Examination of Witnesses (Questions 20-39)
MINISTRY OF DEFENCE, SHAREHOLDER EXECUTIVE & QUINTEQ
3 DECEMBER 2007
Q20 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: Can I answer that question?
Q21 Chairman: Yes, please, that is only fair.
Sir John Chisholm: The NAO Report itself says that if the company had not achieved a 20% return at least then the management team would have lost their whole investment.
Q22 Chairman: But was there any doubt that you would achieve this? Surely, not for a second did you doubt that with this secure contract from the MoD you would not achieve this. Are you seriously suggesting that you ever thought your £100,000 was at risk?
Sir John Chisholm: The major document which was produced to support this element of the privatisation was a long form report produced by the reporting accountants and in that Report the top four issues, it says, were: "MoD revenues will go down. QinetiQ trying to penetrate markets in which it has no experience. Revenues will be unpredictable. Risks will increase". There was a considerable sense of risk at the time.
Chairman: That is your point of view, fair enough.
Q23 Mr Touhig: I was a minister for part of the time, although I had no direct responsibility for the Ministry of Defence, and as you point out, Mr Jeffrey, you were not there for most of the time either, you came in almost at the tail end, however you are here to answer for the Department. It is clear from the Report that the MoD did not want defence manufacturers involved in this bidding and the only trade bidder was SERCO but they were ruled out after opposition by QinetiQ. Do you think you should have allowed that?
Mr Jeffrey: They were ruled out, Mr Touhig, and this was again consistent with the financial advice the Department was receiving, on the basis that their bid was weaker than those of others.
Q24 Mr Touhig: But QinetiQ opposed them, did they not?
Mr Jeffrey: I think they may well have done but that was not the reason they were ruled out. The view that was taken within the Department was that the SERCO bid did not adequately address how potential conflicts would be dealt with.
Q25 Mr Touhig: Here is a company, Mr Jeffrey, about to be privatised and you are allowing it to have the lion's share in the say of who should be the successful bidder. Do you think that is healthy?
Mr Jeffrey: I would question if I may the premise of your question. It is not my impression looking back into this that that was the story of SERCO not having their bid advanced.
Q26 Mr Touhig: Little was done to give them a chance to mount an effective bid because it was opposed by QinetiQ.
Mr Jeffrey: There was a discussion with SERCO at the time about the extent to which the bid might advance but the reason was not that QinetiQ was opposing it, the reason was the one I have given.
Q27 Mr Touhig: It came down to two bids in the end, Permira and Carlyle. Permira would have wanted to appoint a new chairman. Carlyle became the preferred bidder and QinetiQ certainly did not support Permira, did they?
Mr Jeffrey: I cannot recall whether they supported them or not, but, again, the reason for favouring Carlyle over Permira was that it was a more attractive bid, including financially, and when the two companies were given an opportunity to improve their bids Carlyle did and Permira essentially did not.
Q28 Mr Touhig: Out of those two bids, Permira and Carlyle, QinetiQ opposed Permira, yes, and Carlyle became the preferred bidder aided and abetted by QinetiQ's management who then went on to make a substantial fortune as a result.
Mr Jeffrey: First of all, I think it is worth bearing in mind that at an earlier stage what became QinetiQ management were opposed at one point to the involvement of Carlyle in the competition. I think underlying your question, Mr Touhig, is a sense that what became the QinetiQ management were unduly influential within the Department and that is not my sense, I have to say, because there was clearly a good deal of care taken to establish teams that supported—
Q29 Mr Touhig: The Report tells us, Mr Jeffrey, that the QinetiQ board had an active role in evaluating the bids and they played a substantial part in the Department's decision not to involve Permira but to involve Carlyle. The result was that Carlyle were then the successful bidder and they were aided and abetted throughout by QinetiQ.
Mr Jeffrey: They played an active role in the sense that their views were taken and I think it is quite reasonable that as those who would have been working with the private sector partner their views should have been taken. Their contribution was by no means decisive and a good deal of care was taken within the Department to ensure that advice that went to ministers came from a completely separate team reporting to the then finance director.
Q30 Mr Touhig: You see our concern, because one of the first things that Carlyle did when it became the preferred bidder was to change the planned management incentive scheme following representations from the QinetiQ Board. The outcome of this, as the Chairman has pointed out, was that top management got almost a 20,000% increase on the return on their investment. Sir John, that is not so much the unacceptable face of capitalism as the unacceptable face of greed, is it not?
Sir John Chisholm: I do not accept that, no.
