalls between to serve the two or more different customers,
(in the case, for instance, where there are several competitors).
20. QinetiQ's firewalls have been audited
on a number of occasions and the company is confident of their
integrity. The heritage of the company is that of national secrets
kept within tight "need to know" compartments so the
discipline of firewalls sits comfortably within the QinetiQ culture.
NATIONAL SECURITY
— How are National Security interests
to be protected when Carlyle have voting control of the company?
21. QinetiQ will continue to operate exactly
the same security procedures as it does today. Classified information
is released only to appropriately cleared personnel with a "need
to know".
22. Three members of Carlyle are being cleared
including Mr Youngkin. This is primarily for ease of access to
QinetiQ premises. Access to national security information will
continue to be subject to the same "need to know" principle.
LEVEL PLAYING
FIELDS
— Will QinetiQ have an unfair advantage
over its competitors due to its close relationship with MoD?
— Has QinetiQ been granted specific
contracts in order to fatten it up for sale?
23. MoD's research programme is being progressively
opened to competition in that part where QinetiQ is the main supplier.
Those parts supplied by Dstl and AWE, amounting to more than 50%
of the total, are not open to competition on a project basis.
The rate of competition in the open part will be progressively
increased over the next four years. QinetiQ has been granted no
contracts different in type or scale compared to those done routinely
for the last 10 years.
24. QinetiQ, in common with most defence
suppliers, greatly values its relationship with MoD customers
and seeks to ensure through assiduous efforts at first rate service
that the relationship is close and mutually respectful. When competing
for QinetiQ's core research work, other suppliers can claim the
advantage of a close interaction with their manufacturing capability.
QinetiQ offers its technology skills and the independence from
an early choice of manufacturer. It is for customers to choose
the offering that best meets their needs. Thus whilst the playing
field is not precisely flat, it is arguable in which direction
it is tilted. In practice, the relative advantages vary from competition
to competition.
25. In terms of the much larger market for
Defence Equipment, including the complete food chain down to technology
supply, here the playing field is certainly not level since QinetiQ
is excluded from competing unless it first receives MoD's specific
acquiescence.
26. The one major long-term contract QinetiQ
has negotiated is for the provision of Test & Evaluation services.
Historically the contracting basis for this work has been short
term resulting in an inability to justify the necessary investment
to modernise the services. The consequence was that the services
provided were becoming progressively less cost effective and customers
were beginning to find alternative (overseas) suppliers. The availability
of private capital has allowed QinetiQ to make a proposition to
MoD (DPA) customers under which QinetiQ undertakes to invest up
to £150 million and in consequence, reduces costs to customers.
The Long-Term Partnering Agreement (LTPA), for which Heads of
Terms have been signed, provides the contractual framework under
which the investment and the return to the MoD become possible.
LIABILITIES
— Has MoD taken on new liabilities
in order to get the sale away?
27. MoD, as QinetiQ's owner, is already
exposed to all liabilities associated with QinetiQ. Thus the list
recently published by MoD of the liabilities it is prepared to
retain after the sale does not represent a change. The change
following the sale is the liabilities the company is taking on
and thus the MoD is relieved of. The list is significantly longer
than the MoD's retained liabilities and a summary can be provided
if the Committee desires it.
EMPLOYEE INCENTIVES
— Are fat cats to be created through
generous awards of share options to senior executives?
28. QinetiQ is a company that achieves its
success for its customers exclusively through the extraordinary
efforts of its staff. It is a well-established principle that
the more ownership staff feel in their company, the more commitment
they give to it and the better service they provide their customers.
29. It was therefore an explicit objective
of the company from the beginning of the PPP project to provide
a well-targeted employee share ownership scheme. The key concept
has been that while there would be a modest free hand out to all
staff, the great majority of share ownership would be achieved
by employees buying shares with their own money at the same price
as other investors.
30. Under the Carlyle investment the main
employee opportunity is to co-invest alongside Carlyle's fund
investors in 3.7% of QinetiQ worth a total of £4.6 million.
This investment is structured as a package of preference shares
(carrying a 9% coupon) and ordinary shares in the ratio of 9:1.
All employees have been offered the opportunity to invest at least
£500. Some 3,000 senior staff have been offered the opportunity
to invest greater amounts, up to £20,000.
31. In addition, there is a scheme involving
just ordinary equity for 230 staff engaged in general management
roles. Under this scheme they will be invited to buy a new issue
of ordinary equity amounting to 7% at the same price as other
investors. As the preference shares must be paid in full before
the equity can be redeemed, this is a higher risk investment.
Effectively it becomes worthless unless the company approaches
9% returns. For that reason, investment in ordinary equity is
offered only to those involved in general management who have
some ability to manage the risk they are taking on.
32. This investment is additionally subject
to performance related incentives. If on exit the company has
achieved at least a 30% IRR and a three-fold return then there
is an additional 5% equity tranche available for distribution
amongst the 230 participants. Should the company do even better
and achieve a 40% IRR and a four-fold return, then the top ten
executives will share a further additional 2.5% equity tranche.
33. The free allocation to all staff is
by way of an option to buy £40 of ordinary equity at the
issue price, maturing at exit. This is the only option scheme
open to any employee in QinetiQ.
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