Examination of Witnesses (Questions 1-19)
DAME PAULINE
NEVILLE-JONES,
SIR JOHN
CHISHOLM AND
MR GLENN
YOUNGKIN
TUESDAY 21 JANUARY 2003
Chairman
1. Lady and gentlemen, welcome. This is the
fifth time we have visited the subject of DERA; we have our reports
and there will certainly be one more. Originally our first report
said we thought the process was deeply repugnant. I have since
recanted—we are totally wrong and I just find it repugnant.
I do not hide my dislike of the whole process but we are not going
to rake over the coals. The business is largely done and it would
be superfluous to revisit all the questions that we raised. If
anyone is interested they can look at the full reports to get
the full measure of what we thought of the process. QinetiQ has
told us that, "Carlyle is a good match for QinetiQ because
its experience enables it to understand and commit to the QinetiQ
business plan . . . the MoD has recognised the benefit of Carlyle
being a global investor with deep knowledge of a range of industry
sectors, global markets and routes to market". Fine. May
I ask you, and I know not whether one or all three of you would
wish to answer but as you are in pole position on this occasion,
Dame Pauline, you can crack the whip, as I know you are able to
do very fiercely: bearing in mind the quotation from QinetiQ,
what do you consider to be the most important attributes that
Carlyle will bring to QinetiQ?
(Dame Pauline Neville-Jones) Chairman,
thank you very much for your welcome and also for what you have
just said about not looking back but forward, because that is
certainly what we in the company want to do. If you would just
permit me, and I do not want to take up time, I thought it might
be useful firstly to introduce my colleagues, one of them very
well known to you the other not, and if this would be helpful—but
tell me if you would not think so—I think your question
is very key but it might be helpful if you knew from Carlyle directly
what Carlyle brings by way of background and what sort of investor
it is, so what I thought I might do is just rehearse for the benefit
of anybody who has not been thinking about QinetiQ recently what
kind of company we are, ask John Chisholm, the CEO, to bring the
story up to date and then ask Glenn Youngkin, who is the managing
director of The Carlyle Group in the UK, to lead in by giving
you a little bit of an insight into the company and then answer
the question you have asked, which is why is Carlyle a good match
for us. QinetiQ is, as you rightly say, the company that springs
out of DERA and what I am about to describe by way of our activities
are really the activities that we intend to continue to pursue,
and I think we intend to be in five years' time, say, recognisably
the company we are at the moment—obviously, we hope, having
developed—and we do now, and will continue to do, the following.
Obviously the first thing we do which is key to our existence
is our relationship with the Ministry of Defence, who is our main
customer, where we do really three things of importance I would
say: firstly, clearly, we do research on a contracted basis with
the Ministry of Defence in the defence area: we do evaluation
activity of technologies which they may be considering procuring
and for that reason, as you obviously know, there is a very stringent
compliance regime: and we also, under a long term partnering agreement
that is still being negotiated, maintain and will keep up to date
the various test facilities. That is our relationship with the
Ministry of Defence. There are also a couple of other areas where
we are active and where I think over time there will be expansion,
which are the following: clearly, being partners with other defence
companies, ie developing our commercial defence business in areas
where we are permitted, and finally using some of those technologies
in the civilian field of the economy, because clearly there are
things that can be done for the benefit of the company and it
is in the national interest to take those technologies to other
civilian applications, and it is that background that Carlyle
comes into. I am going to ask Sir John Chisholm if he would just
like to bring the Committee up to date on what has happened since
you last examined, and then ask Glenn Youngkin to say a little
bit about Carlyle and then lead in to the question of why we are
a good fit.
(Sir John Chisholm) Chairman, since we last met, of
course, we have proceeded with the QinetiQ plan that we discussed
last time and I think the main point to make about that is that
the company is very much on the plan that we outlined to you before—in
fact, quite remarkably so when I look back. I can see the plan
unfolding year by year, the increasing competition which we face
in our core business with the Ministry of Defence has certainly
been unfolding, and we have been facing up to that and to the
changes in the Ministry of Defence's requirements, and equally
we have been using the technologies which our staff have developed
to develop those in several markets and in other markets in which
we operate to the benefit of our all customers. So that has been
the basic plan and we have been doing it. Each year it gets harder,
and I do not need to tell anybody on this Committee I am sure
that we operate in very tough markets these days. Both our commercial
markets and our Ministry of Defence markets have been difficult
for us this year but our plan is unfolding. Last year we hit the
targets which we set ourselves and as of now, the third week into
January with the end of the year approaching, it looks at least
promising that we will hit our targets for this year as well for
which I am hugely grateful, particularly to the nearly 10,000
engineers who work in QinetiQ.
