Business, Innovation and Skills Committee - Minutes of EvidenceHC 539-II

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Oral Evidence

Taken before the Business, Innovation and Skills Committee

on Wednesday 27 November 2013

Members present:

Mr Adrian Bailey (Chair)

Mr William Bain

Katy Clark

Mike Crockart

Caroline Dinenage

Rebecca Harris

Ann McKechin

Mr Robin Walker

Nadhim Zahawi


Examination of Witnesses

Witnesses: Rt Hon Vince Cable MP, Secretary of State for Business, Innovation and Skills, Rt Hon Michael Fallon MP, Minister of State for Business and Energy, Department for Business, Innovation and Skills, Mark Russell, Chief Executive, Shareholder Executive, and William Rucker, Chief Executive, Lazard & Co. Ltd, gave evidence.

Q233 Chair: Good morning. Can I thank you for agreeing to address the Committee today and answer our questions? We are short of time, so I want to get on. First, I would just like to ask the panellists if they would just introduce themselves for voice transcription purposes.

Mark Russell: Mark Russell from the Shareholder Executive.

Vince Cable: Vince Cable, Secretary of State.

Michael Fallon: Michael Fallon, Minister of State.

William Rucker: William Rucker, Lazard.

Q234 Chair: Thank you very much. The first question is to the Ministers. There has been a lot of speculation about the bids from the banks. Can you list the criteria on which they were judged?

Vince Cable: There were a whole set of criteria. I would ask Mark Russell to enumerate them in some detail, but of course it reflected an assessment of their ability to carry through the IPO successfully. It reflected their fees that would subsequently be negotiated with them, and their bidding price was certainly a factor. They were subsequently asked if they would underwrite it at that price; I think they declined. There were a set of criteria.

Q235 Chair: I understand there was a list of criteria. That is all I am after at this point.

Mark Russell: I can go through them. There were about 10 different criteria, the principal ones being an understanding of how the banks were going to position the Royal Mail Equity story, and secondly their experience in executing a high-profile, large IPO. The 10 criteria were: equity story and positioning, their views on valuation, capital structure, offer structure, how they intended to market the IPO, target investors and de-risk the transaction, an understanding of the timing and market conditions, the unique selling proposition that they would bring to the transaction, the team and our assessment of their commitment, their past credentials and then, finally, a fee proposal.

Q236 Chair: I believe 21 banks were involved. Can you say which three gave the highest and which three gave the lowest bids at the first stage?

Mark Russell: The highest were given by JP Morgan, Citi and HSBC. The lowest of the tier 1 responses were given by UBS, Barclays and Nomura.

Q237 Chair: Where did Goldman Sachs fit into that?

Mark Russell: They were above UBS.

Q238 Chair: How far above?

Mark Russell: The next one above.

Q239 Chair: It would appear that, in effect, you took three of the four lowest. Would it perhaps not have been better to take a representative from each cohort: the lowest, the middle and the upper?

Mark Russell: As we said, valuation was only one relatively small aspect of the criteria. It got a weighting of probably about 10%1. We were looking far more at the other criteria rather than the straight valuation. We were mindful of the fact that, as I think came out last week, a lot of these valuations have been put together purely from publicly available information. The fact that they had various aspirations on valuation did not necessarily convert into what we believed a deliverable value.

Q240 Chair: Can I just explore the relationship between the Shareholder Executive and Lazard for a moment? Can I ask you, Mr Russell, what role Roger Lowe played in relationships with Lazard?

Mark Russell: He was the project leader and what we call in Government the senior responsible official. He led the transaction.

Q241 Chair: I believe Roger Lowe was a former employee of Lazard. Is that correct?

Mark Russell: That is correct, as was I.

Q242 Chair: Was he a contemporary of yours, Mr Rucker?

William Rucker: We crossed for a couple of years, but he left over 16 years ago, I think. He joined in the late 1980s.

Mark Russell: I left 28 years ago.

Q243 Chair: Quite clearly, you would not exclude a company on the basis that current employees had previously worked for them, but it would be expected that, in effect, there was transparency there and measures put in place to ensure past relationships could not influence decision-making there. What measures were put in place?

Mark Russell: The process was transparent. We had a clear scoring process. The people involved in the choice extended far beyond me and Roger Lowe; there was a representative of the Treasury. The scoring was rehearsed with Ministers before the appointment.

Q244 Chair: You may have seen that last week I did ask Goldman Sachs if the information about the bids that had been put to you as clients could be published. Could we have the details of that scoring and the different bids from the different banks?

Mark Russell: Are you talking about our independent advisers or the global coordinators and bookrunners?

Q245 Chair: Shall we say both? Could we have that information?

Mark Russell: We can certainly give you a summary of that.

Q246 Chair: We will look at the summary and then see if we want any more. Did the Shareholder Executive conduct a valuation of your own prior to the bidding process?

Mark Russell: Formally, no. We were constantly looking at values, and one of the first tasks we asked the independent adviser, Lazard, to do when appointed was to conduct their own valuation. We discussed that at length with them. That was used as a basis to discuss other global co-ordinator and bookrunner valuations.

Q247 Chair: It does seem a little odd that, as the Government Department that presumably had the most detailed knowledge of Royal Mail, you did not do a valuation of your own upon which to make comparisons with the others.

Mark Russell: Let me correct that. We were constantly looking at valuations. Did we construct a very detailed model ourselves? No, we did not; we felt advisers were best-placed to do that, but we reviewed those models for assumptions. In many ways, our own valuation would be somewhat irrelevant. We would be in particular relying upon the Lazard valuation.

Q248 Chair: As an outsider, I would have thought that the Department that had had most dealings with Royal Mail and presumably knew most about its history and potential capacity would be best-placed. If all the others only based their bids upon publicly available information, you were in effect much better placed to make a valuation than they were.

Mark Russell: Yes, and it is the degree of valuation here. Of course, we had good views on a valuation, and of course, at a high level, we were conducting values and having opinions of values all the time. However, we did not construct a very detailed valuation model.

Q249 Chair: Why not?

Mark Russell: Because we felt that that should be the role of our advisers when appointed. They would have the resources to do that.

Q250 Chair: Again, as an outsider, it does seem odd to me that the bestplaced organisation did not make a valuation. You went by advisers who perhaps were not best-placed. Can I just turn to Lazard? You conducted a valuation; could you give details of it?

William Rucker: We conducted a valuation, and in contrast to the bookrunners, who were given very limited information through the Shareholder Executive, we had had full access to all the required data to value it in a much more detailed way. We updated our valuation on a regular basis, but the valuation stayed around the £3 billion to £3.5 billion range.

Q251 Chair: £3 billion to £3.5 billion. Can I just ask the Ministers who signed off the valuation?

Vince Cable: Ultimately, I did, but we constantly had reference back from our advisers and the Shareholder Executive.

Q252 Chair: So, ultimately, the buck stops with you, Secretary of State.

Vince Cable: Yes, it does.

Q253 Ann McKechin: Goldman Sachs has just settled a litigation for $7.5 million and has been accused of undervaluing an IPO. Were any of you aware of this at the time when you were making your assessment of the share price? If so, how did you take this into account when you appointed them as one of the global co-ordinators?

Mark Russell: I think you are referring to the litigation of Goldman Sachs over a decade ago.

Ann McKechin: Yes, which they have just settled, with an undervaluation.

Mark Russell: Which I believe was settled.

Q254 Ann McKechin: Only just. It was not settled at the time you made your decision.

Mark Russell: Yes. But to answer your question, we were not aware of that. That litigation happened over a decade ago.

Q255 Chair: The litigation and negotiations were ongoing.

Mark Russell: The case, I should say.

Chair: The Goldman Sachs representative denied any knowledge of it. I find it quite astonishing that something that was publicly available on Google should not be understood by people closely involved in the process. As an outsider, I have to say that appointing Goldman Sachs on a flotation given this court case is a bit like asking Ronnie Biggs to have an appointment at Securicor.

Q256 Ann McKechin: Mr Russell, did you have a list of the IPOs that Goldman Sachs were previously involved in?

Mark Russell: I do not have a list here.

Ann McKechin: You did not have any list?

Mark Russell: I did have a list.

Ann McKechin: You did have a list; how many were there?

Mark Russell: I cannot remember.

Q257 Ann McKechin: Were there 10 or 20? Can you give us a rough estimate?

Mark Russell: Many 10s.

Q258 Ann McKechin: Were they asked to provide an indication of how accurate those valuations had been in the past?

Mark Russell: No. Sorry; I thought you asked if we had a list of IPOs that they were involved in. In their credentials when they pitched to us, they gave us extensive knowledge of that. As far as I can remember, they did not provide valuations against each of those.

