Examination of Witnesses (Questions 100-119)
MINISTRY OF DEFENCE, SHAREHOLDER EXECUTIVE & QUINTEQ
3 DECEMBER 2007
Q100 Mr Davidson: So the pension deficit was not known about beforehand?
Mr Schofield: As I understand it, this was something that came out of the—
Mr Woolley: The bid from Carlyle was always subject to a settlement of the pension fund deficit.
Q101 Mr Davidson: Did Permira ever comment on the pension fund deficit or did they not have the right to do so?
Mr Woolley: Their bid would have been subject to the position of the pension fund deficit.
Q102 Mr Davidson: But so was Carlyle's and then Carlyle's changed because of information about the pension fund. Did you not then go back to Permira and say, "Look, here is the same information, what is your view on this?" That could have changed the financial balance.
Mr Woolley: There would be no reason why it would have a different impact between the two bidders, the effect of the pension fund deficit.
Q103 Mr Davidson: But you did not ask the other people?
Mr Woolley: At that stage Carlyle were already the preferred bidder.
Q104 Mr Davidson: So that is a no then, is it? That is a no, you did not?
Mr Woolley: We did not specifically go back to Permira on that point.
Q105 Mr Davidson: That is a no, that is fine. I just wanted to clear that up.
Mr Schofield: Mr Davidson, it is also worth adding that the Government Actuary's Department made their own assessment.
Q106 Mr Davidson: All these people would have made assessments of the position before they made their bids and then Carlyle got their foot in the door and changed their bid, I understand that. Can I just clarify a point that has been made quite strongly on a number of occasions about the rise in value and so on. How much of this has simply been because of a general rise in the market? I notice around about that time there was a general uplift, was there not, both in defence and technology share prices and, therefore, there was a substantial element of simply a windfall gain. I take it there was nothing in the contract that would lead you to have an automatic, as it were, claw back of any windfall gains of that sort. Nor was there any recognition, as I understand it, in terms of the huge amounts of money that Sir John got away with of the simple rise in the market. How was that dealt with?
Mr Jeffrey: It is certainly the case that some of the growth in the value of the company between the sale of the minority stake in early 2003 and the flotation in early 2006 reflected conditions in the market, but it also reflected the success of the company in finding new business.
Q107 Mr Davidson: What was the balance?
Mr Jeffrey: I do not have that figure in my head. I think they were both substantial elements.
Q108 Mr Davidson: Sir John, you are going to tell me.
Sir John Chisholm: I do not have the number but the point I made earlier on was if you look at the things that the analysts now pick out as being valuable in QinetiQ today, they are not the things that were predominantly in the company at the time of the PPP.
Q109 Mr Davidson: I think that is interesting.
Sir John Chisholm: The value has been added since then.
Q110 Mr Davidson: That is interesting but it is not actually an answer to the point I made because I was asking for a balance between the value added by yourselves and your management and the general rise in profits.
Mr Schofield: Mr Davidson, I could give you some numbers. As the Report shows, the rise of the operating profits was something like 260% and there was also an improvement in the contribution in terms of cash generation of today's profits. In terms of the benefit from the performance of the business there is that element. In terms of the market, the aerospace and defence sector in the UK in December 2002 was trading on a PE multiple—price earnings multiple—of 10.8 times and at the time of the flotation in February 2006 was on 17.2 times. What you will see is 260% from the performance of the business and about 70% from the movement in the stock market.
Q111 Mr Davidson: Sorry, what were the relevant percentages there?
Mr Schofield: 10.8 times was the PE multiple on which—
Q112 Mr Davidson: I understand completely that the profits went up but what I am not clear about is what percentage of that was as a result of the innovative management perhaps that was introduced and to what extent it was simply because the market in general terms was rising and, therefore, there was more business going. I am also not clear about the extent to which the value of the shares were reflecting those improvements in the company and to what extent they were just simply the value of the general rise in the market, which is why I wonder what percentage of Sir John's gains was simply due to the work of others or acts of God.
Mr Schofield: To give you some numbers, the business was sold on an enterprise value of £319 million. The impact of the improvement in profitability was 260% on that. The business was more cash generative, so every pound of profit was generating additional cash which was paying down debt, and the business paid down £300 million of debt over the course of the period. In addition, the business benefited from this growth in the market from 10.8 times the PE multiple to 17.2 times. Taking those factors together you will see all of the uplift in value that took you to an enterprise value of—
Mr Jeffrey: What was undoubtedly happening over that period, Mr Davidson, was that the company was outperforming the rest of the market in terms of building markets elsewhere and over time becoming somewhat less dependent on us as customers.