Q31 Mr Touhig: You do not?
Sir John Chisholm: As I said before, the taxpayer was by far the biggest beneficiary of the whole episode. Over a billion pounds has been created for the taxpayer and that is a very acceptable outcome. In 2002-03 the business was unrecognisable compared to what it is today. The elements which create the value today did not exist in 2002-03. This is all an achievement by Carlyle and the management team.
Q32 Mr Touhig: It is an achievement, Sir John, by a lot of collaboration between QinetiQ's management and Carlyle, the successful bidder. The point I am making to you is when they became the successful bidder they changed the incentive scheme and, as a result, you and your senior colleagues became very rich indeed.
Sir John Chisholm: Perhaps I could help you with an element of that. Post the agreement for Carlyle and Permira to go forward for the last two, they were both asked to talk to the management. Up to that time there had been no contact other than very formalised management presentations, so it was natural that before their confirming their bids they would want to decide who should be the management in the company into which they were investing.
Q33 Mr Touhig: But we are told in the Report, Sir John, that following the QinetiQ Board's evaluation of the Carlyle bid you argued that the 10% of equity offered to management employees was low.
Sir John Chisholm: I am glad you mention that because that is a letter of five pages with about 50 paragraphs in it. That particular paragraph is just one of those. The issue behind that 10% being low was principally that I suggested to Carlyle that their idea of incentivising or just bringing the top half a dozen or dozen managers into the share scheme was not right in the context of QinetiQ, it was dependent upon the efforts of far more people than that. I suggested to them that a scheme which allowed up to 300 managers to invest in the company, plus an opportunity for the staff at large to invest in the company, would incentivise and bring along far more people in the company and we needed those people in the company.
Q34 Mr Touhig: You were supportive of Carlyle's bid and when they eventually got the company they improved the lot of the top management. The MoD made it clear to bidders that they could not be reimbursed for the cost of their bids, yet QinetiQ, when they got up and running, allowed Carlyle to take £16 million out of the company to reimburse it for its bid. Sir John, is it not a case of your scratching their back and they scratch yours? You stitched up the MoD.
Sir John Chisholm: I am sorry, I have lost which question I am answering there. Is it the question of the reimbursement for the bids?
Q35 Mr Touhig: Although the MoD said that the bidders should not be reimbursed for their bids, when it got up and running QinetiQ gave Carlyle £16 million to reimburse it for its bid.
Mr Jeffrey: If I might intervene. The extent to which the bid cost could fall to the company is quite well precedented in other acquisitions of this sort and if it had not fallen to the company in the end it would have had a bearing on the price that was paid, so it is swings and roundabouts.
Q36 Mr Touhig: But you made it clear, Mr Jeffrey, that there should be no reimbursement and when QinetiQ got up and running that was one of the first things they did.
Mr Jeffrey: It was made clear in relation to unsuccessful bidders but not, as I understand it, in relation to the successful bidder.
Q37 Mr Touhig: It just seems to me that QinetiQ helped Carlyle win the bid and in turn Carlyle decided to improve the management incentive scheme which overnight created millionaires out of the senior management, and finally QinetiQ handed back £16 million of the company's money to Carlyle to cover its bid costs. Some people would suggest that was tinged with corruption.
Mr Jeffrey: I would not accept that, Mr Touhig, because—
Q38 Mr Touhig: It stinks to high heaven, Mr Jeffrey.
Mr Jeffrey: The sequence of events is as I have described it and the key decisions were taken by the Department. They were taken by the Department in a fashion which, although it admitted discussions with QinetiQ about things that it was reasonable for QinetiQ to be involved in, there was submission of advice to ministers separately from QinetiQ management and it was taken on the basis of fairly serious financial advice at every stage. I do not think the theory that this was a great conspiracy by QinetiQ and Carlyle to stitch up the Department really hangs together.
Mr Touhig: You said decisions were taken by the Department but it seems to me, Mr Jeffrey, that you lot were taken for a ride. That is it, Chairman.
Q39 Dr Pugh: There are two conclusions that leap out from the Report as a whole. One is that you created a successful independent company and the second conclusion which the NAO come to is that they are unable to reach any conclusion on whether you have actually delivered the objectives of the scheme in the first place, that is in terms of contract prices, enhanced flexibility or improved services. Do you agree with both of those conclusions of the NAO Report, one that you created a successful independent company, and I am sure you will agree with that, and, two, that they cannot and nobody can reach any conclusion on whether you actually delivered what you set out to do?
Mr Jeffrey: Is your question addressed to me?
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