Examination of Witnesses (Questions 240-259)
MINISTRY OF DEFENCE, SHAREHOLDER EXECUTIVE & QUINTEQ
3 DECEMBER 2007
Q240 Nigel Griffiths: And usually with such NAO Reports on the MoD I am spoiled for choice for critical comments. What I see here is, chapter after chapter, "The restructuring was completed in a challenging timetable and largely well managed", page 14, and page 15, "The department put in place measures to safeguard UK defence interests", Part Three, "The department executed the flotation and achieved a good price". These are pretty flattering statements from the NAO. "The business appears to be performing satisfactorily in the private sector". Were you surprised at the level of hostility that was reported when this Report was published a week or so ago?
Mr Jeffrey: The points that have been made by other Members of the Committee, that this issue strikes a raw nerve with the public and can be seen in the light that it has been portrayed in in this hearing, I think are very valid ones, so in a sense I was not surprised that those comments in the Report which suggest that we could have done better, for example, were seized on in the media, but I do myself feel, and I imagine this has come through in my evidence, that this is mostly a good story for the reasons that you give, Mr Griffiths.
Q241 Nigel Griffiths: When Lord Moonie reminded the public that the Government had indeed shared in the rising value of the company was he referring to number 15, page 8, that 112% on the investment was the internal rate of return to QinetiQ and that 99% (not far short of 112%) was achieved by the department?
Mr Jeffrey: He may have been. The only reason for the difference between the 112% and the 99% goes back to the slightly contentious point about departmental costs that we were discussing earlier. He may also have been referring to the fact that, as this stands at the moment, as I said earlier, the proceeds from the various sales have already amounted to £578 million and we retain a share which is currently estimated as being worth around £235 million, so there is potentially a very substantial benefit for the taxpayer in this whole episode.
Q242 Nigel Griffiths: When the Report says in Part Three, "The Department executed the flotation well and achieved a good price", do you believe that a better price might have been achieved if this were to be, with hindsight, done in 2007?
Mr Jeffrey: I do not believe so. I, as it happens, was around at the time, although only just, and I think those who made the judgment to go to market early in 2006 got the market about right and got a very good price for the shares, which has since then been sustained. It has neither, as Mr Williams remarked earlier, shot up, which suggested we sold cheap, nor is it depressed.
Q243 Nigel Griffiths: When it says in Part Four, "It is too early to be able to assess authoritatively if some of the objectives have been met", what have you got in place with the company to measure objectives? When do you think we will be able to see a report that shows whether objectives have been met or not?
Mr Jeffrey: I think what has been happening in recent times is the gradual, if you like, normalisation of the relationship so that our relationship with QinetiQ is closer to the kind of relationship that we have with all suppliers in this sector. We have certainly been discussing with them the nature of the safeguards that need to be there to protect against any question of conflict of interest where they are giving us independent advice as well, and we have recently been auditing internally exactly how these arrangements work, so it is a developing relationship and the way I would characterise it is that from a starting point where this was just any old part of the department we are going into a mature relationship with a company that is playing a significant part in the British defence sector.
Q244 Nigel Griffiths: In paragraph 3.9 it says: "The process for appointing advisors for the flotation was robust". You must take some pride in that.
Mr Jeffrey: I think it is a fair reflection of what happened.
Q245 Nigel Griffiths: And, more importantly to all of us, when the department put in place measures to safeguard the UK defence interests, again, do we have to await the verdict of history on that or do you have evidence that UK defence interests have been effectively safeguarded?
Mr Jeffrey: I think the relationship at the moment is working in such a way as to safeguard defence interests, although, for the kind of reason that Mrs Browning was hinting at earlier, we need to keep an eye on this very carefully.
Q246 Nigel Griffiths: Sir John, I mentioned earlier paragraph 2.1 which was the cut in the budget for research which fell by over 40%. What is the present figure? Do you have one?[8]
Sir John Chisholm: I do not have a figure for the Ministry of Defence research budget today because I am no longer involved at that level.
Mr Jeffrey: We can provide one. It is one of the issues that I have been looking at in the context of our overall judgments about financial plans over the next few years. I certainly think that maintaining the level of MoD investment in science and technology generally and research in particular is very important. As a matter of fact, over the years when this was happening it was declining. My recollection is that in real terms it flattened out after that period of decline.[9]
Mr Woolley: I think the challenge for QinetiQ has not simply been the decline in the overall value of the research budget but also the fact that it has been progressively open to competition where previously it was virtually assigned to the old DERA.
Q247 Nigel Griffiths: Do you think it is a fair summary of this Report that greater proceeds might have been achievable from the sale to a strategic partner, page 35?
Mr Jeffrey: I think it is very hard to judge. That is why I have been a little non-compliant in this session. I think four or five years after the event there is an argument, and the NAO Report expounds it, to the effect that we could have got more from this. It was a complicated sequence of negotiations in which properly equipped financial advice was taken at each stage, and I am very reluctant myself to conclude that it produced a sub-optimal result, but clearly it is a matter of opinion.
