Investing for Development: the Department for International Development's oversight of CDC Group plc - Public Accounts Committee Contents

1.  Supplementary memorandum from the National Audit Office

Questions 186 to 193 (Mr Richard Bacon):  Valuation of Actis LLP

  1.  At its hearing on 15 December 2008, the Committee of Public Accounts asked the Department for International Development (the Department) about the price paid by incumbent management for Actis, a fund manager previously wholly owned by CDC Group plc. The Committee also asked about the relationship between the amount paid by management (£373,000) and the first year's reported operating profit for the partnership (the US dollar equivalent of £4.6 million).

  2.  The Committee asked the National Audit Office to provide a note on the valuation of Actis when it was part-sold to its management in 2004, and the profits generated subsequently.


  3.  In 1997, the Department for International Development (the Department) converted the Commonwealth Development CDC into a public limited company—CDC Group plc (CDC)—in anticipation of the sale of substantial stake to private investors. There was, however, little interest from potential investors[11], and the Department instead decided in 2003 to restructure CDC. As part of this restructuring the Department established a separate fund management arm, known as Actis LLP (Actis).

  4.  The Department sold a controlling stake in Actis to its managers in July 2004. Thirteen individual partners and twelve overseas corporate partners, together with an Employee Trustee, subscribed £373,040 for 60% of the voting rights in the business, subject also to various governance conditions. The Department holds 40% of the voting rights in Actis. The sale terms provided for the management initially to receive only 20% of any residual profits, or any proceeds from an onward sale of the business. This would increase to a 60% share after 10 years.

  5.  Actis's main role is to promote and manage funds invested in emerging markets on behalf of investors. Its single biggest investor is CDC itself, which is wholly owned by DfID. In the new structure established in July 2004, CDC retained ownership of its existing investment portfolio, built up over several decades, known as the "legacy portfolio". DfID agreed that Actis should manage this legacy portfolio on CDC's behalf for five years extendable to ten years at CDC's option. The legacy portfolio was valued at £805 million at 1 January 2003.


  6.  CDC was responsible for implementing the sale of Actis. To oversee the conduct of the sale, CDC's Board formed an Independent Committee (the Committee) in early 2003, comprising board members who had no direct interest in Actis. The Committee took advice from KPMG and from McKinsey. The Board was separately advised on remuneration matters by Towers Perrin. DFID was advised by Treasury Solicitors in relation to public law, Campbell Lutyens & Co Ltd on corporate structuring and finance, Field Fisher Waterhouse on commercial law, PricewaterhouseCoopers on tax matters and the newly formed Shareholder Executive, then part of Cabinet Office, in relation to corporate structuring and finance.

  7.  KPMG, in accordance with terms of engagement agreed with the Committee on 31 July 2003, undertook an initial non-binding valuation of Actis on behalf of the Committee. The valuation was not commissioned to set the price at which someone would invest but helped guide discussions with Actis's management over the appropriate price they should pay to purchase Actis.


  8.  Valuing Actis was not straightforward. In valuing any entity, the valuer must identify the residual earnings that accrue to the business owners. The valuer must then estimate how much potential new owners would be willing to pay for the right to these residual earnings.

  9.  These calculations were complicated in the case of Actis because the entity was purchased by its employees. These owner-employees have access to two streams of income:

    a. The amounts they earn from their labour as fund managers. These amounts should closely reflect the market rate for similar fund managers elsewhere. The fund managers would in principle enjoy these amounts whatever ownership structure they worked under and whoever owned Actis. The rewards for their labour are not relevant to the valuation of Actis.

    b. Their rights to enjoy the residual earnings achieved by Actis. These amounts represent the dividends the owner-employees would be entitled to as a result of taking the risk of investing capital in Actis and so form the basis of the valuation of Actis.

  10.  The valuation was also complicated because there were few obvious comparators to Actis. In advance of the sale, CDC had negotiated fund management fee levels with Actis that were only expected to cover operating costs and allow Actis to break even.

  11.  There are two common methods used to value businesses for sale:

    a. a discounted cash flow approach; or

    b. a market-based approach, which multiplies expected post tax earnings by a multiplier based on the way investors value other comparable companies.