Q259 Ann McKechin: Right, so you did not actually want to see what their past record was like and how accurate it had been? I would have thought that would be the first thing you would be looking for: what were the actual professional valuations and were they actually up to the job?

Mark Russell: Yes, of course we looked at their ability to bring large public companies to the market. We looked at their ability to price. At the end of the day, we employ advisers to help us price things.

Q260 Ann McKechin: So that would be part of the scoring process that you spoke about earlier. Would that be correct?

Mark Russell: Correct.

Q261 Ann McKechin: Would there not be part of the scoring process where you asked them to disclose whether they were involved in any litigation at the current time? I would have thought it rather surprising that you would not have made that enquiry about whether they were involved in any litigation.

Mark Russell: Yes. I think we would expect them to offer up any issue that they thought would be material. This was litigation that started 14 years ago on the back of the dot-com boom. As you are aware, it has now been settled without any fault being admitted.

Q262 Ann McKechin: Okay, but it was a unique valuation, as was Royal Mail. I would have thought it would have been pertinent to your decision on criteria. What are the criteria you will use to decide whether or not you give Goldman Sachs and UBS the £4 million performance bonus?

Vince Cable: No decision has been made on giving a performance bonus.

Q263 Ann McKechin: I am just asking what the criteria are at this stage. What are the criteria you will use in determining whether they get it or not?

Vince Cable: The overall performance of the IPO, including the value for money, but it will take some time before we can make an assessment of that.

Q264 Ann McKechin: Can I just confirm what weighting you are going to give to the share price when you make that decision?

Vince Cable: The share price will vary considerably over time. We will no doubt get into this in considerable detail later. I made a statement to you when we last met that it will be a very considerable time before we can make a judgment on that. When we do, that certainly will be one of the factors in judging their bonus. In terms of the value for money for the overall transaction, of course it partly relates to the price at the time; it partly relates to the residual value of the existing state shareholding; and it partly relates to the ability of the company to raise finance and support the universal service obligation. That is quite a complex set of considerations.

Q265 Ann McKechin: I think the public would want to know, if there had been a gross undervaluation in the share price, whether that would be a criterion for not providing a bonus.

Vince Cable: Yes. As I said, there is no commitment whatever to making a bonus.

Q266 Ann McKechin: I just wanted a yes or no. Perhaps you could provide when you are going to make this decision.

Vince Cable: Yes, we will come to-

Ann McKechin: When you make that decision, if there has been a consistent gross undervaluation of the price would that be, in effect, a block for any bonus being provided?

Vince Cable: If we were to ultimately decide there had been a misjudgement, clearly that would affect it.

Q267 Ann McKechin: If there had been a gross undervaluation of the scale that we are currently seeing, I think the public want to know whether their money is going to be used for the bonus: yes or no?

Vince Cable: As I said, a decision has not been made and will not be made for quite a considerable time as to whether a bonus is justifiable or not.

Q268 Ann McKechin: What time period are we talking about?

Vince Cable: I am not giving a precise period, but we are talking months or possibly years.

Q269 Ann McKechin: Is that going to be before the next general election or after it?

Vince Cable: No, this is nothing to do with the general election. This is a decision that will be made on the performance of the overall transaction.

Q270 Ann McKechin: I am just trying to find whether it will be the current Administration that will be in charge of this decision or whether it will be the decision of a subsequent Administration.

Vince Cable: That is not part of the criteria.

Q271 Ann McKechin: So they have no idea when they are going to get their bonus.

Vince Cable: No, they have no idea if they will get it or when they will get it. That is a matter in our hands, not in theirs.

Q272 Ann McKechin: That is unusual. Normally when you are talking about a bonus, people have an idea of when the decision might be made and what criteria will be used. I think the public would also like to know that as well.

Vince Cable: The phrase is that it is discretionary, and it is at our discretion.

Q273 Chair: Basically, we can assume that if it is not paid at any time then the judgment is that they have not earned it.

Vince Cable: Yes, that is a reasonable inference.

Q274 Chair: Secretary of State, could I just ask you, before I hand over to Nadhim Zahawi, when you came before us the first time, you said you were "not aware of any other major sources of information going around saying [Royal Mail] is undervalued"? Can you just say how this squares with the statements made by Deutsche Bank, Citi, Panmure Gordon and JP Morgan that they all submitted valuations that were higher? Did you not know about them?

Vince Cable: The only equity analyst who put out their estimate in the public domain was Panmure Gordon. That is why I refer to them as an outlier. There are two different categories of estimates. There were those that were part of the bidding process, and one has to treat them in that context, and there were those who were making independent analyses. When you asked me that question, which was some time before the launch, Panmure Gordon had gone out on their own with a rather public view, and I was reacting to that.

Q275 Chair: With respect, Minister, what you said does not reflect that. You were "not aware of any other major sources of information going around saying [Royal Mail] is undervalued". That is not quite what you have answered. You must have been aware of other quotations through the bidding process that said there were different valuations.

Vince Cable: There was a constant running commentary in the media, which was partly-

Q276 Chair: This is not about the media; it is about the bidding process.

Vince Cable: These are analysts commenting in the media and who were influencing the debate. As I say, Panmure Gordon were the people who came forward with a welldeveloped argument of their own that was contrary to the common view at the time.

Q277 Chair: There were bids you knew that gave higher valuations. This is not just about what you read in the press.

Vince Cable: We knew, in parallel with the equity analysts who were giving their independent assessments, the fact that there was a range of bids that had been offered. We did not regard those as meaningful valuations. As Mark Russell has said, they were desktop estimates. As far as we can gather, in some cases, they made inaccurate estimates of the dividend payments. Some of them did not factor in the potential costs of industrial disruption. We would not regard those necessarily as giving serious information on the underlying value of the company.

Q278 Chair: Some of them were certainly more accurate than the valuations you subsequently accepted.

Vince Cable: I do not accept that. You are talking about the current short-term price. As I said to you when I met your Committee, we have to look at these things in a much longerterm context.

Chair: We will come on to how you expect the price to go a little later on.

Q279 Nadhim Zahawi: We have had Royal Mail report its profits this morning. Mr Rucker, when you looked at the valuation in detail, did you talk to management about the future of the business and where they saw the profits moving to?

William Rucker: Yes, as part of our process we had extensive discussions with the management about the current and future prospects of Royal Mail, including the risks around industrial relations in particular and what that could mean financially for the company.

Q280 Nadhim Zahawi: Presumably, valuations are an occupational hazard in your industry. We heard from three of the bankers that did not win the mandate, and their valuations were higher than what the trading price was at when we had them before the Committee. Therefore, it would have meant a failed IPO.

William Rucker: I think it is important to make it clear on the valuations the banks pitched on. We did not disclose a lot of sensitive information on Royal Mail to 21 banks, because this company was going to go into the public arena and that would have been very damaging for the company to have had that information out there. By necessity, we had to restrict the information the banks were making their estimates on. The other important thing is to remember the scale of this company, which makes £9.5 billion turnover and has net profit of around £300 million. You only have to make very small changes in assumptions regarding margin to come up with a very different result. We saw that very graphically last Wednesday, when people talked about a dividend assumption of £350 million, rather than the £200 million that the company was actually working on. You can see with very small changes in assumption there you can end up with very different results on valuation. That is really what you are seeing when you talk about the wide range of valuations from the 21 banks.

Q281 Nadhim Zahawi: That came across from the evidence that was given. We asked the banks about their tender process. What was the process for your appointment as the independent adviser, Mr Rucker?

William Rucker: We went through a similar tender process. We do not know the details of all the other banks. Mark Russell can give you those details, but we went through a formal tender process, where we had to submit our views on valuation, fees and a host of other aspects.

Q282 Nadhim Zahawi: What fees did you negotiate in terms of flat fee and performance bonuses for Lazard?

William Rucker: There is no discretionary fee; it is a flat fee of £1.5 million.

Q283 Nadhim Zahawi: Who made the final decision on your appointment: the Shareholder Executive or the Ministers?

William Rucker: That is probably best taken by Mark Russell.

Mark Russell: Ministers.

Vince Cable: The Ministers signed off, on their advice.

Q284 Caroline Dinenage: This is to the Ministers, please. What advice did you, as Ministers, receive on the share offer range from Lazard and the Shareholder Executive during the process?

Vince Cable: The share offer range that was put forward to us was the one that you have publicly discussed. It was based on a variety of factors. It was based on an attempt to assess the underlying value of the company, by looking at the dividend yields of comparative companies. There were not many, but I think I described Belgium, Austria and part of Deutsche Post as a reasonable comparator, and they did that analysis. More substantially, they did the pilot fishing-as it was described-as they were building up the book, talking to very large numbers of potential investors, concentrating particularly on the longterm investors who we were anxious should dominate the share register, in order to form an estimate of what was a plausible range. Those were the figures that were put to us.

