3.2 Throughout the procurement the Department was aware that Mapeley was a new company which had put in a low bid to win future business. It priced its bid based on potential returns from increases in the value of properties transferred, rather than profits from managing the estate. In November 2001 Mapeley told the Department it faced serious cash flow problems as a result of errors in the pricing of its bid, variations made to the contract since contract signature, and claims arising out of the procurement process, and asked for additional money. Following favourable movements in the commercial property market, the injection of further funds by its shareholders, and settlement of an outstanding claim relating to specification errors in the original information and changes to service requirements, Mapeley's financial position improved. The Mapeley Group has now secured other lines of business including a 20-year contract with Abbey National (now Abbey) and a contract with the Identity and Passport Service. In 2004 it also began to build its own portfolio of properties (Appendix 3).
3.3 We previously concluded that Mapeley's pricing and business model was such that its finances would continue to be finely-balanced for the foreseeable future, and that it was essential for the Department to undertake good risk management to secure the full value of the deal. Our analysis of the 2006 refinancing cash flow model suggests that operating profits from the contract have been minimal, and will continue to be low over the life of the contract. Mapeley needs to supplement operational cash flows with disposals of surplus freeholds and through making deals on leases.
3.4 The economic slowdown that began in 2007 affects Mapeley in several ways:
• Slowdown in the property market: the value of commercial property has fallen, reducing the opportunity for Mapeley to benefit from selling freehold property vacated by the Department and affecting the value of assets held. The value of the STEPS portfolio decreased by nine per cent between December 2007 and December 2008 to approximately £470 million.13
• Difficulty re-letting vacated properties: to maintain its income Mapeley needs to re-let vacated buildings, which is more difficult in the current climate, particularly for partially vacated properties and properties in more remote areas. As part of its loan arrangements with banks, Mapeley is required to maintain certain levels of income in relation to interest costs. The Department's plans to exit buildings could adversely affect Mapeley's income levels.
• Difficulties obtaining debt finance: the collapse of the credit market in 2008 affects Mapeley's opportunities to refinance debt. This has not affected the part of the group that owns the contract, which has no short-term refinancing requirements and its loan is secured on the freehold property. However, it has affected the Mapeley Group, which had a short-term loan fall due in April 2009 and could not get new debt to cover it. It raised cash to pay off the loan through the issue of 20 per cent convertible bonds underwritten by Fortress. As a result, Fortress owns more than 75 per cent of the company and it de-listed Mapeley Limited from the London Stock Exchange in April 2009.
• Economics of the deal: the combined effects of decreasing revenue flows and asset values may affect the long term profitability of the deal. The Department does not have a good understanding of the profitability of the deal, the Mapeley Group, or the benefits realised over the contract life.
3.5 The contract contains clauses that protect the Department in the event of Mapeley default, including rights to continue occupying buildings and to take over the service contract. However, a default would have cost implications for the Department. In the first year, it might have to cover unpaid rents, utilities, and suppliers. These one-off payments could total £40-110 million. The Department would incur substantial additional ongoing costs on estate management and administration, for negotiations with landlords for rent, maintenance, managing tenants, and increased rent liabilities.
3.6 The arrangements by which the Department transferred leases to Mapeley contribute to the Department's liabilities in the event of Mapeley default. The Department recognised that landlords would be unlikely to accept Mapeley as tenant, as a Government tenant increases the value of a property by providing a low risk income stream. The Department virtually assigned its leases to Mapeley through the contract, meaning that the Department remains the legal tenant but granted Mapeley power of attorney to act on its behalf (a concept used in the PRIME deal).14 The contract requires Mapeley to endeavour to re-negotiate leases into its own name, but it has been able to do so in a limited number of cases. In the event of Mapeley default, the virtual assignments cease to exist and, as the legal tenant, the Department would resume responsibility for the leases, including areas of the estate remaining in its name which it has already vacated. If Mapeley had sublet vacated properties the Department would have tenants to manage, but if property remains vacant the Department would be liable for rental costs. Failure of the contract would also mean the Department would lose the opportunity to vacate a significant part of the estate at minimal costs, which would undermine its ability to achieve efficiency savings targets (Part 2).
3.7 The Department's liabilities would also be higher because of lease extensions Mapeley has negotiated with landlords. Mapeley entered around 70 deals, mostly during 2003 and 2004, and obtained an up-front payment in exchange for lease extensions, and in some cases increased rents. Landlords are keen to enter these deals as they obtain the benefit of a valuable Government tenant for a longer period. In December 2002 Mapeley estimated the total value of these deals would be £70 million on 131 properties. It notified the Department of each deal but it does not have to provide details of the payments received, and Mapeley has not confirmed the total amount realised. Such arrangements are normal for property companies and were part of Mapeley's bid model. Mapeley entered into these arrangements on buildings that it considered the Department would require for a significant period. Having a longer lease protects Mapeley from the risk of landlords refusing to renew leases, in which case it would have to arrange alternative accommodation for the Department. In many cases Mapeley negotiated flexible re-letting provisions within its lease with the landlord, reducing its risk if the Department vacates the building.
3.8 These property deals are conceptually similar to refinancing deals, where contractors refinance their debt on better terms resulting in a benefit for the contractor and potentially increased termination liabilities for the department. HM Treasury guidance is that departments should share in gains realised on refinancing, but there is no similar guidance for these types of deals.
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13 Mapeley also sold some properties during the period.
14 A court decision (Natwest versus Clarence House 23 January 2009) has ruled that, in the absence of consent from the landlord, virtually assigned leases may be in breach of the property lease and that damages may be payable. The Department is currently assessing the likely impact of the decision.