Examination of Witnesses (Questions 84-99)
DR LEWIS
MOONIE MP, MR
COLIN BALMER
AND MR
MARTIN EARWICKER
TUESDAY 21 JANUARY 2003
Chairman
84. Thank you for being so tolerant but we could
not miss the opportunity of discussing these issues with the DERA
people—I refuse to call them anything else. Is there anything
you would like to say to start? We cannot wait to ask Mr Balmer
to explain what none of the witnesses earlier on were able to
do.
(Dr Moonie) I think we can go straight
to questions. Perhaps I can introduce my team, Colin Balmer is
the Director of Finance and Martin Earwicker is the head of DSTL.
I shall be relying on them heavily.
85. Yes. Minister, when the MoD chose Carlyle
as the QinetiQ strategic partner in what way was it better than
other applicants to pick up the role? Who else was there? Can
you tell us who the others were?
(Dr Moonie) I do not know whether I can tell you that
because of restrictions on these things. There was a large field
of initially something like forty applicants, which were whittled
down to 6 on a short list and then after very careful selection,
looking at prospects for the company and the return expected from
the deal we chose Carlyle as the best option. It was as a result
of a very careful sifting process.
86. What criteria did you have in mind when
evaluating whether to accept?
(Dr Moonie) It was not just the size of the cheque,
although that obviously had some bearing on it, and the way we
saw the value of QinetiQ growing with it. Basically it was the
bid that we thought overall was the best option for allowing the
company to grow and prosper in the way that we would like to see
it doing.
87. Who was on the selection panel? Who decided?
(Dr Moonie) On the advice of our financial advisers
ultimately the Secretary of State and myself decided.
88. Who were the financial advisers?
(Dr Moonie) UBS Warburg.
89. We heard from Dame Pauline that it is a
British company. BAE Systems were allowed by the MoD to slip into
majority foreign holding. How long is it going to be before QinetiQ
becomes international rather than British?
(Dr Moonie) We do own 62% of the equity just now,
certainly not until that were to change. We have safeguards in
place, Mr Chairman, if you like, to ensure that the company retains
its identity as we would wish.
Rachel Squire
90. Perhaps yourself and Mr Balmer can throw
some light on the complexities of the transaction affecting Carlyle
and QinetiQ.
(Dr Moonie) We shall do our best.
91. I live in hope. Can I, first of all, ask
whether you can clarify what the financial transactions will be
when the deal with Carlyle is finalised later this month? What
exactly will the MoD get financially from the transaction?
(Dr Moonie) I shall pass this without further delay.
(Mr Balmer) Thank you, Minister. There will be three
components of our receipt. The first is that we will have repaid
to us the debt which was vested into the company to the tune of
around £40 million, plus a bit of interest. The second component
will be a continuation in a slightly different form of some of
that debt, about £60 million worth, which will be a loan
note contingent on the sale of some properties, particularly the
property at Chertsey. Those two notes between them replace the
£100 million of debt which the company still owes us, which
was part of the £150 million that we vested in the company
on 1 July 2001. So we will be receiving in cash of the order of
£40 million and as a further loan note a further £60
million or so. The timing at which that will be turned into cash
will depend on the negotiations for the sale of the Chertsey site
and the point at which cash flows from that, and that could happen
over the next year or two. The third component will be a cheque
from Carlyle, the exact size of which will depend on the completion
accounts which we will be going through with both QinetiQ and
with Carlyle over the next few weeks and we expect to be of the
order of £40 million or so, so that the total we receive
will be somewhere between £140 million and £150 million,
which were the figures that were contained in the Minister's statement.
Mr Howarth: The £150 million is
the £140 million you lent them.
Chairman: Let Rachel unfold her question
first and immediately afterwards you can come in, Gerald.
Rachel Squire
92. That leads me neatly on to the next question
which was what that £140 million, £150 million expected
from Carlyle would actually cover and whether, in fact, Carlyle
are paying more than the face value of the shares or are they
paying less than the face value of the shares? I suppose the fundamental
question is who is actually gaining from this?
(Mr Balmer) In a sense the face value of the shares
has no particular relevance, what matters is the value that is
being attached to them. The value that is attached to them is
whatever someone is prepared to pay for them. This is the first
time we have had an opportunity of establishing what a market
value is for these shares. Previously we have only been able to
look at the balance sheet of the company and things like the asset
base. We now have a market driven assessment of the value of the
shares and that means that we are able to expect from the company
of the order of £140 million to £150 million in exchange
for having parted with around a third of the equity. Carlyle are
only paying a certain amount in cash and that some of it is coming
in loan repayments to us simply reflects the balance of debt and
equity in the company. Had we not vested debt into the company
then we would now be getting the same amount of money for the
equity, because that is what the company is worth. We would still
be getting about £140 million to £150 million. We chose
to vest some of it as debt. We did not lend the company the money,
we never parted with any cash to the company, we simply parted
with the assets to the company when we vested them and in exchange
we said "You owe us £150 million and we will have the
shares". In realising a value for those, it is the total
value that matters and the total value has been £50 million
repaid already, which was paid a year ago, and now another £150
million or thereabouts, subject to the final completion accounts.
93. So that links in then, am I getting this
right, with what I understand the Minister told the House last
month, that around £200 million would have been received
by the MoD from the PPP which appears to include the £50
million previously received from QinetiQ? Am I understanding that
correctly?