Q285 Caroline Dinenage: Did you additionally receive any further advice?

Michael Fallon: No, we had the same advice throughout.

Q286 Caroline Dinenage: Did you accept the advice you were being given at face value at all stages, or did you question it?

Vince Cable: We did interrogate them. Certainly, Mr Fallon met them more frequently than I did, but he interrogated the advice that he was given, and I certainly did. Certainly, as we got very close to the launch, there was a great deal of speculation going on about whether this was the right range or not. We certainly asked very tough questions of the advisers and explored with them whether we should be doing things differently. That is our role as Ministers, and we did it.

Q287 Caroline Dinenage: Given the fact that there was very high media speculation at the time, and the media speculation was to do with the fact that this was undervalued, did you then require your advisers to go back to the banks and seek evidence that the price you were setting it at was appropriate?

Vince Cable: We interrogated them very closely as to whether they were making the correct call. I can just briefly rehearse the kind of arguments we had. The point that was being made to us was that, had we sought to push the price range higher, we would have lost a significant number of the long-term investors whom we wished to attract into the company. There were very high risks attached to changing the valuation. We did go in the final analysis to the top end of the range, but if we had sought to reopen that whole issue, there would have been very considerable risks and a very large downside.

Q288 Caroline Dinenage: When you say that you interrogated them closely about this, is this something that happened orally, or is it something that happened in personal, face-to-face meetings?

Vince Cable: We had several face-to-face sessions. There was one in particular just before the launch. Mr Fallon and I were both there with the Shareholder Executive and Mr Rucker.

Q289 Caroline Dinenage: Were there any requests in writing to have another closer look at it?

Vince Cable: No, and that is not the way we function. After all, this was moving rapidly and ministerial meetings are the forum in which these interrogations take place.

Michael Fallon: Can I just add to that? As you can imagine, there were a series of meetings over this very intense period, as the sale was finally prepared. We challenged the advice we received on a whole range of issues, not simply the price, but the price range, the size of the stake to be sold and all these issues. We challenged the advice that was there. It became very clear to us there was a point at which institutional investors would not invest. That became very clear to us, and that was something we kept testing. There was a point at which the price would get to a level where institutions would simply walk away, and there was some evidence of that right at the point at which the IPO was launched.

Q290 Mr Bain: On that point, could I ask the Secretary of State: can you rule out that any of the institutional investors have in fact bought shares at the current share price if those statements that you and the Minister just made were correct?

Vince Cable: We cannot rule that out. The question I was asked before was what our assessment was of their likely behaviour had the price been pushed above the level at which it was fixed. The very clear, unambiguous advice we got was that this would be a very unwise thing to do, because significant numbers of those long-term institutional investors would walk away.

Q291 Mr Walker: UBS told us last week that they advised the Government that they believed they could get an additional 20p above the 330p if they repriced. That would have potentially delivered about £200 million extra to the taxpayer. What were the reasons for rejecting that offer?

Vince Cable: There are two aspects to that. There was the view that if we simply tried to get rid of it at the highest price regardless of the investors, we could have got a little bit more, and we are talking about that kind of price range. The other was the potential risks and costs of launching this process again with a new prospectus in an attempt to get a higher price. There were major risks around at the time, not just in international markets, but the industrial relations situation was highly uncertain. It is quite possible that, had we attempted to redo this in order to get that extra margin, the price eventually could have been lower and the whole process could have failed. There were very high risks attached to that.

Q292 Mr Walker: Other factors that got mentioned last week obviously were the potential for a US default, the nature of the retail offer and the sheer difficulty in execution in re-running a retail offer. Was that a factor that was considered?

William Rucker: Yes, I think so. It is also saying that when UBS discussed a potential extra 20p, it was only potential. It was not certain that we could have got that. That was something that we debated: could we actually stretch it to that level? We were not passing up on that. It was a risk that we would have taken. The risk that we would have taken is the fact of having to delay the process. Because there was a large retail offer, we would effectively have had to go back and delay the process and re-price. With the US debt crisis, with industrial relations and other aspects hanging over it, it was deemed that the risk-reward was not sufficiently attractive.

Q293 Mr Walker: How do you weigh up that risk-reward, given we were talking about a 48-hour delay and £200 million value.

William Rucker: With the 48-hour delay, when you are doing a book-to-bill process, the risk is that the thing starts to deteriorate in front of you as events happen. We had effectively lined up a very considerable number of investors to sell 600 million shares and raise £2 billion for. To run the risk of seeing that deteriorate would obviously have been a very major concern.

Michael Fallon: If I could add to that in one respect, the 20p was not an offer to us. It was not offered to us. We considered whether we could get that extra 20p, and in the end we concluded the risks were just too high. This was the biggest IPO in Europe for two and a half years. There were huge risks around this offer; indeed some of the speculation and media commentary drew attention to the sheer number of pages in the prospectus outlining the risks. Above all, our aim was to protect the six-day-a-week service by ensuring that we had a privatisation that meant there was a sustainable share base and that the Government would not have to step in and provide any extra capital for this business. If we had over-priced this business like Facebook and were not able, therefore, to return to the market for a year and a half until the price got back to the offer price, we could seriously have jeopardised the sixdayaweek service.

Q294 Chair: Could I just intervene at that point? The Government paid UBS to give advice. The advice from UBS was that they could get at least 20p more, but the Government rejected that advice. What is the point of paying taxpayer’s money to get advice that would increase taxpayer’s revenue and then rejecting it?

Michael Fallon: A few minutes ago we were being asked whether we had challenged advisers sufficiently. It was our job to weigh the advice that we got, with the benefit of our independent adviser, who was quite separate from the whole process. That is what we did.

Q295 Chair: So you challenged and made an assessment that was actually more detrimental to the interests of the taxpayer than that being advised by your professional advisers.

Vince Cable: That is a massively loaded question.

Chair: It was actually a statement.

Vince Cable: You are citing one of the banks involved. The independent advisers did not share that judgment, and as far as I am aware, even UBS said to you that when they offered that piece of advice it was full of qualifications about the risks involved.

Q296 Mr Walker: On this point about the risks in the demand, obviously, when the actual IPO went through, the institutional offer was 20 times oversubscribed and the retail offer was seven times over-subscribed. Mr Rucker, you will have been involved in a number of these types of transactions. How unusual is that level of oversubscription?

William Rucker: If you take Facebook, it was 25 times over-subscribed, but it is unusual to have that strength. The thing to bear in mind here is that this was the first privatisation since the 1990s; it was the first privatisation with social media; it was the first privatisation where online was a factor behind the retail offer. The scale of it has to be put in context. Yes, it was strongly over-subscribed, but equally the level of over-subscription does not mean there is certainty the price is going to go up afterwards. We have seen that with Facebook.

Q297 Mr Walker: Who made the final decision on share price and where it would stand? Is that a decision of the Secretary of State or the Minister?

Vince Cable: I signed off on it ultimately, as a result of a meeting with my colleague and our advisers.

Q298 Mr Walker: Just coming back to a point that has been raised earlier, Secretary of State, you described Panmure Gordon as an outlier in terms of its valuation earlier in the process. Given that the share price and overall valuation of the company are actually rather closer to what they said than to what other advisers say, do you regret that description?

Vince Cable: Not at all. When you asked me that question, that was the state of affairs. I do not want to simply go over what I said earlier, but a lot of figures are now being bandied around. They were the one group of equity analysts that were out there advocating that view rather strongly. The other figures came from parts of the bidding process of the banks who were pitching for business. I can perhaps refer back to the point I made right at the beginning of this session: that when those banks were asked whether they would underwrite those high prices, they declined to do so. That suggests a lack of conviction in them that Panmure Gordon did have.

Q299 Mr Walker: We have seen the share price obviously rise very sharply since listing and then decline a bit during the course of November. I think it is down slightly on the results today, certainly last time we checked, but it is substantially above where it was listed. You have said that you do not think it is early enough to decide whether it is overvalued or undervalued. At what point will you be able to take a view on that, and will you be able to actually say whether this was undervalued at listing?

Vince Cable: The question is why the price is at its current level rather than at the offer price. There are two major reasons why that is the case. First of all, at the moment, the trading is in a very, very narrow range. We are talking about 1 million or 2 million shares a day out of 600 million. The challenges of actually making a flotation of 600 million shares as opposed to buying and selling 1 million or 2 million a day are fundamentally different, and they tell you fundamentally different things. It is also very clear, and it has emerged since the flotation, that there are groups of shareholders with fundamentally different views about the strength and otherwise of this company. They are perfectly entitled to have them.

You asked me about the future and when we will be able to make a considered view about this. I did have a look at some the equity analysts and what they are saying about a year from now. It is quite striking that, of the leading group, about half think the price is likely to stay about the present level; the other half think there will be a substantial fall. Some of them envisage a downside scenario where the price is much lower than indeed the offer price. In fact, the Royal Bank of Canada has a downside scenario of the price collapsing to 50p. There is a wide range of possible outcomes.

