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7 Mar 2006 : Column 237WH—continued
QinetiQ
1 pm
Dr. Vincent Cable (Twickenham) (LD): I am grateful for the opportunity to introduce a debate on the controversial issue of QinetiQ. It will centre on recent events, from the public-private partnership that took effect at the end of 2002 through to the privatisation—or the public offering of shares—during the past couple of months. The issue is controversial not simply because I say so; two of the Minister's predecessors in the Department have made similar comments. Lord Moonie, whom I remember as a balanced, calm Minister, said that he was extremely "unhappy" about this process, while Lord Gilbert said it was no less than "a scandal".
Some of the issues involved will be dealt with in the context of a National Audit Office investigation, which I sought and which has now been agreed. The matter is sufficiently serious to have it raised early and on the Floor of the House. As the Ministry of Defence has rushed to tell us, the NAO inquiry is routine. The time scale involved—by the end of this year—is fairly leisurely, but the issue is more important than that, which is why I sought this debate. It is important not just in itself, but because of the extent to which it may set a precedent for how privatisations of comparable organisations take place. The United Kingdom Hydrographic Office is due to be floated in a similar way and a similar approach is under discussion in relation to the Forensic Science Service.
I want to make it clear that I have no ideological, dogmatic problem with PPPs or with privatisation of this type of enterprise. As it happens, my Twickenham constituency is home to the National Physical Laboratory and the Laboratory of the Government Chemist, which was privatised through a management buy-out. The National Physical Laboratory remains in public ownership, but there is a management agreement with Serco and also a private finance initiative. Both those organisations are successful, and I am all for encouraging such collaboration, but serious problems and questions have arisen in the case of QinetiQ.
I will start by discussing a few background elements. QinetiQ emerged from the Defence Evaluation and Research Agency. We are talking about half a century of scientific research done in our national security interests. It produced, among other things, radar during the war, microwave radar, carbon fibre, liquid crystal displays, flat-panel systems, 4,000 patents and 8,000 or more highly qualified scientists. It is a considerable national asset. There has been a sensible move to put it on a more commercial footing: splitting off DERA from the Defence Science and Technology Laboratory—the Government-owned side of the laboratories; the decision in 2001 to create a limited company, and therefore commercial freedom; the subsequent move to a PPP; and the flotation.
Before I put my questions to the Minister, some of which I have tabled in writing, it might be useful to summarise, without comment, the key facts at the centre of this matter. There are issues concerning the PPP at the end of 2002. The first relates to the sale of 34 per cent.—later reduced to 31 per cent.—of the company's equity
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to the Carlyle group. That was purchased in the form of £40 million of equity backed up by a loan of £150 million—an interest-bearing note.
Secondly, there was substantial employee share participation, notably by senior management. I believe that Sir John Chisholm had a 2 per cent. share and Mr. Graham Love, then the company's finance officer, 1.6 per cent. A 50 per cent. stake remained with the Government. The other key element of the PPP package was the long-term partnering agreement that was reached and announced on the same day as the Carlyle group's strategic acquisition. It involved a 25-year contract, £223 million a year in revenue and a cost of more than £5.6 billion. We are talking about a major Government contract for QinetiQ in support of that project.
At the beginning of this year, the public offering took place and 49 per cent. of the company was sold. It would appear that about £1.25 billion was raised. What is the problem? The accusation that has been made—I put this as a question rather than an assertion, because there are many unresolved issues—is that for a modest sum the Government effectively gave away a substantial part of a public asset to a company and to senior executives who took on virtually no risk.
The balance of risk and reward is at the heart of PPPs and the argument is that the balance was seriously disturbed on this occasion. The Carlyle group made about 10 times its original investment—the relevant figures are £40 million and £400 million—in three years. To single out the largest example, Sir John Chisholm increased his stake from about £129,000 to £26 million, which represents a multiple of almost 200. In the trade, that process is called ratcheting. The people I have talked to in the trade are shocked by the extent to which the gains were ratcheted.