(Mr Balmer) That is correct because when we vested
the company we vested £150 million of debt, they owed us
that much and we had shares. In two separate transactions we have
taken £50 million of cash out in repayment of part of the
debt and we will now take in a mixture of repayment of debt and
a loan note for the site still to be sold and a cheque from Carlyle
and we will be expecting another £140 million to £150
million, so the total is of the order of £200 million at
this stage. We will still then own nearly two-thirds of the equity
so that in due course when the company has increased in value
and we judge it is the right moment to exit we will sell our remaining
shares for, I hope, a considerably larger sum of money.
Mr Howarth
94. Basically what you are saying is that there
was no cash transfer when you vested the company and you said
in exchange for all these assets that QinetiQ was taking a portion
but in the parliamentary answer I received it said that in its
current state it is valued at £342 million. You said that
would be funded, the assets of the company would be funded, by
way of partly equity and partly debt and that the debt would be
represented by these loan notes which QinetiQ would pay to us
in due course.
(Mr Balmer) That is correct.
95. You have had £50 million so far.
(Mr Balmer) Correct.
96. However, I have to say, whether deliberately
or otherwise, the perception the public has is that the Government
is raising some £50 million, at least £50 million, from
the sale to Carlyle, if not £150 million, but that now does
not seem to be the case. Mr Youngkin told us a moment ago, as
you heard, that his group is paying £42 million for a third
of the equity. If I can ask you the question that they were not
able to persuade us of the answer to. If the net assets of the
company are £312 million, that is net of liabilities, which
presumably includes the £140 million owed to you under those
loan notes, therefore the free capital, if you like, is £312
million, can you explain to us as laymen why is Carlyle paying
£42 million for a third stake in a company which has a capital
value net of debt of £312 million?
(Mr Balmer) Can I take this question in two parts.
First, Carlyle will be paying us in the order of £40 million,
as I said the exact figure will depend on the completion accounts,
but they are also allowing us to be repaid by the company the
debt that I have described, so Carlyle are in effect paying us
£140 million to £150 million but they are not having
to provide cash from their own shareholders for all of that. The
company will be worth less because we have taken our money out.
As regards the balance sheet value of the assets—
97. I am sorry, I am going to stop you there
because they will not have taken their money out because the figure
of £312 million is net of the debt, the liabilities are in
the accounts at £251 million as creditors falling due in
one year, so that is already accounted for, is it not? We know
that the company has been valued at £500 million but after
you deduct the liabilities, of which the £140 million to
£150 million due to you in the loan notes is a part, the
net result is that we have still got assets on the books of £300
million where you have got two-thirds of the action and Carlyle,
plus the employees with their, in my view, rather small stake
in privatisation, they have got the rest. Therefore, they have
paid £42 million for assets worth £117 million.
(Mr Balmer) The asset values on the books are recorded
in the company's accounts. From the figures you have correctly
quoted and as was disclosed by the Minister in a Parliamentary
question the net asset value is £312.5 million as at 31 March
last year, those are the closing accounts for the company at that
stage. The directors of the company made clear in a note to those
accounts that the valuation of the assets was done on a depreciated
replacement cost basis, a perfectly normal process, which is not
the open market value of the assets. Had an attempt been made
to assess the open market value of those assets the director's
view was that the assets would have been worth substantially less
than that, by more than £100 million. The view at that point
in time of the net assets of the company was £312.5 million
less a substantial amount if you tried to sell the assets in the
market place. That is the asset position. What Carlyle have done—
98. That is phoney accounting, is it not?
(Mr Balmer) No, that is perfectly normal accounting
and those were the notes disclosed by the company in its accounts
and passed by their auditors. The figure for the opening balance
sheet that year had previously been agreed by the National Audit
Office but the closing accounts were agreed by the company's new
auditors KPMG. The figures have all passed normal audit processes.
The question about what Carlyle or whoever we sold these shares
to should pay is a different question. Clearly an asset value
is one consideration that one would take into account. Other things
to take into account, and this will clearly weigh very heavily
with Carlyle are: What happens to this company in the future?
What will the future performance be? What future requirements
are there going to be for capital investment? What future liabilities
might arise in other circumstances and what cash can the asset
base be expected to generate in normal trading? The amount of
cash that the company should generate over a longer period discounted
back to today's value is a more normal way of valuing companies
at a point of sale and our own advisers suggested that is probably
how Carlyle or anybody else would have valued the company. I do
not know what value Carlyle did put on any of those calculations,
that is their business, they simply gave me the enterprise value
at a figure of about £500 million on the assumption there
was neither debt or cash in the company. The underlying value
is about £500 million. Clearly there was a mixture of debt
and overdraft and cash holding so at any point in time the working
capital movements would mean that the actual value would be less
or more than £500 million, probably less than £500 million
taking account of those liabilities. If you work that calculation
through and you take account of what we think the working capital
balance will be and we take account of the debt the company owes
that is how we get down to a number which generates a flow to
us of about £140 to £150 million.
99. You start off by saying there is an underlying
value of 500 million, the balance sheet shows net assets of £312.5
million but you say that the directors reckon that an open market
would be about 100 million less.
(Mr Balmer) More than £100 million less, they
actually said £113 million.
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