You ask when precisely we will know whether this is a good outcome or a settled outcome or not. I said to you when I came to the Committee I thought three to six months, or perhaps a year. One of your banks, when they were interrogated by you last week, said two years. It will be a long time before we are able to take a proper, considered view about the underlying value.

Q300 Chair: I would add that Panmure Gordon actually said this was the correct price-about the right market price. Can I just pick up a couple of things? We were told this IPO was 20 times over-subscribed by institutional investors-now 25.

Mr Walker: 25 was a different IPO.

Chair: Sorry; certainly 20 times. If it were 20 times oversubscribed at 330p, it is impossible to believe that all that interest would evaporate if that price were raised even by 30p or 40p.

William Rucker: If I just take an example, Facebook was 25 times oversubscribed-more heavily over-subscribed than Royal Mail-and within three months the share price had fallen 50%. The direct linkage between the level of over-subscription and subsequent share price performance is not there. The other thing to bear in mind is in a lot of the orders that go into the books to try to assess how much the thing is over-subscribed by, there is a heavy element of gaming. The three biggest orders were $1 billion each. That would have represented 20% of the company. Those institutions had no expectation of ever receiving anything like that quantum of stock.

Q301 Chair: Mr Rucker, everybody knows that different companies in different areas will have different trading prospects, and their shares can be affected by all sorts of different circumstances. You were paid to make an assessment for Royal Mail. Are you anticipating there will be the same catastrophic impact on Royal Mail share prices in the months to come as you have just outlined for other companies?

William Rucker: The success of Royal Mail will ultimately depend on how well the company executes its operational plan. Everybody associated with the deal is hopeful that will be a great success.

Q302 Chair: Is it not your job to make such an assessment? You are the professionals.

William Rucker: Yes, we made the assessment of what was the best price achievable in selling 600 million shares.

Q303 Chair: Do you expect it to drop over the next few months?

William Rucker: I am not going to make a prediction on share price.

Chair: You are not going to make a prediction.

William Rucker: No, I think it is inappropriate.

Q304 Chair: Could I put it to you that the reason that you are not making a prediction is actually because you are pretty clear that it will at least remain at the sort of level it is now? Could I actually just turn to Mr Russell from the Shareholder Executive? I am looking at the annual review of the Shareholder Executive. If I can quote from it: "In challenging circumstances, and following years of failed attempts to privatise Royal Mail, ShEx delivered a sale of 60% of the shares in Royal Mail to a mix of long-term high-quality institutional investors and almost 700,000 members of the public. Nearly £2 billion was raised for the Exchequer, and the Government still holds a 30% stake in a company that has"-and I emphasise this-"as expected, increased in value following the introduction of private sector ownership". Have you really obtained value for the taxpayer? Could you not have got more for it, in the light of what you have said in that review?

Mark Russell: As the Secretary of State has said, we will need to make an assessment of that in the months to come. There is no question that if you look at wellexecuted IPOs you are aiming to place and sell shares, so that the share price certainly does not move down and, ideally, it will move up a bit. We talked about an IPO discount. On the basis that we had 600 million shares to sell, we were certainly anticipating some type of IPO discount. Additionally, one of the main reasons that we are pursuing this policy of bringing in private sector capital is we expected private sector disciplines to come in on the back of the private sector capital. Both of those points, in terms of the IPO discount and the fact that over time we would expect this company to perform better in the private sector than the public sector, were key drivers for the decision to retain a 30% shareholding. The comment in the report is to say that the very reason we were maintaining the 30% shareholding was because we anticipated that over time there would be some movement of share price, and we wanted the taxpayer to gain from that.

Q305 Chair: You were caught out by the scale of the increase.

Mark Russell: We did not anticipate the share price to move to the extent that it did.

Q306 Chair: Is that not part of your job: to make professional judgments and to get them right?

Mark Russell: Yes, it is, in combination with our advisers. I do not think any of us anticipated quite the extent of the jump, although I would say, if you look at a number of the IPOs that have occurred in this country since the start of the year, we have had massive movements.

Chair: Again, we are looking at other IPOs. We are talking about Royal Mail.

Q307 Nadhim Zahawi: On this morning’s results, there is a quote here from Richard Hunter, Head of Equities at Hargreaves Lansdown. He suggests, "The combined UK Parcels and GLS divisions now account for just over half of group revenue which provides both opportunities as well as potentially inviting more entrants into a fiercely competitive space". Presumably, thinking about the 30% that the Government still holds, there are risks around the opportunity that make it very difficult. If you were going to place another 300 million shares, that would apply a discount to the price. The bankers last week confirmed that, too; there is a difference between selling 1 million or 2 million shares a day versus placing 600 million or 300 million shares. That risk to the business is still there. Hindsight is a wonderful thing, but that risk was still there when you were looking at the business going forward, presumably.

Mark Russell: Absolutely, you raise two good points there. One is that of course there is risk as well as potential upside in holding that shareholding. That is a decision and a balance the Secretary of State took. In terms of the placing of that 30% when the Secretary of State decides to do that, we are absolutely very confident we would get nothing like the share price that is currently offered.

Q308 Chair: Obviously, it is one of the elements of your professional skill that you weight opportunities and risk, but it would appear that you have judged them in a totally different way to the rest of market at the moment.

Mark Russell: You talk about valuation. The judgment that we all had to make was not ultimately a judgment on valuation. It was a judgment on pricing: what was the best pricing we could achieve? Clearly, we had to get over a certain level of valuation to be satisfied that it was a better value than alternatives, and at the price we eventually sold we were significantly above that.

Q309 Chair: With respect, Mr Russell, I think you are dissembling here. The price will reflect the perceived valuation, and the price is very much higher at the moment than you evaluated it.

Mark Russell: I agree, but the decision we were taking was a pricing decision of what the best price was we could achieve for 600 million shares.

Q310 Chair: We come back to the point that it was going to evaporate if you put it at a higher price.

Mark Russell: Significantly decline.

Q311 Ann McKechin: Can I just ask one question from what the Chair has said? Given there was such volatility in the potential value and price, was there any consideration about actually reducing the amount of shares for sale by, for example, selling off 30% and retaining 70%, so that you could actually have a better test of the market? You appear to have had no idea what the market would actually value it at.

Vince Cable: Certainly, consideration was given. I said earlier that when we were challenging the advice we considered different levels of issue and sale as alternatives. The idea implicit in your question that we should only sell a minority would have been a very different proposition. It would no longer have been a private company and therefore would not have had the independence from Government debt calculations, and it would have been a totally different operation. It is very unlikely we would have been able to sell it in the way that we have.

Q312 Ann McKechin: If I could turn to the issue about longterm investors, Secretary of State, when you gave evidence in October, you talked about your priority of having long-term blue-chip institutional investors. When we took evidence from Goldman Sachs, they explained that up until June they had initially met with 65 institutions and then they had a more targeted phase with about 24 accounts. We have now been advised by the London Stock Exchange that there are two companies that have greater than a 3% threshold. One is a hedge fund, The Children’s Investment Fund Management with about 6%, and the other is Singapore’s sovereign fund, which has around 4%. Were those two companies part of that tranche of people whose views Goldman Sachs were testing?

Vince Cable: I believe that TCI-the one that has been publicised-were. Indeed, they did receive a small initial allocation. The bigger answer to your question is that, from memory, something in the order of 85% of the overall allocations initially, apart from the retail and workers’ share, were to long-only institutions. That is significantly higher than is normally the case.

Q313 Ann McKechin: It would be helpful if you could just clarify whether either of these two companies were involved in the original consultation. A 6% share from a hedge fund in a company such as Royal Mail is a very substantial holding and obviously could have an influence. Could I just direct this to Mr Rucker and Mr Russell? A clear objective of the sale was to place the shares in long-term institutional investors. What role did you both play in assessing and approving that allocation of shares?

William Rucker: We played a very active role in the allocation. I should also say that Lazard met independently with all of those leading shareholders you referred to that Goldman Sachs mentioned. We went through the allocation principles to try to establish longterm shareholders; they were not all long-only holders in the main. They are a mixture of different types of investors, but they were all people we categorise as long-term investors. Those were people who were prepared to see this company through what could have been a troublesome time in the event of a strike or other actions.

Q314 Ann McKechin: Were there companies suggested by UBS and Goldman Sachs that you vetoed?

William Rucker: Some institutions were excluded, and the biggest difference was the proposed allocation to the final allocation. We went through the allocation process with the Shareholder Executive and the Treasury, and a number of significant changes were made as part of that process.

Q315 Ann McKechin: How did you determine the grounds for that allocation?