Q248 Mr Williams: Sir John, may I make it clear I am not in any way suggesting that you are a dishonourable man. What I do think is that you may be someone who is out of his depth in the rather cynical world of private equity. Can you tell me, when was the issue of equity for executives first raised? Was it raised early on? Was it raised by your side or was it raised by the bidders?
Sir John Chisholm: All the bids had a section of their bid which talked about equity for staff and managers.
Q249 Mr Williams: So that was envisaged as being something that was to come?
Sir John Chisholm: Yes.
Q250 Mr Williams: Following on what Richard and Austin have referred to, paragraph 2.2, you told the NAO that you were concerned about the potential risk of management making large returns from the involvement of private equity investors. What at that stage did you envisage to be large returns? What did you have in mind? What led you to issue that warning?
Sir John Chisholm: That warning was in the context of the debate over whether the route to market should be through private equity or through a direct flotation. That was the context of that debate and I would not have had a number at all in my mind. I would merely be relating to the perverse issue I discussed early on, that the management team would be employed to create as much value as they possibly could and eventually, if they were successful, that would raise exactly the debate we have been having today.
The Committee suspended from 6.54 pm to 7.00 pm for a division in the House
Q251 Mr Williams: I was asking what sum of money you thought a large return would be. Succinctly, what at that stage would you envisage as a large return?
Sir John Chisholm: I did not have in mind a specific number.
Q252 Mr Williams: Then how did you know to go and ask for more?
Sir John Chisholm: Sorry?
Q253 Mr Williams: How did you know then to go and ask for more?
Sir John Chisholm: As I explained earlier on, the principal thrust in terms of the discussion with Carlyle was that more people should be engaged in it, and in order to bring more people into it we needed more flexibility in the equity scheme.
Q254 Mr Williams: So did you at that stage envisage a possible doubling of it?
Sir John Chisholm: I would have to say that that was not a specific number because I was not proposing any specific scheme at that time. I was merely addressing the issue that this was a different company from many of the other companies that they had done business with.
Q255 Mr Williams: But, you see, approaches were now made as a result of the wish to enlarge the sum and they were made before the decision on the final bid was being made. You are in a pretty cynical, hard-headed world when you are dealing with private equity firms. It looked very much like a nod and a wink to them, and they would just think, "Oh, well, this is it. This is how we get it". Did that thought not occur to you? Did it not occur to you that it might be unwise for yourself as a potential beneficiary to be helping to promote this line of approach?
Sir John Chisholm: Let me make two points. The first point is that at no stage after we had been asked to talk to Carlyle and Permira did we provide any advice to the Ministry of Defence as to the selection of a final preferred bidder, so there was no opportunity in those discussions they had with me for me to influence the final choice of a preferred bidder. That is just a matter of the schedule, the way the schedule worked.
Q256 Mr Williams: Did Carlyle in any way seek advice from yourself or your colleagues, since the first offer had been turned down or indicated as being inadequate, as to what you would have in mind?
Sir John Chisholm: They certainly asked us about the willingness of our management group to invest and they certainly asked us what type of scheme would be readily accepted.
Q257 Mr Williams: Yes, but we are talking about scale here. Did you give advice on what would be the level of equity that you would expect to have available to distribute?
Sir John Chisholm: They certainly asked us for that, yes.
Q258 Mr Williams: And what was your advice to them?
Sir John Chisholm: They asked for advice as to who were the key people and I provided at least an outline list at that stage as to who they might be, because the key discussion was around my feeling about who the key people were.
Sir John Bourn: So what you are saying is that they wanted to know how many people were going to be participating before they decided how much they would offer? Is that how it happened, or were the two running together?
Sir John Chisholm: It is clear that in order to make a final bid the bidder needs to know what he is bidding for.
Q259 Mr Williams: Yes, and that is exactly where I come back to the nod and the wink again. How did they eventually arrive at the figure they offered or were they told that would be acceptable to QinetiQ?
Sir John Chisholm: No, no. It was not a question of being acceptable to QinetiQ because QinetiQ, as I have just explained, did not have a further voice in that selection. What they were doing was a professional job of designing their principal tool for the achievement of their end, and indeed the other shareholders' end, of increasing the shareholder value. Private equity companies do not manage the business themselves. They (a) select a management team and, as I have said, they were engaged in that process by talking to me, and (b) they design an equity scheme which in their experience achieves the best result in creating value for the shareholders.
8 Note by witness: The Department's spending on research for 2007-08 is approximately £630m. This figure includes the Science, Innovation and Technology (SIT) budget as well as some of the other research activities carried out in the MOD as defined by the OECD Frascati guidelines (the Frascati guidelines provide a point of reference for the definition of research and development and its outputs). Back
9 Note by witness: The Department's spending on research for 2007-08 is approximately £630m. This figure includes the Science, Innovation and Technology (SIT) budget as well as some of the other research activities carried out in the MOD as defined by the OECD Frascati guidelines (the Frascati guidelines provide a point of reference for the definition of research and development and its outputs). Back
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