It is accepted that a privatisation—a flotation of this kind—will produce substantial returns to the people involved. A factor of 10 was regarded as probably reasonable for somebody such as a chief executive in this context. However, a multiple of 200 was regarded as wildly extreme—not to mention obscene—and has caused great concern within the company and outside. The other aspect of the criticism involves whether the Government got value for money. Of course, they realised a substantial amount of cash and retain an equity stake, but the question whether they got value for money is different.
In the time remaining, I want to pose a series of specific questions to the Minister. He will know where I am coming from because I have already put some of them to him in writing. First, what exactly was the process by which Carlyle acquired its strategic 34 per cent. stake in the company with relatively little money—£40 million in equity—and virtually no risk? Indeed, some more thoughtful commentators, such as Patience Wheatcroft in The Times, have suggested that the money at risk as a result of the financial deals involved came to as little as £14 million. Be the sum £14 million or £40 million, how it multiplied to £400 million remains an issue.
The Government, in explaining their role, claimed on a webpage called "Combating 'Urban Myths'" that the way the Carlyle PPP operated was as follows:
"Best value for money was secured through an open and competitive auction between about 40 serious potential investors."
I have talked to some of those potential investors and they have no recollection of any such process having taken place in the way the Government described. Indeed, I received an e-mail from one of them. Such people are reluctant to be named because they do other Government business, and I hope that we can take things at their worth.
That person's company was trying to put together a competing bid. He said that he was firmly told that at least £200 million would be required and that his company should be prepared to go considerably higher. At no stage was it ever suggested that his company could get away with putting up £40 million backed by a loan. There might have been a misunderstanding, but any such misunderstanding would be serious because it led to a substantial number of potential bidders not participating.
That leads to the question of what were the criteria by which Carlyle was selected. They clearly revolved around the amount of money and the amount of money in the form of equity, but other criteria were involved. Another potential bidder told me that when they talked to the Ministry of Defence it was made clear to them that they should not put in a bid that did not include retaining the services of Sir John Chisholm, who was then chief executive. I do not know whether that is true—this may or may not be a good point to make; the man may be a genius for all I know—but he clearly made a personal fortune out of this transaction. There is an issue about whether that was a key criterion. Was there an issue about the stake to be acquired by the strategic partner?
What was the connection with the rifle range contract—a massive Ministry of Defence contract of over 25 years giving a complete monopoly in respect of MOD rifle ranges? That is what made the Carlyle deal so attractive; it could acquire loans from the banks on the back of the income stream that would come from the QinetiQ deal on the rifle ranges. Again, the Government's view is that this was done through an entirely competitive process, but I have spoken to someone in one of the leading British companies involved in this area of business, who says:
"Although QinetiQ claims to have won this contract, it was in fact awarded without competition, presumably because it would fatten up QinetiQ before sale. A number of other contractors"—
There is clearly an enormous misunderstanding—or worse—about the basis on which the competition took place. The best way to deal with that would be for the Government to set out how the competition took place, what the ground rules were and how the decision was made.
The next question is, why was QinetiQ sold when it was? It was sold two years after the dotcom bubble, at which point prices in hi-tech markets had seriously collapsed, and before the recovery, which has led to substantial appreciation in such share values. That is the issue on which Lord Moonie has focused his attention:
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"We should not have sold it at the bottom of the market . . . They could have held off for a couple of years. Geoff was neutral"—
he was talking about the former Secretary of State for Defence, who is now Leader of the House—
That is recorded in the national press. Therefore, there is an issue about why the decision was made to sell at that time, with the obvious implication that the company, and therefore the Government and the taxpayer, thereby realised substantially less than they could and should have done.
The next question is a business question, but it relates to the Government because they were the principal shareholder: how much of the increase in the value of the PPP was due to the strategic partners and the chief executive? How much did they contribute to the adding of value and was that sufficient to justify the ratcheting of their returns? As far as I can piece together, the company roughly doubled in value after the PPP—its value rose by about £600 million to £1.25 million. There are doubts about what the base was; I have a parliamentary answer saying that the company was valued at £312 million at that time. I guess that there was a difference in the basis of the valuation.