William Rucker: We had a number of principles we established for the allocation process that were set out. Those were what were adopted.

Q316 Ann McKechin: Were there any hedge funds in terms of that list?

William Rucker: Yes, there was a mixture of funds in that. Many funds these days should not be categorised as either long-only or hedge. A lot of funds run multiple types of investment strategies and, therefore, there are a number of institutions in there that you may have described as hedge a few years back, but today run a whole range of strategies.

Q317 Ann McKechin: Just finally to the Secretary of State, we are still obviously awaiting the complete share register. How can you be certain that Royal Mail is owned by responsible long-term investments? What influence do you think these larger shareholders are going to have to bear on the company’s operations in the future?

Vince Cable: We do not have the share register now, but it is with Royal Mail. My understanding is that the long-term investor still dominates the share register, and that is extremely important in terms of the objectives we are trying to achieve. Those are to ensure that the long-term value of the remaining state share is maintained and that the company can improve its performance by borrowing in the markets in the way that we have described to you on several occasions before.

Q318 Mr Walker: The point that Ann touched on of the scale of the free float must have been something that you took substantial advice on and took views from the various banks pitching on this. Last week, I asked them whether they were set a specific number, or whether they were allowed to advise on that. They said that they were allowed to advise. Having over 51%, as the Secretary of State has already pointed out, would have made a big difference in that respect. Obviously, when the last attempt was made to privatise Royal Mail by the Labour Government, they were looking at trying to sell part of the company to private equity, rather than necessarily putting it into the market. Mr Rucker, in your professional judgment, what difference would that have made to the valuation if part of the company had been tied up in private equity ownership?

William Rucker: It depends on what would have happened to the company in the mean time, so it is very hard to judge. It is worth saying that part of our role here was not just to look at the flotation of Royal Mail; it was also to look at bringing capital in to Royal Mail. As part of the process, when the industrial relations issues looked like they would not be resolved-which questioned whether the float would be feasible-we were charged with exploring whether we could bring private capital in to Royal Mail. Therefore, we had discussions with a number of potential investors, including private equity firms. It was quite clear to us from those discussions that the price achievable would have been very, very significantly short of the 330p per share this company was floated at.

Michael Fallon: It is important to put on the record that we did explore alternatives to an IPO from last autumn onwards. We had a preference for an IPO because that was clearly the best way of getting the employee share into the business that Parliament itself had wanted and voted for. We did look at all the alternatives, and we examined it again in the spring because of the deteriorating industrial relations position where there was no agreement. We did look again at private equity, but it was again clear to us, as William has said, that we would not have got anything like the price that was eventually on offer.

Q319 Katy Clark: There has been a great deal of speculation about the value of the property portfolio that Royal Mail has. It owns over 2,000 properties all around the country. When we spoke to the bankers last week, they seemed to be saying that they would not make any serious attempt to value properties because these were properties that Royal Mail would be using in the main. Is it something you were concerned about that the taxpayer owns substantial assets around the country that may well get sold over quite a long period of time? Are you worried about asset-stripping over a period of time, and are you worried that the value of that property was not taken into account and that the taxpayer has lost out as a result?

Vince Cable: Mr Russell will talk in detail about this, but you did ask me about this last time. We certainly wanted to know what the property assets of Royal Mail were. As I think I told you, they were independently assessed; Jones Lang LaSalle did that work. Much of the land is in operational use, but there were some clusters of sites in central London and a valuation was put upon them. Do you want to develop that point?

Mark Russell: Of course we were alive to this issue. Royal Mail has in the region of 2,000 sites, probably 50% of which are freeholds, so of course we were alive to that point. In the preparation for sale, obviously our starting point is what the accounts tell us. As you are aware, in the last set of annual accounts, the directors did give a view of the difference between book value and market value on the basis of current use, which gives us our figure of about £1 billion. We are aware that there are three big sites that are surplus and potentially would have alternative use, which were the London development sites. Those are the sites that have probably received the most attention.

As you are aware, there has been a valuation done on those sites on the basis of alternative use. It is a valuation that we have seen, and as the Secretary of State commented in his letter to Mr Bailey, the valuation was well within the range that was given in terms of what that might be worth, and it is. That is the biggest single bundle of surplus sites. Are there other sites that are potentially surplus? There is nothing significant that we are aware of, and, indeed, if you look at the prospectus they are pretty clear on that. I can read from the prospectus; there are sites-

Q320 Katy Clark: I am not so much interested in the surplus sites. I understand there was a value put on them. Whether that is an accurate value or not could maybe be debated. I am asking whether you are worried about the fact that the real value of the properties does not appear to have been taken into account because of the way that this privatisation has been valued. Can you answer that? Do you think that is a genuine concern that the taxpayer should have: that all these sites worth all this money around the country have not been properly taken into account?

Mark Russell: Undoubtedly, some people are taking different views on whether these sites could be made available for alternative use. The management is pretty clear that, with the exception of those London development sites, the switching of sites for alternative use has no big gains to be made. It is some time out. Yes, over the next five to 10 years, I am sure some of those sites will convert, but there is nothing immediate.

Q321 Chair: Mr Russell, can I just put to you an article in The Guardian yesterday? "Clifford Chance, the ‘Magic Circle’ City law firm with links to some of the leading investors in Royal Mail, has been privately analysing the newly floated company’s portfolio of 2,000 UK properties". Do you think that might be a reflection that perhaps there is a belief in the market that they are worth rather more than they have been valued?

Mark Russell: It is difficult for us to comment.

Q322 Chair: You do not want to comment on that, okay. Before we move on, can I just ask the Ministers about the role of Equiniti and the selection of this company to handle the retail float? My understanding is that it is a dormant company and that it has a parent company that is actually a hedge fund. Can you explain why this company was chosen?

Michael Fallon: I do not think, with respect, that is right. There were two or three companies that we considered for this particular role. Perhaps Mark can give more detail.

William Rucker: Their role in the transaction was to be registrar and the receiving agent.

Q323 Chair: But they are handling sales.

William Rucker: No.

Q324 Chair: Who is handling sales for the retail shares?

William Rucker: Solid Solutions was the retail offer adviser.

Q325 Chair: I think we will investigate that a little further. It does seem to be bizarre that a company that is dormant has been used by the Government in any capacity whatsoever. Can I just quote an article in The Independent today? "It is listed as a dormant company, does not trade and is therefore exempt from audit. Its ultimate controlling company is Advent International Corporation, an American hedge fund". It says: "the firm handling Royal Mail shares bought via the Government’s website, include banks ABN Amro and JP Morgan, and leading hedge funds such as Hargreaves Lansdown". Could you comment on that?

William Rucker: I will have to look into it; I am sorry. Advent is actually a private equity firm and not a hedge fund. I am not sure what the source is.

Q326 Chair: I am quoting a report in The Independent today. You dispute what they are saying; in that case, if you could report back to us later on that, I would be grateful.

William Rucker: Of course.

Q327 Rebecca Harris: At the risk of slightly going over ground we have already covered, but just so I can be clear in my own mind, Ministers, you said earlier that you were advised there was a point at which institutional investors would walk simply away. Were you informed of those institutional investors that were refusing to buy shares above the 330p offer price? If it becomes clear subsequently that they did buy at a much higher price, would you see that as a failure of the advice you were given by Lazard and the global coordinators?

Vince Cable: We did challenge the assessment that the block of long-term investors would walk away. We were given examples; I do not think I can quote them for confidentiality reasons, but it was certainly a very plausible explanation that there were significant risks attached to this.

Q328 Rebecca Harris: When it subsequently becomes public, will you be able to give us a breakdown of those institutions’ original position and what they actually bought it at? Will that become public? Will we be able to get that?

Vince Cable: Quite a lot of the detail of the process, if this is what you are asking us about, is being made available to the National Audit Office and it will subsequently be in the public domain.

Q329 Rebecca Harris: Mr Russell and Mr Rucker, you talked about the shares being 20 times over-subscribed; you compared that to Facebook and the problems they had, and they were 25 times over-subscribed. Are you able to tell us now whether all of the institutions were only offering at the £3.30 offer price? Are you are aware of how many have bought it at a higher price?

Mark Russell: There was a tapering. It is important to come back to the point that the judgment ultimately was at what price we could sell 600 million shares. We were very conscious of the point that there was tapering above 330p. Our advice was that there was significant tapering above 330p, to the extent that that would be insufficient to sell 600 million shares.

Q330 Chair: I think there is now a lot of reported evidence that demonstrates that those banks that recommended this particular level of share price at flotation have traded shares at much higher levels and made a considerable amount of money at it. Again, to the outsider, a bank that advises the Government that shares should be appropriately floated at one level and then is prepared to handle sales and, for all I know, make recommendations to people that they should buy at a much higher level begs the question of what the motives were for the advice they gave to you. That is the crux of the issue. Putting it bluntly, were they conning you?