(Mr Youngkin) Mr Chairman, I must admit when I moved
to the United Kingdom three years ago the expectation that I would
be sitting in a room like this for this session was quite far
from my imagination so I appreciate the opportunity to be here.
You have seen from our submission what Carlyle does and the kind
of firm we are but I thought I would highlight a few things. I
have been with the firm for eight years and have been a partner
for the last four and in the United Kingdom for three of those
four. The Carlyle Group is a global investment firm; it is a partnership
owned by its most senior investment professionals; we have been
in business for 16 years; we manage around $14 billion of capital
in the United States, Europe and Asia; our investors include the
world's largest public and private pension funds, banks, insurance
companies and such. We employ around 500 people around the world
in 22 offices and have invested in a variety of businesses—everything
from technology start-ups to mature businesses in industries that
would include automotive, aerospace, defence, health care, industrial
manufacturing, energy and, most importantly, telecommunications
technology and media which is our biggest area we invest in, with
roughly a third of our funds going into that sector. Our funds
have performed pretty well over the years and we think that is
really based on the principles that we apply. First, we are conservative,
not cowboys. Secondly, we try to invest in businesses that operate
in industries we know well. Thirdly, we back strong management
teams, and I will say that is one of the most attractive attributes
of QinetiQ and the commitment they have to the business. Lastly,
we have a high ethical standard in guiding the way we will interact
with our investments. Each investment stands alone. There is no
other way to safeguard the interests of the investors, the customers
and the employees than to treat each investment on a stand-alone
basis. That particular point was enhanced in this deal as we,
from the very beginning, had to comply with all the Ministry of
Defence requirements particularly around national security with
this investment. Lastly, the firm has a particular history in
investing in partnerships. We have invested with companies like
Cadbury Schweppes and General Electric and that has allowed us,
we think, to gain a great experience in what it takes to have
a successful partnership. We think we will work well with the
Ministry of Defence in our partnership in QinetiQ; we think it
will have to work quite hard over the next three to five years
to achieve our goals, but we think the company is poised for that
success. I hope that is helpful as background. To get to your
direct question on what we think we would bring to this particular
investment and why we were eager to pursue it, firstly, we understood
from the very beginning the special security interest and special
attributes of QinetiQ and really, from the very first interaction
with the Ministry of Defence, we were comfortable with what their
requirements were. Secondly, we have a track record that will
demonstrate that in the world of technology and the industries
that QinetiQ aspires to compete in we have good experience. Thirdly,
our global network will help the company grow and finally, as
I mentioned previously, our partnerships with other entities will
allow us to perform well with the Ministry of Defence.
2. Thank you. Sir John, when the saga first
began that I strongly alluded to, there were a lot of pretty angry
people—a lot of people on your staff who did not want to
leave the orbit of the Ministry of Defence: defence contractors
who felt that you would be pinching a lot of their research money:
some of the trade unions were opposed—quite a few organisations.
Now, I said I am prepared to an extent to let bygones be bygones—you
recognise when you lose a battle in this world—but have
you managed to convince those other groups, the defence manufacturers,
the trade unions, and all of those other groups who really did
not like what the government and you were doing? Have you managed
to placate them? Of course, in the early days, amongst the strongest
opponents of the privatisation of DERA was the US Department of
Defence who we have been told, although we have never had it from
them in the last three years, are now perfectly happy with the
arrangement. So I would be grateful, if everyone is alongside,
to know how you managed to do it.
(Sir John Chisholm) First of all, I can only answer
what people say to me when they talk to me, so that is what I
will talk about. So far as our staff are concerned, there has
been a steady increase in the percentage of our staff answering
our staff surveys saying that they are content or are positively
inclined towards the plans as they are now emerging, so the feedback
I get from our staff is that, as time goes on, they have become
increasingly content with the direction which the company is taking—indeed
they have to be because the company depends on our staff and our
company is doing reasonably well in difficult circumstances.
3. What is the percentage now?
(Sir John Chisholm) The most recent survey that we
have done has shown more than 60%. I do not have the figure immediately
to hand but I can provide it to you. It is of that order.
