Examination of Witnesses (Questions 1-19)
MINISTRY OF DEFENCE, SHAREHOLDER EXECUTIVE & QUINTEQ
3 DECEMBER 2007
Q1 Chairman: Good afternoon. Today we are looking at the Comptroller and Auditor General's Report into The Privatisation of QinetiQ. We welcome back to our Committee Mr Bill Jeffrey, who is the Permanent Under Secretary of the Ministry of Defence, and Peter Schofield, who is the Director from the Shareholder Executive, and also Sir John Chisholm from QinetiQ. Perhaps you might introduce your other colleague.
Mr Jeffrey: My other colleague is Trevor Woolley who is the Finance Director at the Ministry of Defence.
Q2 Chairman: Thank you very much. Perhaps we could start, Mr Jeffrey, by looking at paragraph 2.2 of Sir John's Report, which tells us that Sir John Egan, QinetiQ's chairman at the time: "told us that the poor markets presented an opportunity to get the business in shape ahead of privatisation and could not see what value could be added by private equity houses or the trader partners who were likely to bid." That leads me, Mr Jeffrey, to ask why did you not take up Sir John's advice at the time. Why did you not get this business into shape in the public sector first rather than selling a stake in QinetiQ in 2003? If you had got it into shape in the public sector first and then privatised it you might have avoided Carlyle profiteering at the expense of the taxpayer.
Mr Jeffrey: I think it is matter of judgment, Chairman. The judgment the Department reached at the time, which the NAO endorses, was that it was not right to go straight to flotation.
Q3 Chairman: Why not?
Mr Jeffrey: Because at the time the market and the market's knowledge of DERA, as it then was,—
Q4 Chairman: I was not suggesting it should have gone straight to flotation, what I said was why did you not take up Sir John's advice to get the business in shape in the public sector.
Mr Jeffrey: The judgment at the time was that it was unlikely to achieve that within the public sector and the best way to grow the value of the business was to introduce a strategic partner from the private sector. The result in terms of the benefits to the taxpayer a few years later, I would argue, tend to vindicate that judgment.
Q5 Chairman: We can certainly accept for the sake of this hearing that the taxpayer did make a profit. I think the purpose of this hearing is to establish whether the taxpayer could have made much more of a profit. We will go on pursuing this, we have got all afternoon. Let us now look at paragraph 1.7 which tells us that: "The inclusion of a £250 million receipt in the 1999-2002 Comprehensive Spending Review had the potential to create pressure for the PPP to be completed by the end of the financial year in March 2002." How did this Treasury earmarked £250 million affect the timetable? I suspect that this may have pressurised you into rushing the sale.
Mr Jeffrey: I do not believe it did. I have looked at the papers on this to a certain extent and I have found no evidence within the Department that people felt they were being rushed in any way about this. It is also the case that there was a specific understanding, as the Report brings out, with the Treasury that if the introduction of the public-private partnership did slip into the year 2002-03 then it would still be credited to the Department's budget in 2001-02. I do not think there is evidence there that the Department was operating under that sort of pressure.
Q6 Chairman: Let us look at the heart of this which is summarised in paragraphs five and six. It tells us in paragraph six that: "After Carlyle were appointed preferred bidder they negotiated a reduction in the value of the business of £55 million". So why would did you not settle the terms of this Long Term Partnering Agreement between QinetiQ and the MoD before starting these sales? Would that not have been wise? The fact that you had not settled it meant that you were really in a very weak bargaining position with Carlyle and, indeed, this was precisely what happened.
Mr Jeffrey: The initial Carlyle offer, certainly in terms of the financial advice the Department received at the time, was not such that as we came to settle the Long Term Partnering Agreement it was unreasonable for the company to expect some recognition of the impact of that agreement. I think the position the Department was in at the time was that there was a risk in concluding the agreement more quickly than was sensible. There was a risk also, and that was certainly the view of our financial advisers, in delaying the sale of the minority stake in the business. Those responsible at the time did their best to balance these risks.
Q7 Chairman: You are not surely suggesting to this Committee are you, Mr Jeffrey, that if you had not got into bed so quickly with Carlyle you would not have got a higher price? The fact is you got into bed with them too quickly, your arm was forced and, frankly, you could have got a lot more. You are not denying this, are you? Are you seriously suggesting to this Committee that you got the best price you possibly could have got?
Mr Jeffrey: What I am saying is that there was a properly conducted process. It involved eliciting bids which were properly considered. They were reduced and the ones that were discarded, the NAO accept, were weaker. We then reached a point where there were two and they were invited to bid and the result was the one that was reported in the Report.
Q8 Chairman: I have got to move on, others will come back to that. Let us look at this incentive scheme. Let us look at paragraph 2.15, shall we. Halfway down it says here: "Carlyle should revise their offer to include a three-tier structure to encompass middle managers. The Chief Executive", that is Sir John, "also expressed the view that the 10% of equity offered by Carlyle was low..." You allowed Carlyle and QinetiQ to sort out the incentive scheme between them, did you not?
Mr Jeffrey: Chairman, one has to recall the basic strategy that was being pursued. As we have said, it was not to float the whole enterprise immediately, to introduce a strategic partner from the private sector that had the expertise to develop the business and to give that partner only a minority stake so that the taxpayer could share in any growth of the business. Given that we were doing that, the view that was taken was that it was reasonable to leave the design of the share incentive scheme to the strategic partner. That is what firms like Carlyle are expert in.