Let us say for the moment that the company doubled in value, because that appears to be what happened. It doubled in value for several reasons that were completely unconnected with the strategic partner or the activities of the top management. First, the stock market appreciated in value by 45 per cent. Therefore, there was serendipity. Also, the Government agreed to guarantee the pension fund, which was in deficit by over £100 million. The Government provided working capital, too; that was repaid of course, so there was no cost to the taxpayer, but an opportunity cost was involved.
Furthermore, substantial sums of money were raised not through the strategic activities of the new partner, but simply by selling property. Approximately £150 million was raised by selling property, and the annexes to the flotation, which I have before me, suggest that QinetiQ is a very wealthy property company. It has property assets of well over £300 million in net book value, let alone market value, and a great deal of the value of the company is vested in property. There was also the contribution of the rifle range contract.
If we put all that together, we have a conclusion that is best summarised not in my words, but in those of Lord Gilbert. He said, echoing my view entirely, that while he has
"no objections to the workings of a capitalist system where a man takes big risks and makes big rewards, in this case the people at the top of the tree took virtually no risks.
All the value was built up by public servants using public money. I consider it a complete outrage . . . a scandal."
One could be pragmatic and say, "Well, okay, maybe they did make too much money, but it has all worked out well because the taxpayer has also made a lot of money." That may well be true—it is for the NAO inquiry to establish—but I would simply say that that is difficult to establish, because we need to establish the counter-factual case: what would have happened if the PPP had not gone ahead, or if it had gone ahead with a different partner?
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We cannot answer that question, but what we do know is that although the Government have realised a lot of cash, they have also made major guarantees and commitments, and public assets have been sold that could have been sold in any event. It is very clear to me and to many other people who have looked into this matter that the Government did not realise anything remotely like the value for money that this project could have realised. Ultimately, however, it is for the NAO to assess that.
To move on to another matter, how and why were the senior managers, non-executive directors and others able to establish the formula from which they have made such great personal fortunes out of this privatisation? I have referred to the case of Sir John Chisholm; I could have referred to several other people. It is important to establish this: despite their claims to the contrary, this was virtually a risk-free commitment. They have argued in the press that if the shares they bought—in Sir John Chisholm's case worth £129,000—had dropped in value after the PPP, they would have lost money. Of course, technically there was a risk. However, it is inconceivable in view of the Government's commitment to this company, plus the rifle range contract and the guarantees, that it could have lost value.
There is also an issue in respect of why the chief executive—and then the chairman, as he became—was allowed to lock in an arrangement whereby he could multiply his investment by a factor of 200. That is absolutely extraordinary.
Lord Gilbert is clearly very exercised by this matter; he has tabled questions in the other place that are designed to get to the bottom of it. For example, he asked who appointed this man as chairman. We must remember that he is a chairman who is presiding over public assets. The answer was that he was appointed by Carlyle, the American company that had acquired the strategic stake. Lord Gilbert also asked about who determined the terms under which the chairman and other senior executives acquired their shares. Apparently, that was not the Government; it was the company, because it had been incorporated since 2001. Those are very serious issues. Lord Gilbert is doing us a service by raising these questions, and I want to pursue them in this place, too.
There are other issues to do with the way senior executives of this company profited from the privatisation. About 7 per cent. of the shares were allocated to the top 250 to 300 managers and 6 per cent. to the rest of the work force. There is enormous disgruntlement in the work force, and particularly in the trade union, because company managers have, down to a fairly lowly level, been allowed privileged access to stock options from which they have benefited enormously, but the scientists, including the most senior ones, have not had access to that scheme. They have had a free offer of £500 of shares, which has of course produced some money for them, but the terms of this arrangement are highly inequitable, and I believe that it was approved by the MOD.