Mark Russell: We do not believe that they were. On your point about buying and selling of shares, many of our advisers of course have separately regulated businesses in the business of asset management.

Q331 Chair: Separately regulated businesses-yes, I would agree. I am sure that it conforms to the regulation, but it is impossible to believe that one part of the business would not know of the potential benefits to another business that it was associated with of pitching a price low so it could be traded higher and more commissions could be made. Would you agree with that?

Mark Russell: I would put it another way, which is we were satisfied that the advice we were getting from those parts of the banks was properly independent advice and that they were acting in our best interests.

Q332 Chair: Are you still satisfied with what has happened subsequently?

Mark Russell: Indeed. At the time they absolutely offered the best advice.

Chair: With respect, Mr Russell, it does seem to me that you are demonstrating a degree of gullibility that I would have thought incompatible with the role that you had to perform in the sale of this.

Q333 Nadhim Zahawi: I will just pick up the Chairman’s last point. Presumably, it is illegal for those Chinese walls to be broken between one part of a bank that has a proprietary trading desk or traders versus the advisory side. If that is found to be true then something very bad and very illegal would have happened.

Mark Russell: Yes, that is right.

Chair: I do not think anybody would dispute that.

Q334 Nadhim Zahawi: I just felt that we needed that on the record, because I was hearing that there is an assumption in the court of public opinion that these Chinese walls were permeable and that the adviser was advising a low price, so that they can make a profit on the other side of the bank. That is not true, or you do not believe that has happened because otherwise that is highly illegal.

Mark Russell: No.

Chair: Yes, but I think it is also fair to say there is a degree of public cynicism about the effectiveness of Chinese walls.

Q335 Nadhim Zahawi: Just for clarity, I have a question to both the Minister and the Secretary of State. Did you direct Lazard and the Shareholder Executive to take a stronger negotiating position with the investors in light of this over-subscription? Did you have that conversation with them?

Vince Cable: It was not at that stage at which we were challenging the advisers over the extent of the sale and the price. Of course, it was not a negotiating situation; it was a judgment about how they would behave. In many ways, I think we are going over the same ground. There was an assessment that when we were trying to sell 600 million shares, the risks were very considerable and quite different from what they are on a day-to-day basis. We think we made that point several times.

Q336 Nadhim Zahawi: My next question is to the whole panel really, so I am happy to take all of your views. If you had taken a different strategy, been a little bit more opportunistic, and rather than focusing on long-only institutional investors whom you believed would hold the shares for a longer period, could you have achieved a higher share price at the IPO-if you had just said, "Actually, we’ll just take anybody’s money."?

Vince Cable: I have acknowledged that earlier and we have been quite open about that. The differential probably is not very large, but almost certainly if they had gone out and simply tried to get the highest bidder then they probably would have got a bit more for it. When I spoke to you before the launch, I was very clear what the objectives were. We were thinking about the longterm future of the Royal Mail. As Mr Fallon said much earlier on, our basic objective is to protect the universal service obligation. To do that, we need to have largescale private investment; to do that, we have to have a stable investor base. The focus from the very outset was making sure that we had the right kind of long-term investors. That dominated consideration, rather than just the extra bit you might have got from opportunistic traders.

Q337 Mr Bain: Can we turn to issues around risk and other factors around the IPO? UBS claims that, ideally, we would have done an IPO when the pay and pensions discussions had concluded favourably, but the feedback we got was that it was unlikely that was going to happen, even if we delayed until the following spring. Can any of you illuminate the Committee with any information about whether that advice or feedback was given by any of you?

Michael Fallon: Let me take that because I dealt directly with the CWU throughout this period and throughout the last year. We were told pretty constantly that a pay deal was on the point of being signed or was likely to be signed in the next few months. I was told that before last Christmas; I was told that in the early part of this year. The existing deal, as you know, expired on 31 March. I was then told by management that it was likely we could see a deal done immediately after the end of the year in April, in May and then June and July. It became clear to everybody involved by August that we were not in fact going to get a pay deal. It was not going to be in the interests of the CWU to come to a deal before our launch, which they were aware was becoming imminent. I think it became clear to everybody in August that we simply were not going to get a pay deal in time. Indeed, I note we still do not have a pay deal. I noticed today that the pay deal has been postponed yet again. This is a pay deal that was overdue at the end of last March. We had to factor that in, and it was an important part of the consideration.

Q338 Mr Bain: What advice did Mr Rucker or Mr Russell give to Ministers in relation to delaying possibly the timing of the IPO, given these risk factors that were out there?

Mark Russell: We always acknowledged that industrial relations was having or could have an effect on the value of the business. A judgment had to be made on whether this pay deal and the industrial relations would be settled. The danger is it would never have been settled, so a judgment had to be made by Ministers as to at what point we just accept that a pay deal probably is not going to be resolved and attempt a sale, or whether we waited further. That was a judgment made by Ministers.

Michael Fallon: Let us be clear. I met the unions throughout this period. They made very clear their complete opposition to this process, and so they were determined to block it. They had seen of previous attempts at privatisation, and they were determined to see off this one. You will recall they campaigned publicly and in Parliament to that effect.

Q339 Mr Bain: Were there any discussions that you had with your global coordinators about any possible delay, given this overarching risk of industrial action?

Michael Fallon: No. As I have said already, it was very clear to us by August that there was no point in waiting for a deal. There was no real prospect of any deal and nor was there really any interest or incentive, actually, on the side of the union to reach such an agreement before the IPO was launched.

Q340 Mr Bain: Was that decision ultimately to proceed made by you, the Secretary of State or jointly?

Michael Fallon: It was made by Ministers to proceed. It was one of the risks we had to weigh up, and it was a very considerable risk. Let me put it in these terms: Royal Mail turns over £30 million a day. Several days or a couple of weeks of strike action could have wiped out its entire profit for the year. It was a very considerable risk to this business of industrial action, and that risk, of course, still hangs over it because the deal has not yet been done.

Q341 Mr Bain: In the run-up to the proposed strike, the share price continued to rise. Does that not indicate that perhaps too much emphasis was being put on the dampening effect of the dispute on likely fluctuations in the share price?

Michael Fallon: I think you are talking about the very end of the period when the strike ballot had already been announced, but to us it was a very real risk and we had to weigh it.

Q342 Chair: Could I just intervene at that point? Yes, it had been announced and there was going to be a strike. You would have thought that was the worst possible scenario, but the share price still rose. Somebody had got their assessment of this issue wrong.

Michael Fallon: I do not agree with that. The alternative would have been to have pulled the issue and waited yet again for management and the unions to reach a deal over pay and conditions that there had been no prospect of them reaching throughout the preceding months.

Q343 Chair: What I was saying is that actually their assessment of the impact of this action on the market reaction to the valuation and the share price is what the advisers got wrong.

Michael Fallon: No, I do not accept that.

Q344 Chair: Given the fact the share price continued to rise even when it was known there would be a strike, I do not see how you can refute what is blindingly obvious?

Vince Cable: I do not think they did know there was going to be a strike. There was a threat of one, and they had to discount it accordingly.

Q345 Chair: They had already had a strike, if my memory serves me right, and if they had already had a strike then it was reasonable to assume there would be more.

Vince Cable: Yes, but strikes vary enormously in their intensity and length.

Q346 Chair: Yes, but it is reasonable for those professional advisers to take all those weightings into account. Their advice was not commensurate with the market reaction.

Vince Cable: As I referred to earlier, there are people who are now looking forward to the future price and some of the equity analysts envisage, in fairly extreme circumstances, a complete collapse of the price, partly based non-delivery in industrial action.

Chair: You will always get these extreme scenarios. The fact is that the market judged it differently from the advisers, and you pay advisers to assess the market.

Q347 Mr Bain: I am slightly confused because the prospectus said that there was no way of reliably quantifying the impact of industrial action or potential industrial action upon the share price, but the tenor of the evidence that we heard last week and what we appear to be hearing today is that there was some assessment made about how much lower the share price would be if this continuing risk of industrial action continued to be there. Is that a fair assessment of where we are? How much, in terms of that quantifying, did the global coordinators make, in terms of an assessment of what the reduction in the share price would be?

William Rucker: As Mr Cable said, the type of strike and the length of it are obviously crucial in trying to analyse the financial impact. We did our own valuation. We worked on a basis of lost revenues at £30 million a day as a consequence of strike action. When we analysed what the financial impact of that was, we obviously had to take into account the likelihood and risk of there being a prolonged strike versus a short one. That is pretty common across what the global coordinators did as well.

Vince Cable: There is an obvious point about industrial relations and the share issue. When the advisers did their global fishing, the feedback that Ministers received back was that very many of the investors were very concerned about the industrial relations record of Royal Mail and the effect this had on its long-term potential. That weighed very heavily in their judgments, and that mattered much more than short-term fluctuation in the share price.