4. 60% who are either very happy or acquiescent?
(Sir John Chisholm) Yes. So far as the defence industry
is concerned, again I can only speak for their interaction with
me, and when I speak to the defence industry they certainly raise
concerns and issues which they have which I always answer, "If
you have those issues, come to us, put them before us, we will
deal with them precisely", and that very rarely ever happens,
but when I talk to chief executives they tell me they are completely
content to work with the new company now it has emerged and they
look forward to generating worthwhile partnerships which are going
to work for both sides. So that is the impression I get when I
talk to defence industry. I am always perplexed by what I read
in the media about this subject because certainly, for instance,
if BAE Systems—to name the company at random—were
to decide to separate itself from its research laboratories and
to put all its research out to competition and to allow me to
compete for it, I would regard that as probably an advantage for
me as a company—
5. I think the Ministry of Defence is trying
to separate it from its shareholders, actually.
(Sir John Chisholm)—and if it was further said
that there were limitations for its laboratories to compete for
my business, then that would make me even happier. So, from the
perspective of the typical scientists in our laboratories, they
would see the situation as it arises as being one which can only
be a win for other companies. Other companies can only gain from
the circumstance because more business has been made available
for other companies to compete for. So the fact that both our
staff and other companies have reason to believe that there are
positive things in this change for them I think is good.
6. And what about the trade unions and professional
associations?
(Sir John Chisholm) The trade unions I believe we
have a positive relationship with. We have always striven to have
a positive relationship with our trade unions. We have kept them
fully informed right through this whole process, and we believe
that we are working together on creating a very successful company.
7. I expect the US government is quite happy
now there is an American company firmly ensconced within the organisation.
I cannot resist a little provocative remark: you must forgive
me for lapsing into bad behaviour!
(Sir John Chisholm) I do not talk directly to the
Department of Defence in the United States any more.
(Dame Pauline Neville-Jones) As long as I am Chairman
of this company it is going to be a British company and we have
a British board and we will obey the rules of British law.
Chairman: That is very encouraging. Thank you
very much. That was a very painless first session.
Syd Rapson
8. I have to declare an interest because both
DSTL and QinetiQ are heavily involved in my constituency and are
less than a third of a mile from my home, and I must say DSTL
had the courtesy of inviting me along to get me on-side so that
is a point worth noting. When QinetiQ was set up it had a particular
balance of debt and equity. £179 million in loans from the
Ministry of Defence and £346 million in equity. What alternative
combinations were considered, and would you have preferred to
see the debts cleared giving you a greater equity?
(Sir John Chisholm) Mr Rapson, first of all, if we
have not invited you to visit us to understand better what we
are doing, let me immediately repair that omission. Secondly,
in relation to your question about the mixture of debt and equity
in the company, it is very common in companies in our phase where
we are in the process of transition and there is a lot of change
to do in the company and where private equity comes into the company
in the first place, for the capital of the company to be represented
with a limited amount of equity and a substantial amount of debt
which allows us to undertake the necessary transition, pay down
the debt, and improve in due course the balance sheet of the company
as it develops. So the mixture of debt to equity is very common
for companies in our phase of transition, and I as chief executive
am obviously content with it. More importantly in a sense our
board, which is predominantly composed of non executive directors
with considerable experience in the private sector, are right
behind me in believing this is an appropriate mix of debt and
equity for a company in our stage of transition.
9. That is a very good answer and probably would
have been better if you had greater equity, but I take that answer
as being straight. Mr Youngkin, your firm is acquiring a 33.8%
share in QinetiQ. What was Carlyle's negotiating position, what
alternative figures were you considering, and to extend that what
was the bottom and top line that you would have preferred to have
as an ideal figure?
(Mr Youngkin) In the negotiation with the Ministry
of Defence and through the process of the competition that was
run, the initial requests from the Ministry of Defence asked for
proposals for a substantial minority position, and that was the
direction. We found that to be somewhat vague and when asking
really, "What kind of proposals did you want?", we were
led to a proposal that was somewhere between a quarter and a half
interest. Being the simple mathematicians that we are I proposed
in the middle at 33%.
10. And that is a perfect figure for you?
(Mr Youngkin) That is fine.
11. Obviously you were very successful and that
is good. You will be buying shares in QinetiQ at £1, at face
value. Would you have gone for a higher figure?