To give the Minister time to reply, I shall raise only one further set of questions, although there are a great many others I could raise. This final question aroused considerable interest in the financial pages of the newspapers: why was this offering not made available to
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the ordinary public—the Sids? The Minister has not had oversight of this matter, but the Minister with responsibility for it, Lord Drayson, said:
"This is a very complex business and providing an explanation to the public was going to be too complicated and expensive".
Therefore, the offer was to be made to institutions rather than to the public. However, the availability of the offering was changed and the public were allowed to buy into it through stockbrokers, but on a rather belated and disadvantageous basis.
A lot of analysis has been done that suggests that the reason for this—a cost of £20 million—was wildly overstated. For example, there was no need to give a shareholder discount, and the use of the internet would have greatly reduced the cost. There were many mechanisms by which the Government could have insisted, had they wished to do so, that shares be made available to the general public, so that they could have profited along with Carlyle and the senior executives. However, the Government did not choose to take that route and the magic circle of institutional investors has effectively scooped the pool.
There are many other questions, but I will not go on any longer. I will pursue the answers to them through freedom of information requests and parliamentary questions, as I want to give the Minister time to reply to at least some of my questions.
1.20 pm
The Minister of State, Ministry of Defence (Mr. Adam Ingram) : I congratulate the hon. Member for Twickenham (Dr. Cable) on obtaining time for this debate. I will try to be as balanced as my previous Ministry of Defence colleague, Lord Moonie, but the hon. Gentleman has not been wholly balanced himself, given the amount of time that he took. He has left me with less time in which to respond.
Let me start from the headline—the top issue. Although I am not the Minister who dealt with the issue, I am corporately responsible as an MOD Minister. However, anything I say, I firmly believe in, so it is not that I am simply coming along and giving the MOD's position. These things are weighted and considered.
The recent initial public offering of QinetiQ was a real success for the taxpayer. It demonstrated the success of the Government's public-private partnership policy, through which QinetiQ was transformed from an in-house research and development organisation into an international defence and security company that develops cutting-edge technology for our armed forces.
Why do I say that? The Government have received some £600 million since the start of the PPP process and retain a stake in the company worth some £250 million—that is more than their total stake in QinetiQ in 2003; the hon. Gentleman glossed over that. The IPO met the Government's objective of achieving maximum value for the taxpayer while being consistent with a stable after-market. It raised net receipts of £347 million for the taxpayer, of which £250 million—72 per cent.—was ploughed back into defence to meet defence priorities. That demonstrates the validity of our overall approach to the PPP, and I note that he said that he is not hostile to such an approach.
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The PPP was one of the recommendations of the 1998 strategic defence review. At that time, it was judged that the in-house Defence Evaluation and Research Agency faced external challenges and needed to change if it was to continue to provide the armed forces with the technology that they required. The aims of the PPP—as they always are, in a sense—were to introduce private sector capital and expertise into the company to allow it to meet its investment needs and develop its capabilities, and to enhance opportunities for the commercial exploitation of taxpayers' investment in science and technology.
However, we considered some elements of DERA's work to be too sensitive to be put into the private sector. That is why in 2001 we split the Defence Science and Technology Laboratory, which was to remain within Government and undertake that most sensitive work. At that time, QinetiQ was vested as a wholly Government-owned company.
The original intention was to float QinetiQ on the stock market, but we took specialist advice, made a careful analysis of what was best, and decided that the Government's objective of securing long-term value for the taxpayer would be better met through the introduction of a strategic partner to work with management to develop and grow the business. We therefore ran an open competition for such a strategic partner, and after about 40 initial expressions of interest we selected 12 companies to produce indicative bids. That is not quite the flavour of the story that the hon. Gentleman tried to portray.
Carlyle won the competition, as it was judged that its bid offered the best deal for the taxpayer. The Government received £150 million from the final deal. Carlyle's valuation was benchmarked against other comparable companies. The hon. Gentleman says that he has had representations from one company and from other sources, and says that there must have been a whole layer of misunderstanding, but it was an open process; who misunderstood who? I would claim that it was not the MOD who misunderstood. It was open in its approach.