Q9 Chairman: What was the result of this? "Bidders initially intended making just 10% of shares available to management". Carlyle, because you had such a light touch on this, doubled their proposal from 10% to 20%. Why did you agree to this?
Mr Jeffrey: In the end it was Carlyle's judgment. They are the experts in incentivising—
Q10 Chairman: That is precisely my point.
Mr Jeffrey: They had no incentive to make the scheme more generous than this.
Q11 Chairman: You have obviously read figure 19 on page 38. The top ten managers get a 19,000% increase on their investment and the ordinary workers get £9 back for every £1 they have put in, which I think is a perfectly adequate incentivising scheme. Let me put it this way: you are not suggesting you need a 19,000% return on your investment to incentivise you, are you? You are not going to come to this Committee and defend this. It would be much better just to apologise now and admit that you got it wrong.
Mr Jeffrey: What I am saying to the Committee is, first of all, I think everyone has agreed that the growth in the value of the company exceeded what was expected at the time and that did lead to these very high rewards for the executives in the company, but in the end --- If we had second-guessed Carlyle, who had been brought in order to grow the company, in order to improve its management, first of all, as the Report observes, there might well have been an impact on the price that Carlyle were willing to pay because these incentivisation schemes are a key element of what companies like Carlyle bring to the party. Of course rewards of quite that order were not foreseen. It might have been an option to place some sort of cap on it, but we need to recognise that if a cap had been placed on it, it might not have incentivised—
Q12 Chairman: It did not occur to you that this was the best deal of all time? It did not occur to you that this was a fantastic deal for whoever was buying it?
Mr Jeffrey: What I would say is if one looks at the whole course of events, one looks at the effect of the strategy of selling part of the company to start with and then hoping that the private sector partner would succeed with management in growing it, that strategy has been successful because it has brought very substantial gains to the taxpayer.
Q13 Chairman: But we believe that you should have got much more. Mr Schofield, here we have a conflict of interest within the MoD, both as shareholder and as customer, do you think you could have made a difference? Would you have made a difference?
Mr Schofield: As the Committee knows, we were set up in order to grow shareholder value. If we had been involved I think we would have added the same value that I hope we added in the flotation, which we were involved with. That is setting out very clearly an approach that is based on getting our objectives right, being very clear about what the Government's objectives are and being very clear where objectives compete against each other. We would have brought skills and experience in terms of managing transactions of this kind and we would have brought experience in terms of managing advisers.
Q14 Chairman: Do you not think it was a bit odd that defence manufacturers were barred from bidding, although at the time of flotation QinetiQ, hey presto, was allowed to carry out defence manufacturing work? Do you not think this was rather odd? If you had been involved, would you have done it this way?
Mr Schofield: We would have started by trying to be clear about what the MoD's objectives were in taking the transaction forward. I think it is very clear that the MoD were looking to maintain a source of impartial advice, which is the reason for the—
Q15 Chairman: Mr Jeffrey, I think you were just naive babies in a sea of sharks.
Mr Jeffrey: I do not accept that, Chairman. I have looked at this myself, and it clearly predates my time at the Department, and I know that is not a relevant consideration for the Committee, but—
Q16 Chairman: Listen to what Lord Gilbert said, former Defence Procurement Minister. I am going to put this to Sir John, he is here to defend himself and his profit margin. One of the things Lord Gilbert said that irritated me, and that is a soft word, was: "Never once in my presence did Sir John Chisholm indicate that he might have a conflict of interest or was going privately to be enriched by what was going on". What do you say to that, Sir John?
Sir John Chisholm: I would say that never once in my presence did Lord Gilbert suggest he was against the policy of the then government.
Q17 Chairman: That is not an answer to the question I put to you. Is Lord Gilbert right in saying that: "Never once in my presence did Sir John Chisholm indicate that he might have a conflict of interest or was going privately to be enriched by what was going on"? Is Lord Gilbert right in saying that or is he making it up?
Sir John Chisholm: At the time that Lord Gilbert was in office there was not in prospect a private equity investor. Indeed, the plan was not private equity at that stage, it was institutional investment, so the whole issue of any management or staff shareholding was simply not discussed by anyone. It was not in the frame at that time.
Q18 Chairman: Yes, because you told the Defence Committee on 28 February 2001: "In regard to people who were already in the organisation, certainly when they have proved themselves successful they can expect to earn a reward but they cannot expect to earn it just because we have been privatised". What the public think is that it is frankly appalling. It goes totally against any concept of ethical capitalism, Sir John, that you can put £100,000 into a business and emerge with £25 million of taxpayer's money. Nobody from outside can understand it. Do you have any sense of shame here before us?
Sir John Chisholm: I have a considerable sense of having led a team to create £1 billion worth of value for the taxpayer. I think that is a great achievement by the team.
Q19 Chairman: Why should your poor staff get £9 for every pound they put in but you get £200 for every pound that you put in? Do you think that is fair?
Sir John Chisholm: I believe in any deal like this there was a contractual agreement put by the investor to the management team that had considerable risk for the management team at the time and they signed up to it.
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