(Mr Youngkin) For a higher ownership?
12. Yes. Or will you be going for a higher figure?
(Mr Youngkin) The percentage?
13. Yes.
(Mr Youngkin) The percentage that we offered to buy
we were comfortable with. I think if the Ministry of Defence had
asked us to purchase more we would have done. I think that the
balance that has been created between our ownership, the participation
of the British taxpayer and the continuing value creation, and
really the partnership terms that have been negotiated are quite
stable and we can work with them. There was no requirement for
us to own more but, if the Ministry of Defence had asked us to
propose to buy more, we would have.
14. So how much are you paying for each pound
share? That might be easier to understand.
(Mr Youngkin) Let me see if I can answer it in a different
way. We have basically arbitrarily set the number of shares to
the percentage that we are going to buy so that the equity value
of the company is equal to the number of shares times £1.
We felt £1 was a comfortable number that everyone would understand
and it was easy maths for me, so we are basically buying 33% of
the company times the equity value times £1 in shares.
Mr Howarth
15. Could I first declare an interest in that
the headquarters of QinetiQ reside in my own constituency and,
as Sir John so felicitously put it, when the company was DERA
and wholly in the public sector he was accountable to me, and
he would like me to know that as they are now entering the private
sector I become accountable to him, and as his constituency Member
of Parliament I am happy that that relationship should continue,
but I also pay tribute to the success of QinetiQ and its employees.
I am also bound to say I declare an interest as a council member
of the DERA Aero Club, shortly to become I think the Farnborough
Aero Club. Dame Pauline, can I ask you to try to take us as laymen
through the accounting arrangements here because I have to confess
that, despite having spend some time in the City, I find it quite
difficult to follow exactly what the government is up to. This
Committee's job is to try to scrutinise what the government is
doing, not necessarily what you are trying to do, and I would
be grateful if Mr Youngkin could explain exactly how much money
Carlyle has handed over to the British government because I understand
they have paid £50 million so far and there are some loan
notes outstanding.
(Mr Youngkin) I will do my best to explain this topic.
First, I think it is helpful to talk about the overall enterprise
value of the business, comprising its equity value plus its debts
and liabilities. In this particular circumstance we placed a value
of £500 million on the business.
16. Apart from the fixed assets, which are about
£342 million, was that a figure that was otherwise plucked
out of the air? What is the basis of the £500 million, apart
from the loan?
(Mr Youngkin) In fact, the £500 million was based
on our valuation of the cashflow of the business, its liabilities,
other obligations and its outstanding debt. What that ended up
adding up to was £375 million of debt and liabilities and
£125 million of equity. The two of those together totalled
£500 million, and that is the enterprise value for the business.
Your specific question was what we paid for our share. We bought
roughly 33% so we paid £42.2 million for our 33% of £125
million. The business will assume all of those liabilities, the
£375 million, which today are part of the shareholders' liabilities.
The business will assume all of those, but that is what we paid.
17. I do not understand. You paid £42 million
for a third of an organisation which has assets totalling £350
million. Can you explain why you did not pay £115/117 million
for a third of a stake in a company which has assets which theoretically
could be disposed of tomorrow for £350 million, and I speak
in round figures.
(Mr Youngkin) We believe that the assets of the business
are worth £500 million but the assets are counterbalanced
by two components—its liabilities and its equity account—so
we believe that the capabilities of this business and its potential
to earn a cashflow is £500 million. That is counterbalanced
by its liabilities that are £375 million, and in equity that
is £125 million, so if the company were to sell all of its
assets today for only £350 million, it would have trouble
meeting its £375 million of obligations.
18. Not by very much, though.
(Mr Youngkin) No.
19. I am finding it difficult to reconcile these
figures but let us move on. So you have paid £42 million
so far and I have a Parliamentary Question here in which I am
told that £50 million has been paid not £42 million,
and I am told that you will have an obligation to pay a further
£150 million. That presumably is not in equity but how are
you going to account for that £150 million additional that
you are going to pay the British government?
(Mr Youngkin) Mr Howarth, I am not familiar with the
extra £150 million but what I can say is our £42.2 million
is joined by £5 million that the employees of the company
have offered to invest for a total of £47.2 million, and
that will equal the 37.5% that equals the rest of the ownership
from the Ministry of Defence, which will retain a 62.5% interest.
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