  12.  As discussed with the Committee, KPMG utilised a discounted cash flow basis and also took into account the level of net assets held by Actis. A market approach to valuation as a cross-check was not required of KPMG because Actis had not been structured to generate significant profits. The few traded funds management businesses identified as possible comparators were generating profits from assets under management and other activities.

  13.  KPMG based its discounted cash flow valuation on agreed forecasts of the residual cashflows that would accrue to the new owners of Actis from each part of the business. It then applied a discount rate to these cashflows to calculate a capital value. KPMG used discount rates considered suitable for the area of business, taking into account its riskiness. For management fees from existing funds, KPMG adopted a discount rate of 13.2%. For new funds, KPMG used a higher rate of 18.6% to reflect greater risk of uncontracted potential future funds. This took into account the difficulty and uncertainty in raising and investing new funds.

  14.  In September 2003, KPMG's initial non-binding valuation of Actis on behalf of the Committee concluded that the whole business could be valued at between US$3-4 million, equivalent at that time to £1.8 million to £2.4 million.


  15.  In November 2003 KPMG were requested by the Committee to reconsider the valuation of Actis because the employees were not purchasing the whole company. Instead employees were purchasing 60% of the voting interest and 20% of the rights to residual profits (for the first 10 years) and were subject to various governance conditions (paragraph 16). Furthermore, KPMG were informed that there was no basis for expecting any cash distributions of residual profits in the first five years. And there was no public market in which managers would be able to dispose of their shares.

  16.  The Department holds veto rights over the appointment of the chair of Actis LLP and two non-executives, the three of whom together make up the Business Principles Committee. The Department has the voting and consent rights common to all Actis members and, in addition, the ability to block decisions in certain areas ("special decisions") and enforce business objectives.

  17.  Taking into account these factors, KPMG valued the interest in Actis to be sold to employees ("interest valuation") at between US$580,000-$700,000, a 70% discount on the whole business valuation of US$3-4 million in September 2003. In March 2004, at the request of the Committee, KPMG provided an interest valuation revised to take account of prevailing exchange rates—which resulted in an interest valuation of between £320,000 and £387,000.

  18.  The Committee agreed that the amount to be paid by employees on 7 July 2004 for their interest in Actis should be £373,040. A Trustee on behalf of employees provided 15% of this amount, with 25 partners providing the balance.

Figure 1



Trustee for Actis employees55,950
Actis partners317,090
Secretary of State for International Development 427,000

  19.  The National Audit Office has concluded that assumptions about revenue and expenses underpinning the valuation were reasonable, and that the discount rates used in the calculation were also reasonable. The sale price was not, however, tested through a competition because, after option appraisal and advice, the Department and CDC's Board considered that such an approach would have significantly damaged CDC's management capacity, and risked damaging the £805 million portfolio value (as at January 2003).

  20.  A competitive process is usually the best way of getting best value in a sale. Had management been made to compete against external bidders, and had external bidders shown an interest, management might have attributed more value to the operational independence that owning their own business gave them. There might also have been a strategic value to other bidders from CDC's existing strong investment presence in emerging markets. In particular there is value in having CDC as a "cornerstone" investor—an investor whose £805 million of funds under management demonstrated investor confidence in providing the Actis team with funds to manage and who provided fees that would cover most of the running costs thereby reducing the business risk.

  21.  The Department, however, considers that a number of factors meant that this approach was not practicable in this case. It is not clear that any potential investor would have had a better track record of managing funds in emerging markets than Actis' existing management team. The lack of such a record could have put CDC's existing investment portfolio at risk, particularly in light of the detailed knowledge that Actis management had of this portfolio. Any such theoretical buyer would also have had to take into account that whilst they were buying a 60% voting interest, they would only be entitled to a 20% interest with regard to their share in residual earnings. Nevertheless, it is the National Audit Office's judgement that, wherever feasible, it is better to test a sale price through a competitive process.


  22.  The Shareholder Executive is responsible for managing and/or advising on the Government's ownership interest in 27 publicly owned businesses, including Actis. As part of a value for money study the NAO commissioned an attempt to value the Shareholder Executive's business portfolio, comprising some 18 businesses for which similar private sector firms could be identified. This exercise, subject to a number of caveats set out in the Comptroller & Auditor General's report[12], estimated the enterprise value of the portfolio to be between £17.1 billion and £20.8 billion as of 30 June 2006. The report published broad valuations for sectors and none for individual companies.

