Select Committee on Defence Minutes of Evidence

Memorandum submitted by the Carlyle Group (15 January 2003)


  This statement aims to outline some of the key factors why The Carlyle Group believes it is an ideal investor in QinetiQ and strategic partner for the MoD, in preparation for the HCDC hearing concerning the QinetiQ PPP.

1.   Track record

  Over the past 16 years The Carlyle Group has grown into one of the world's leading private equity firms. It has been at the forefront of the private equity industry's transformation from a collection of boutique alternative investment firms to well-established financial institutions.

  The firm is a private partnership, owned by senior investment professionals within the firm and CalPERS, the world's largest pension fund that has a 5% ownership interest. These investment professionals manage funds on behalf of Carlyle's investors, which are comprised of public and corporate pension funds, banks, insurance companies and some high net-worth families. Each fund has a specific remit to invest within a particular geography and investment sector such as buyout, technology venture capital, high yield or real estate. Carlyle currently manages 23 funds across the US, Europe and Asia.

  By applying a conservative, disciplined and rigorous approach to its investments the firm has achieved outstanding returns for its investors. To date, the firm has invested $7.2 billion and achieved an average internal rate of return of 36 per cent.

  Carlyle has invested capital into a diverse group of industries including: aerospace, automotive, consumer industries, defence, energy, industrial, technology, telecommunications and media, (see chart below). Its strategy is to support strong management teams that are well equipped to run the business. As a result, the firm's employees do not take operational control of portfolio companies but rather work through active boards of directors.

  Carlyle's reputation has attracted high-quality investment professionals in all geographies. Globally the firm employs more than 500 employees, while in Europe it employs 100 people based in Barcelona, Frankfurt, London, Milan, Munich and Paris.

2.   Ability to meet MoD requirements

  When the MoD announced, in March 2002, that it was interested in finding a strategic partner to invest in QinetiQ it set out clear objectives for this partnership:

    —  enhance the opportunity for exploitation of technology held by QinetiQ and contribute to the overall scientific base

    —  improve access to technologies from the civil sector for military application

    —  introduce private capital into QinetiQ to meet its investment needs and thereby accelerate its development through exposure to private sector disciplines

    —  provide increased freedoms for QinetiQ in, for example, employees terms, conditions, reward and its ability to grow commercial business

   (Source: letter re: QinetiQ from MoD 15 March, 2002)

  Carlyle's structure, experience and track record make it a perfect partner for the MoD in achieving those objectives.

  As a private equity firm, Carlyle's interests in QinetiQ are perfectly aligned with the MoD's. As a financial investor, Carlyle stands only to gain by QinetiQ's expansion and growth following its investment. The firm's investors will only realise a return on their investment when Carlyle's shares are sold, probably at an initial public offering (IPO) within the next three to five years. Until that time the capital invested remains entirely at risk.

  Indisputably, Carlyle has a wealth of experience in overseeing the development of corporations of all sizes in order to increase shareholder value. Through the years the firm has demonstrated its ability to prepare companies for successful IPOs and trade sales. Its investment professionals are keenly aware of how to encourage and monitor the growth of companies against a variety of economic conditions. This experience will be channelled into QinetiQ at board level and help to steer QinetiQ through the transition from public entity to private company successfully.

  QinetiQ's competitive strength lies in its ability to provide a unique combination of world-class science and services to the government. Carlyle believes that a constant focus on customer service and sustained investment in cutting edge technical abilities are prerequisites to fulfilling QinetiQ's aspirations. In parallel, Carlyle supports the QinetiQ management plan to continue to serve the MoD as its primary and most important customer. Additionally, we anticipate that QinetiQ will have the opportunity to grow its commercial business as well.

  With more than 60 investment professionals dedicated to commercialising technology through the firm's venture capital funds in the US, Europe, Asia and Japan, Carlyle is well qualified to provide support to QinetiQ's venture operations. In addition, Carlyle's buyout team has created a network of relationships with large corporations that have the potential to become important customers for new technology solutions.

  In particular, Carlyle has extensive knowledge of the telecommunications and IT markets—both key markets for QinetiQ. To date, 35% of the firm's corporate transactions have been invested in these industries. Carlyle's recent appointment of Louis Gerstner, former CEO and chairman of IBM, as its new chairman underlines its ongoing commitment to these sectors.

  As a prominent player in the financial community, Carlyle has developed deep relationships with the world's banks and other financial institutions. Importantly, this provides QinetiQ with greater access to capital and future support for an IPO than was previously possible under complete MoD ownership.

  QinetiQ's employees have demonstrated their belief in Carlyle's strengths as an investor in their business by committing to invest an estimated £5 million in the business themselves.

3.   Carlyle's commitment to maintaining QinetiQ's role within the UK

  Carlyle is committed to maintaining and deepening QinetiQ's reputation as a centre for excellence in science research and development and helping it grow to become the global leader in this field. This can only be achieved by QinetiQ safeguarding its capabilities and leveraging them to generate services that customers demand. QinetiQ will remain a British company and its success will be Britain's success.

  In recognition of the sensitivity of QinetiQ's role in the national economy Carlyle has created a special purpose fund to support this investment. This ensures that the interests of these investors are focused solely on QinetiQ's success and QinetiQ is independent of any investments Carlyle has made through other funds.

  The dedicated fund is a British company subject to UK law and its investors are predominantly institutional investors from the UK, Europe and the US. Taken together with the MoD majority interest and that of the staff, the beneficial ownership of QinetiQ will remain overwhelmingly British.