Q348 Mr Bain: There is still a sense that this IPO went ahead without a proper assessment of the impact of the potential industrial relations position on the share price. Secretary of State, were you speaking to other Ministers in Government about this? In particular, were you speaking to the Treasury? What was the view of the Chancellor or the Chief Secretary? Did you discuss any potential delay with them, and what were their views on any such proposal?

Vince Cable: The Treasury were kept informed throughout about this process. They never indicated at any stage that they disagreed with the judgments that we were making.

Q349 Mr Bain: Were they pushing you to proceed?

Vince Cable: No, they were not pushing or pulling. They agreed with the assessment that our Department was making.

Q350 Caroline Dinenage: Secretary of State, at the risk of going over some old ground, I just want to consolidate some of your answers into one neat little package. I often describe this sort of IPO as a bit like the Grand National. You get people who would buy shares who would not normally be share buyers, in the same way that at the Grand National people bet who would not normally regard themselves as regular betters. Of course there was an element of excitement and a sharp increase in the share price, and this is something you have described as "froth". I wondered if you could, just for our purposes, put a value on what you regard the froth of this was, and when you expect it to dissipate.

Vince Cable: I am very happy that I used the word "froth". It is a good, straight AngloSaxon word that describes something that could be described in much more elaborate terms. I will perhaps refer you to this year’s winner of the Nobel Prize, Robert Shiller, who wrote a book about asset markets and particularly stock markets.

Q351 Chair: With respect, Minister, I think some taxpayers may have other Anglo-Saxon terms to describe what has happened.

Vince Cable: He described the process as "irrational exuberance". The simple point he is trying to make is that in these markets you get momentum up and down and the price of these assets/shares diverge enormously from underlying value for quite prolonged periods of time. That is a rather formal way of describing what I described as "froth".

Q352 Caroline Dinenage: When do expect that the froth will work its way back up to the top?

Vince Cable: I cannot be more precise than I was when I first spoke to you. I said that it would be useful to start reflecting on this three to six months out or possibly a year. Since I gave that suggestion to you, some of the banks came before you and said maybe you should be thinking about two years. This is a long-term process. You get wide variations in price that reflect departures from underlying realities.

Q353 Caroline Dinenage: If you removed the froth, what would you see as the true value of shares?

Vince Cable: Circumstances change. The valuation of shares reflects the information that is available at the time, and that is based on fundamentals, which are going to change. As Mark Russell said earlier, the whole purpose of this exercise was to improve the performance of this company by allowing it to invest, and that would raise its value. At some point, that will be captured in the share price. It would be utterly foolish for me to start predicting price or predicting turning points.

Michael Fallon: This was a successful transaction. We set the objective of overall value for the taxpayer. The Committee should be clear about that. We are measuring that not simply by the initial value from receipt in October, but by our ability to obtain good value again from the retained stake and our ability to protect the six-day-a-week service to 28 million addresses in this country, by ensuring that Royal Mail can continue to access the capital markets. In the end, that is how we should be assessing the overall value to the taxpayer.

Q354 Caroline Dinenage: Absolutely. I do not want to keep banging on about froth; but equally, we did take some evidence from Panmure Gordon, who did not agree with this concept at all. They said, "I do not think this is froth. These shares have been trading on the market for nearly six weeks and several hundred million shares have traded hands. Today’s value of the company is the value that the market attributes to it, and the markets generally are fairly efficient. This is not froth." What would you say about that?

Vince Cable: There are different views about this. These reflect the fact we are dealing, as I quoted earlier, with enormously different views about how markets work and what the outcomes are. There are some people who believe that stock markets are efficient, in the language of economics, and others like me who do not.

Q355 Chair: Surely, Minister, the ultimate test of how the market views it is the current price.

Vince Cable: No, I do not think that is true at all, because the current price will vary enormously from day to day.

Q356 Chair: The point is that for six weeks or so it has been trading at a huge premium on the flotation price. My most common association with froth is on the top of a pint of beer, and I would normally expect it to dissipate very quickly in order to see what substance is left. I do accept that the share price is rather different from a pint of beer, but I would have thought after six weeks that there are enough professionals and analysts in the City to take a view on this. There does seem to be a prevailing opinion that the current level of price is not froth.

Vince Cable: I would categorically refute your idea that six weeks is a sensible period to measure these elements of volatility in the market. You had people who came before you last week tell you that you should perhaps be looking at two years. There are analysts out there who are seriously advocating, on plausible scenarios, that in a year’s time the price could be one-tenth of what it is at the moment. I am not expressing a view on that because it is not my job to do so, but there is a wide range of possible outcomes.

Q357 Caroline Dinenage: With that in mind, given that the Government still retains quite a large number of shares in Royal Mail, would it not be sensible to sell off a few of them to make the maximum amount of money for the taxpayer, while there is quite a lot of froth bobbing around.

Vince Cable: That is an obvious question to ask. There is a technical problem, which is that there is a 180-day lockin period that we are obliged to observe. There is a variety of motives that will guide us when we decide when and how much of the remaining 30% to dispose of. It is intended ultimately that it would be sold, of course.

Q358 Chair: If you believe it is froth, do you believe that the price will drop?

Vince Cable: It will go up and down, and that will vary according to the circumstances of the day.

Q359 Chair: Up and down, but do you believe that there will be a longterm drop in the price?

Vince Cable: I am not predicting it, because all kinds of things will change with regards to the performance of the company in the business environment.

Q360 Chair: With respect, Minister, if you are not prepared to predict that it is going to go down in the long term, I do not see how you can assert that the current level of price is froth.

Vince Cable: I think I can assert it, because all I am describing to you, as the Nobel Prize winner did in slightly longer language, is that markets are extremely volatile and often highly irrational.

Chair: The millions and millions of people holding shares now at the current level and not selling them I would assume disagree with that view.

Q361 Mike Crockart: Can I just deal with that very slightly before I move on to other things? Share price is one indication, but it is not the only indication of what the investors regard as its long-term value. Having looked at many of the advisers, they have very different views of whether we should be buying. UBS and Goldman Sachs say sell; Panmure Gordon are saying buy; most of the rest it seems are saying hold. By and large, the market seems to be saying hold on to the shares, but there is a vast difference in what they believe the long-term likely share price will be, even those who are saying hold. They seem to disagree massively about what the long-term share price will be: anything from 400p up to 570p. Is this just a factor of actually having got such a large number of longterm investors in who are going to hold on to it regardless of what the share price is actually doing, because what they are after is the dividends?

Vince Cable: That is a fair assessment. Indeed, when the assessments were made before the launch, comparative dividend yield was an absolutely critical factor. The size of the estimated dividend had a big impact on the assessments of different people out there-equity analysts and others-about what the share price should be, so you are absolutely right. Ultimately, this is driven by fundamentals and issues that surface today about the lack of progress in parcel sales and declining letter sales; those are the underlying drivers the business that will eventually be reflected in the price, but are not necessarily on a day-to-day basis.

Q362 Mike Crockart: My next question relates to that, and I think you have probably already answered it earlier on in the session. Regardless of everything we have just said about share price not being the major thing, if the share price remains at this level, or even increases over the long term, will you be able to claw back performance payments to the global co-ordinators? I think you have been pretty clear that it is discretionary.

Vince Cable: We have said that there is a discretionary bonus and we could decline to pay it; but as I said, the tests of whether we would pay it and when we would pay it are not related to that one single factor.

Q363 Mike Crockart: If I can turn to the issue of discounting, I particularly direct this to Lazard. We questioned the banks about the level of discounting that would normally be expected in an IPO of this size, because obviously you want it to be a successful sale. It was not wide, but there was a variety of answers they gave of anything from 5% to 15%. What figure would you put on the level of discounting that you would expect in an IPO of this sort?

William Rucker: We would expect the normal IPO discount to be in the range of 5% to 10%.

Q364 Mike Crockart: Given what has happened to the share price, do you think that therefore indicates the initial price was too low? If you expected a 10% discount, then surely you would expect the share price now to be sitting at the high 300s or maybe 400p, top.

William Rucker: The 330p price was set at the price we believed was the maximum price achievable to sell 600 million shares at a time. There is no evidence that that was incorrect. When we look at what we could have achieved at that time, when we looked at the order book and what the institutions were saying, there was no clear ability to go above 330p at that time.

Q365 Mike Crockart: Was the level of discounting you talked about the advice that you and Mr Russell gave to Ministers?

William Rucker: When we talk about a normal IPO discount, it is important to also remember that this is not a normal IPO. This is a company that only went into profit in the last 18 months. It is a company on very thin margins on very low turnover, where small changes in assumptions can come up with very different results. Our advice to the Shareholder Executive was that this stock could be very volatile. The volatility could have been up and down. If the union had gone on strike for a week the day after we floated this business, I suspect we would have tested a price below 330p. As it was, we have obviously tested a price significantly north of that.