  23.  At its hearing on 27 June 2007, the Committee of Public Accounts requested the subtotals that made up the estimated enterprise value of the Shareholder Executive's portfolio[13]. Each sub-total was a high level valuation of an individual business in the portfolio, conducted on the basis of a multiple of reported earnings or contemporary forecasts. The portfolio valuation exercise did not further investigate circumstances specific to the individual businesses. At that time the stock market multiples for broadly similar businesses were high, ranging from 30 times earnings to 48 times earnings. The valuation used a lower earning figure of £6 million[14] and a higher earnings figure of £11 million. As a result a valuation range of £182 million to £535 million was attributed to Actis LLP. This valuation range suggested that Actis represented between 1% and 2.5% of the enterprise value of the portfolio.

  24.  The earnings figures used, although based on the partnership accounts of Actis for the year ended December 2005, and a forecast for the year ended December 2006, did not take into account the salary and bonuses of working partners that come out of reported profits. Subsequently, the National Audit Office commissioned a separate assessment to understand Actis' earnings figures better, taking into account working partners' prior claims. This showed, for the reasons set out in paragraphs 35 and 36, that there were no distributable earnings in 2005. As a result the valuation using a multiple of reported profits was too high, and a different approach needs to be taken to any future valuation.

  25.  There have been no other valuations of Actis since the sale in 2004.


  26.  The essence of Actis's business model is simple. Its employees manage investments on behalf of investor clients, who include both CDC itself (through both legacy investments and its commitments to new funds) and new investors. The investors benefit when the value of these investments increases. Actis can dispose of these investments on the investors' behalf, and any resulting profits providing a defined minimum or "hurdle" rate is achieved are then shared between Actis and the investor.

  27.  Actis receives fees from its investors for managing investments. It passes a proportion of these fees on to the individual employees responsible for managing investments. Where it disposes of investments, and providing the "hurdle" rate has been achieved, it will again pass a proportion of profits to the individual fund managers. Individual employees are therefore incentivised to act in the investors' interests because they benefit directly from increases in the value of investments when they make profitable disposals. The hurdle rates of return, and the level of carried interest applicable for Actis's management of CDC's legacy investments, were negotiated at discounts to market rates.

  28.  Since the sale Actis has generally performed in line with the 2004 Business Plan. In two years out of four, both total income and operating profit exceeded forecasts. Actis has achieved this outcome largely because of some £12 million of additional fees generated by investment from third parties. On an aggregate basis between 2004 and 2007, operating profit was 7.5% higher than plans. Overall revenue increased by some 4% compared to a smaller 3% increase in costs.

Figure 2


Profit & Loss
P&L in US dollars P&L converted to sterling
First year

CDC Legacy
9876.3 125241
CDC New Funds9790.2 8.55148
Third party fees3961.7 6.52133
Other015.4 308
Total234243.6 30124129
Total Costs193199.5 25101104
Operating Profit4144.1 52325

Note: Operating profit is subject to employee claims (paragraph 27 above and 35 and 36 below)

Source: Actis—summary extracted from partnership accounts in US dollars, sterling values converted by the National Audit Office at December year end values each year and rounded

  29.  While fees from third parties grew significantly, fees paid by CDC for managing CDC's legacy funds were £11 million less than projected in the 2004 Business Plan. Fees fell as legacy portfolios were reduced in size by earlier than planned sale of investments and the return to the CDC of £876 million of cash out of investment proceeds.

  30.  The total legacy portfolio gain realised, as at October 2008 and as calculated under the partnership agreement, has been £959 million out of which the carried interest payable to Actis has been £83 million—an average profit share of 8.65%[15]. Actis calculate that, had the same portfolio entirely consisted of third party funds, then full market rates—although not appropriate in the case of CDC—would have generated a much larger carried interest payment of up to £193 million.


  31.  Actis reports annually a range of financial results, including operating profits. Operating profits are calculated by deducting relevant expenses from annual turnover. Relevant expenses include administrative costs and the remuneration of non UK partners.