Q113 Angela Browning: Mr Jeffrey, as I have been listening this afternoon I have been reminded of something from Alice in Wonderland, the Caucus race where everybody gets a prize. I am a bit concerned that what we have been really told this afternoon is that this has been such a wonderful success and despite all these disparities between what Sir John and other senior managers got, et cetera, in proportion to the return to the taxpayer, the fact that the taxpayer got a good return should be sufficient. But I am concerned, as was my colleague, David Curry, about whether the Department has managed this in such a way that actually they could have got a better deal and return for the taxpayer. I would like to explore that in a minute. I would like to take a look at the future about what lessons are to be learnt. It seems to me, Chairman, that we do not know yet, sufficient time has not passed, to give a clean bill of health to the outcome of what has happened with QinetiQ. Could I just ask you, Mr Jeffrey, to look at pages nine and ten where the National Audit Office have listed their recommendations. In the first ones at the top of page nine there is a very clear instruction here and it says: "The Department must actively manage the risks that privatising QinetiQ has created if the transaction is to realise value for money" and it goes on further down with some recommendations under one, and one was about benchmarking, and we see the Department should ensure that these are developed in advance of the first price review period in March next year. March next year is not far away. Can I ask you, is your Department geared up to this? Are you on time to do it? Has that lesson been learned?
Mr Jeffrey: I think the lesson has been learned. It is certainly the case, as you say, the eventual outcome of this is not yet known because the company is still building its way in the world. We feel that there is a continuing developing picture in our relationship with the company over, for example, the understandings that we have with them under which they are required to identify potential conflicts of interest for us and ways of mitigating these through Chinese walls, et cetera. As our relationship changes, as they become less able to rely on MoD business and really are in a position where they have got to compete like everybody else then clearly we need to manage that and manage that very carefully.
Q114 Angela Browning: Is there anything in that first section concerning the Department's ongoing relationship with QinetiQ that you do not think you will deliver as recommended by the NAO?
Mr Jeffrey: I do not think so, no.
Q115 Angela Browning: Could we move on then to the lessons learned which follows on on page nine beginning at paragraph three. I will not go through all of them but can I ask you again, from three through to nine, is there anything in those recommendations that you feel you would not implement if such a situation arose again?
Mr Jeffrey: The only reservation I have about them, if I may put it this way, is that they imply shortcomings in the process that the review has been examining and we do not necessarily accept all these that we have been discussing in this hearing, but in themselves they are very sensible observations about how this sort of activity should be managed. Principally, I think it is fair to say they are directed at the Treasury because the indication is about guidance to be given to all government departments about handling privatisation of this sort. Between us, we and the Treasury certainly are examining them that in principle we think they are on the right lines.
Q116 Angela Browning: Could I pick on one as an example, that is in seven on page ten. This has been touched on this afternoon. "Departments should protect their interests by not allowing management to discuss incentive schemes with potential partners until the main principles have been agreed and a preferred bidder chosen". Would you agree that is how your Department will proceed in future?
Mr Jeffrey: As I said earlier, in this case I do not think it was unreasonable for these sorts of discussions to take place. The NAO has made this point and it is a very fair one and one which we and the Treasury will certainly be looking at with a view to reflecting it on the Treasury's part, I would guess, in guidance to departments in the future.
Q117 Angela Browning: You understand why that recommendation is in there specifically in relation to the way the Department dealt with the QinetiQ bid?
Mr Jeffrey: Yes, I do.
Q118 Angela Browning: I am looking for a stronger reassurance from you, Mr Jeffrey. If you are going to reflect and look at it, you have had prior notice of receiving this NAO Report and presumably if you did not agree with anything in it you would have made that known before we all sat down this afternoon.
Mr Jeffrey: As I said earlier, there were regrettably some respects in which the Report was not agreed but this was not one of them. It is a recommendation and I personally think it is along the right lines. What we always do when the NAO make reports of this sort is to take the recommendations on board and in the Treasury Minute, no doubt, there will be a response to it.
Q119 Angela Browning: Could I ask you to turn 2.34 which is on page 26 of the Report. This has been touched on, the question of the reimbursement of Carlyle's bid costs, which were £16 million, which in the grand scheme of things I appreciate was a very small sum of money in relation to the other sums that are being discussed today, but what is very interesting in this section here is that it states: "It would therefore have been reasonable to refund Carlyle's costs" which you defended just now, "only if the Department's costs were also fully reimbursed". Were the Department's costs fully reimbursed?
Mr Jeffrey: They were not. In the end they were something that we netted against the very substantial proceeds of this sale.
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