Q366 Mike Crockart: I would press you a little bit further on that, though. You did expect volatility and we have certainly had volatility, but only in one direction. That volatility was significantly greater than the level of discounting that you gave as advice to Ministers.

William Rucker: There are two aspects. One is the IPO discount. Shareholders are buying this on the basis that they are going to make a profit. Therefore, most people think the cost of getting that done is 5% to 10%, in terms of the initial IPO discount. The subsequent share price reaction is based on a host of other things. In the short term, share prices tend to be a popularity contest; in the long term, they tend to be much more an assessment of the company’s achievements. When we talk about the long term here, given the nature of this company, I think we need to be looking quite a long way out to assess that.

Q367 Mike Crockart: Can I ask the same or a similar question to the Minister and the Secretary of State? What type of advice would you be giving on the level of discount that you would have to apply to get these 600 million shares out into the public?

Michael Fallon: This was a huge issue. This was the first privatisation for some 13 years. It was one of the biggest issues the Exchange has seen for a long time. We certainly knew that we would have to offer a discount. We did offer a discount. This was a successful transaction; it was over-subscribed. If it had been under-subscribed, it would have flopped. I would have been far less comfortable sitting here trying to explain why 750,000 people, including 150,000 staff, were sitting on losses.

Q368 Chair: Minister, that is somewhat disingenuous because, when it comes down to it, if you sell something for a very low price, it is not difficult to get a lot of people prepared to buy it.

Michael Fallon: We do not yet know whether the price was too low. What was really important here was to protect the six-day-a-week service and minimise the risk to the taxpayer that the taxpayer would have had to step in and finance this company if the price had flopped and the company had been unable to return to the capital markets, like Facebook. The last Government, Mr Bailey, if you will recall, had to spend several billion pounds sorting out Railtrack. I did not want that to happen to Royal Mail.

Chair: Red herrings. The fact is the market has judged this differently from both the Government assessment and the assessment of the advisers.

Q369 Mike Crockart: Mr Rucker is really drawing a distinction between the discounting and the other factors that cause the volatility. Going back to your comments about froth, would you say that basically the discounting is one thing and the froth is actually the other volatility? Do you think there is a direct correlation between the level of discount that was given and the volatility that that necessarily then caused?

Vince Cable: There was another factor, which I did refer to earlier, that there were groups of investors with very radically different views of the long-term prospects of the company. I do not know whether you want to incorporate that in my all-embracing phrase called "froth" or something else, but this is at least partly what has been influencing the market behaviour in the last few weeks.

Q370 Chair: Minister, could I just conclude by asking you a couple of questions? First of all, you quite laudably wanted to ensure that investment in Royal Mail was in the hands of responsible long-term investors. Will you be doing any exercise in the future, such as in a year’s time, to assess whether that outcome was achieved?

Vince Cable: Yes, we will be doing that. My technical colleagues in the Shareholder Executive will do it, not least because we have a substantial state shareholding and we will want to track the progress of that because we have further decisions to make on it.

Q371 Chair: That is helpful to know, and we will look at that in due course. Could I just put this to you, Minister? I think what I am saying reasonably captures the public perception of this deal. If you were selling a house for £330,000, you took valuations on it at that level, it was sold at £330,000 and within a matter of a couple of weeks the purchaser of that house sold it for £500,000 or £550,000, and then you found out that the valuer not only got two sets of commissions, but actually made money on that second process, what would your opinion be of that transaction?

Vince Cable: I would question your analogy, because the daily trading is like taking out individual bricks from the house and selling them separately. That is what has caused the disparity between the big sale at the beginning and the daily trading. I think the whole analogy explains much of what has happened and actually rather vindicates what we have done.

Q372 Chair: I think the public might have difficulty understanding your analogy of taking the bricks out. The fact remains that the very people who valued it at a price at which it was sold have cashed in on the subsequent market activity. Do you not think that poses a whole series of questions about the process of the sale of this particular asset?

Vince Cable: I think there was a very good exchange earlier with Nadhim Zahawi that got to the bottom of that. Like you, I am a bit cynical about some of things that happen in the financial markets, but the implication of your question is that the leading financial institutions in the UK are all acting criminally. No doubt, there are some from time to time who do that, but we cannot base the whole policy of Government on the assumption that we are dealing with criminals.

Q373 Chair: Those were your words, not mine. The fact remains that a very large number of those financial institutions that seem to have very close relationships with each other have done very well out of the process. The taxpayer has not. Do you not think, as John Major does, that it is a reason for an inquiry?

Vince Cable: Absolutely not. We think it was a good process for the taxpayer, bearing in mind the set of objectives that we set at the very beginning, which were that the value for money is partly dependent on the offer price, it is partly dependent on the continuing value of the state share, and it is partly dependent on what happens to the company. A few minutes ago, Mr Fallon made a very trenchant point: that if the company is not able to invest successfully, you could be left with a serious casualty. When we take all those things together, I think the conclusion when people have settled down will be that this has actually been a very professional, well-managed and successful operation.

Q374 Chair: The fact is that those people employed to make an assessment of the long-term viability of that company, and with it the level of profitability and its value, appear to have got it at a completely different level than the current market would seem. The taxpayer has lost out as a result of that.

Vince Cable: We would categorically refute that the taxpayer has lost out.

Michael Fallon: The taxpayer has not lost anything. It is far too early to make that kind of judgment. As we have made clear throughout these proceedings, the value of this sale will be assessed in several months’ or a year’s time, and I think we will look back on this sale as a successful transaction that had the best prospect of giving Royal Mail a commercial future that minimised any risk to the taxpayer of having to bail it out.

Q375 Chair: What you are saying is effectively that the price it sold at was the right one. If you continue that line of argument then you would reasonably anticipate that in the long term that price would drop to within a reasonable reach of the initial flotation price. You have not been prepared to do that, and I can only assume that the reason for that is you expect the long-term price to be considerably higher, probably at much the same level as it is now.

Vince Cable: We are not willing to predict because we do not know what the future holds. We do not know what the business environment will be like; we do not know what the industrial relations situation will be like; and we do not know what the performance of the company is going to be like.

Q376 Chair: You can say that about almost any company when you look that far.

Vince Cable: Indeed.

Michael Fallon: Let us be clear. We could not have got a higher price in October for the 600 million shares that we were selling. There are 1 million shares being traded daily at the moment. We could not have got a higher price for the 600 million shares. That was made clear to us by our advisers at that point. At that price level, there were already some institutions walking away from this issue.

Q377 Chair: Even UBS in fact said differently from that-from your advisers’ advice.

Michael Fallon: Chairman, we have had six serious pieces of research on this company since the flotation. As the Secretary of State has already said, they put wildly different valuations on it. Three of them are well below £5; one is at only £4; one of them indeed indicates a range of 50p to 1,000p.

Q378 Chair: But there were others who got it right, and unfortunately they were not the advisers.

Vince Cable: What do you mean "got it right"?

Michael Fallon: There are six valuations-six serious research studies that have been done-and three of them have the price at over £4, not £5, and those are target prices. Those are not today’s prices. Those are the target prices.

Q379 Chair: You sold at 330p.

Michael Fallon: These are target prices of where they expect the shares to be in a year’s time or so.

Q380 Nadhim Zahawi: Just for the benefit of the Committee, Minister, post-IPO is when analysts begin to report; that is what you are saying to us-i.e. there are six analyst reports that have come out, and the target is anywhere between a 90% price reduction to prices at 500p, 400p and so on. Is that what you are saying, because there is a slight confusion?

Michael Fallon: Yes. What is important about these analyst reports is not what they are saying about the price now. It is where they expect the price to end up at one year or so out. Nomura, for example, think it will only get to £4 in a year’s time.

Q381 Nadhim Zahawi: And that depends on management performance, execution of strategy and all sorts of other factors, such as competition and so on.

Michael Fallon: That is right, exactly.

Q382 Chair: The fact is we were selling shares now. The market price has been consistently higher for a time, and the taxpayer did not obtain any benefit. I will rephrase that: the taxpayer did not obtain the maximum benefit from it. That is the situation.

Vince Cable: We just categorically refute your analysis, Chairman.

Chair: Shall we say the Committee will come to deliberations, and then we will do our report in due course, which will assess our opinion? On that note, Minister, can I thank you? It has been a very thorough session, and I do appreciate your willingness to come before us to justify this. Thank you very much.

[1] Note by Witness: In relation to the weighting given to valuation, Mark Russell stated that “It got a weighting of probably about 10%”. The weighting given to valuation was actually 5%.


Prepared 4th September 2014