  32.  Operating profit is subject to a series of deductions to remunerate UK based partners, as follows:

    a. Profit share on disposals of the legacy portfolio and new investments (paragraphs 5 and 26).

    b. A fixed profit share, representing the "salary" and benefits of the working partners.

    c. Short Term Incentive Plan payments.

    d. Notional interest on capital contributions.

    e. Lastly, and only if any earnings remain unallocated, amongst the working partners and the employee trustee[16] (together, initially 20%) and DfID (initially 80%). DfID's share of these net profits reduces to 40% at the end of 2013.

  33.  This order of priority reflects the incentive-based remuneration structure put in place to reward Actis employees. The Department placed limits upon carried interest payments to individuals both within one year and in aggregate limits on carried interest payments, in respect of the legacy portfolio, as set out below:

    —  no individual should receive carried interest payments in an aggregate amount that exceeds £3,000,000; and

    —  no individual should receive an amount in excess of £500,000[17] in any one accounting year, save that the excess may be carried forward.

  34.  PricewaterhouseCoopers, on behalf of the National Audit Office, examined documentation provided by the Remuneration Committee of Actis for the period from 2003 to 2007. This documentation covered the entitlement of the working partners to a fixed profit share ("salary" and benefits) and bonus under the Short Term Incentive Plan against a target of matching the 60th percentile of market rates for comparable employment positions. Benchmarked against market data, the Remuneration Committee found that Actis was below the target level allowed and the documentation made available to PricewaterhouseCoopers supported this conclusion.


  35.  To date, the remuneration of Actis working partners through the incentive payment structure has fully absorbed the reported operating profits. In particular, after the deductions set out in paragraph 32 there were no residual profits available for the Department (who have a right to 80% of the residual profits) or the other owners of Actis, including staff represented by the Employee Trustee, (who have a right to 20% of the residual profit).

  36.  In 2005, for example, Actis statutory accounts reported in US dollars operating profits equivalent to £7.2 million after administrative expenses and taxes. The administrative expenses already included about £5.5 million of payments for overseas partners but no payments for UK partners. Under the partnership agreement, all operating profits had to be applied to the working partners first according to the agreed priorities. In total, £12.7 million was paid to the UK and overseas partners, with about 40% relating to their profit share arising from sale of the investments held in the legacy portfolio, and the balance fully absorbed by their fixed profit share (or "salary" and benefits) and amounts earned under Short Term Incentive Plans.


  37.  This note has explained the background to the sale of Actis and set out the relationship between operating profits and residual profits.

  It shows that:

    a. Valuing Actis is not straightforward. It has few comparators and was not expected to make significant profits. In addition, because it has been purchased in part by its employees, any valuation needs to distinguish between the amounts managers receive as workers, and their residual rights to profits.

    b. The valuation approach adopted in 2003 was reasonable, although it may not have taken into account elements of value that could only be tested through a competitive process which the Department did not consider feasible in this case.

    c. Since the sale, Actis has performed well. It has increased both its funds under management and its operating profits.

    d. In consequence, the employees have received remuneration in line with the incentive-based remuneration approach adopted by Actis.

    e. In practice, the remuneration paid to employees has absorbed all operating profits, meaning that there is no residual profit to distribute, either to the Department (who have a right to 80% of any residual profit) or the employees-as-partners and staff (with a right to 20% of any residual profit).

    f. As a result, the reported operating profit of $8 million in 2004 (equivalent to £4.6 million) is not a meaningful guide to the reasonableness of the £381,610 paid for a stake in the business. Operating profits are all absorbed by incentive-based remuneration, which would accrue to the employees regardless of the ownership structure for Actis.

23 February 2009

11   Ev Q69 Back

12   The Shareholder Executive and Public Sector Businesses HC 255, 28 February 2007-Appendix 3 decribes the portfolio valuation commissioned from Accenture by the National Audit Office Back

13   House of Commons Committee of Public Accounts The Shareholder Executive and Public Sector Businesses 42nd Report of Session 2006-07, HC 409 Back

14   Actis financials are reported in US dollars and have been converted at £0.5507 =$1 (rate at 30 June 2006) Back

15   The CDC base case in 2003 envisaged a total gain of about £250 million (US$450 million) generating carry of about £16 million (US$28 million). The gain has been about four times greater and the carry five times greater. Back

16   The Employee Benefit Trust holds a nine per cent ownership interest in Actis on behalf of members of staff who are not partners and who do not benefit under the partners' profit share and incentive plan provisions. Back

17   The stated limits are adjusted each year in accordance with the retail prices index. Back

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