  Following Carlyle's proposed investment in QinetiQ, UK national security remains protected by the same strict MoD regulations and procedures that currently govern access to classified material. Only those individuals with an MoD approved need-to-know and appropriate security clearances will have access to detailed information. No exceptions to the established procedure will be made for Carlyle representatives on the Board or Carlyle's investors.

  A further imperative for QinetiQ is the maintenance of the Compliance Regime established with MoD upon vesting. This Regime protects the interests of the MoD and the defence industry by providing an exhaustive set of procedures to regulate the potential conflict of interest between QinetiQ's MoD and commercial activities. The Regime stipulates the need for QinetiQ to:

    —  preserve the confidentiality of MoD information;

    —  ensure the provision of impartial advice to the MoD; and

    —  comply with UK security interests.

  The company is legally bound to adhere to the Compliance Regime. Furthermore Board members all have a responsibility to ensure the Compliance Regime is followed and the Board's Compliance Committee performs the function of auditing compliance with the Regime.

  Finally, Carlyle and the MoD have agreed on a Board structure that is overwhelmingly British and an information reporting procedure that will maintain all confidences within the company.

  The QinetiQ Board will comprise of nine members. In addition to the MoD's two representatives it will include:

  Chairman—Dame Pauline Neville-Jones

  Dame Pauline has worked extensively in the Foreign and Commonwealth Office and has been Chairman of the Joint Intelligence Committee, acting as adviser to the Prime Minister on all foreign, defence and intelligence issues. Dame Pauline is currently a BBC Governor, with special responsibility for the World Service and is Chairman of the Information Assurance Advisory Council.

  CEO—Sir John Chisholm

  Chief Executive of DERA (previously DRA) from 1991, transforming it into a successful Trading Fund and developing its commercial business. Previously UK Managing Director of Sema Group PLC and before that Director of Cap Group PLC and MD and founder of CAP Scientific Ltd in 1979. After a degree at Cambridge in Mechanical Sciences, experience includes General Motors and Scicon Ltd, part of BP. Non-executive directorships include Expro International PLC and Bespak PLC. Fellow of the Royal Academy of Engineering, the Institute of Electrical Engineers, the Royal Aeronautical Society and the Institute of Physics.

  CFO—Graham Love

  Rejoined DERA in 2001. Formerly Chief Executive of Comax PLC leading it through privatisation in 1997 before sale to Amey PLC in 1999. Previously Finance Director of DERA from 1992 to 1996. After a degree at Cambridge in English, experience includes management roles with Ernst & Young, KPMG and Shandwick PLC, as well as several years in international consulting. Fellow of the Institute of Chartered Accountants.

  Hal Kruth

  CEO of QinetiQ Ventures Ltd and President of QinetiQ Inc. He joined QinetiQ from SRI International, one of the world's leading independent research organisations where he managed major transactions involving start-up companies, licensing, sponsored research, joint ventures and technology spin-offs.

  Non-Executive Directors

  Jonathan Symonds

  Chief Finance Officer at AstraZeneca PLC, which is a global life science group with a turnover of £11.3 billion, £1.2 billion, pretax profit in 1999. Responsible for all aspects of finance, including financial strategy and corporate finance, and also the global information services and investor relations.

  Glenn Youngkin

  Glenn Youngkin is a Managing Director of The Carlyle Group and leads the firm's buyout activities in the UK. He is based in the firm's London office. Prior to joining Carlyle in August 1995, he was a management consultant with McKinsey & Company, where he worked on a variety of strategic and operating issues in the energy, consumer product and healthcare industries. Previously Glenn Youngkin structured market financings for Credit Suisse First Boston's Natural Resource Group. He received an MBA from Harvard Business School, where he was a Baker Scholar. He sits on the boards of EMPI, Imagitas and Kuhlman Electric.

  Sir Denys Henderson

  Sir Denys Henderson has recently retired from his role as Chairman and First Commissioner of The Crown Estate. Previously, Sir Denys served as Chairman of The Rank Group, formerly The Rank Organization Plc, and from 1957 to 1995 he was with Imperial Chemical Industries PLC, serving as its Chairman from 1987 until 1995. He was also Chairman of Zeneca Group PLC from its independence in 1993 until 1995.

  His current appointments include: Member, The Law Society of Scotland; Companion, Institute of Management; Member, The Advisory Council of The Prince's Youth Business Trust; Fellow, The Chartered Institute of Marketing (honorary Vice President 1989-1995); Chancellor, University of Bath; President and Chairman, The British Quality Foundation; Member, Advisory Committee on Business Appointments; Member, Advisory Council, Centre for Dispute Resolution. Sir Denys is a graduate of the University of Aberdeen. He holds an M.A, an L.L.B., and is a Solicitor. He received his Knight Bachelor (Birthday Honours) in 1989.

4.   Carlyle's partnership approach to MoD

  Carlyle has a well-established track record in Europe of marrying the corporate objectives of its partners with the financial objectives of its investors. Accordingly, the firm has endeavoured to be flexible on the terms of its partnership in order to accommodate the MoD's requirements.

  As a result the firm has agreed to structure its investment so that the MoD is able to retain a majority economic interest in QinetiQ of 62.5% that can be realised during an IPO of the business. The British taxpayer will therefore, be the main beneficiary of any growth in the value of QinetiQ, which Carlyle's investment helps the business to achieve.

  Although the MoD will cede control of the business it will retain a Special Share in QinetiQ. This Special Share allows the UK government to veto any proposed transaction or activity that it considers would be contrary to the interests of national security because of unacceptable ownership of or influence over the company.

  Finally, the shareholder's agreement contains reserved matters, which require MoD approval of major strategic decisions.

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Prepared 9 April 2003