I take some exception to the hon. Gentleman suggesting that the company—I assume that it is a reputable company, otherwise it would not have been in that territory—is worried about raising its concerns about that time because it is still doing business with the MOD. The imputation is that we would somehow punish such a company. I do not accept that for one moment. He should be careful when making those outrageous charges. If the company said that, and if it has evidence, it should bring it to Ministers, and we will deal with it; otherwise, it should stop running hares and making claims that have no substance.
A concern of Lord Moonie's that the hon. Gentleman raised was why we did not delay the process. That, of course, was one of the balanced judgments that was made. The background is that the markets were low at the time, and we took advice on whether to delay the sale. However, we judged that delaying would not have been in the Government's interest, in terms of achieving our goal of maximising value for the taxpayer over the longer term, as it would have delayed the
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transformation of the company. In any event, there was no guarantee that market conditions would improve. We had learned the lessons from previous privatisations; that is why we sold only 34 per cent. of the ordinary equity, ensuring that the taxpayer, as majority shareholder, would keep the largest share of any future growth in QinetiQ.
Since 2003, Carlyle's input has been crucial in the development of the company's business strategy. It provides expertise in bringing technology to market and a detailed understanding of the important US market, and that has resulted in a significant increase in value for the shareholders. That is why I say that the PPP strategy has proved a great success, and it has been suggested that it could be a model for future privatisations.
In the three years since Carlyle became our strategic partner, QinetiQ has positioned itself as a leading international defence and security company with important acquisitions in the US and Europe. Does the hon. Gentleman want to recognise that measure of success? If so, I look forward to his making a submission to that effect. The measure of what we did is its subsequent success, and we can say, with significant credibility, that what we did stands full examination.
There are issues relating to the proceeds of the PPP. It was not driven by purely financial considerations, but the result has proved to be excellent value for money for the taxpayer. If the Government had sold their entire stake in QinetiQ in 2002, we would have received £230 million, but we have received £600 million, and there is still more to be obtained. It is against that measure that the hon. Gentleman should raise his questions, and if he comes to the same conclusions as we did, he would say that the PPP was a success.
Another question asked is why Carlyle paid only £42 million—it was not £40 million; I noted that the hon. Gentleman discounted it to £40 million on the basis of one press report—for a third share in a company now worth £1.3 billion. Carlyle's acquisition was financed by a combination of bank debt and its own equity, as is standard practice in private equity deals of that type. The £42 million refers only to Carlyle's equity investment. In total, the Government received £150 million in proceeds from the PPP but, as I said, they have retained a majority stake in the business. Since the PPP, the company's profits have more than doubled and the stock market value of defence businesses has also risen. I put that down to the careful management of how we are projecting our needs as a Department, and to trying to establish the best relationship with companies and their employees. All of that is proving successful, so we can take some credit for that, too.
As for the question about why retail investors were not allowed to participate, many of them did so. The Government's main objective was to obtain value for money for all taxpayers, not just those who could afford to buy shares. For that reason, supported by advice from our City experts, we decided against a full retail offer and instead had an institutional offer, as part of which private client stockbrokers were able to apply for shares on behalf of their clients. I am pleased to say that, in the event, the allocation represented 6 per cent. of the total offered. It is not correct to say that the sector was somehow completely ignored.
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The hon. Gentleman also talked about what he believed to be the undue profits taken by individuals. He should have followed the matter more closely, because there is a lock-up agreement that restricts the proportion of shares that senior managers can sell over the next three years. That also applies to Sir John Chisholm. The throwaway comment that Sir John made oodles of money is not a fact. Sir John has been at the helm of the organisation since 1991, seeing it through its transformation from a plethora of publicly owned Government laboratories to a successful private sector business. He was not suddenly plucked out of the air by Carlyle; he has a track record of success and I find it unacceptable to hear him diminished in that way.
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