2.27 When the Department began the sale process in March 2002, the long-term arrangements for QinetiQ's provision of test and evaluation services had not been finalised. The Department included draft terms and conditions of the 25-year contract known as the Long Term Partnering Agreement (LTPA) in the information memorandum in order to mitigate the risk of uncertainty affecting the sale process; these terms incorporated both tasking and non-tasking revenue (see Box 1). The financial projections used in the information memorandum did not form part of the agreed outline terms of the LTPA at that time. To avoid a potential conflict of interest the LTPA was negotiated between the Department's customer group, which was distinct from the team managing the sale to a strategic partner, and QinetiQ, in tandem with the sale, and was signed at the end of February 2003. Carlyle's final bid was conditional upon the LTPA delivering £30 million EBITDA23 per year. The detailed assumptions underlying this condition were not known. Subsequently, on the basis of the condition, Carlyle tried to negotiate a £50 million reduction in the value of their bid. This was eventually agreed at £30 million24 and the sale of an additional 2.5 per cent of equity (see paragraph 2.32).
2.28 The Department sought advice on the proposed value reduction from UBS Warburg. In preparing its advice UBS Warburg compared the cash flows of the LTPA from an agreed financial model with the conditional cash flows in Carlyle's bid. The financial model was developed jointly by QinetiQ and the Department's customer group. It represented the contractual payments for maintaining and operating the facilities and did not therefore incorporate tasking revenue. It also reflected the expected cash flow profile, including planned capital expenditure, agreed between QinetiQ and the Department's customer group, although not all the capital expenditure had been contractually committed (full details are given in Appendix 5). Based on the comparison UBS Warburg concluded that the value of the cash flows had declined and that a reduction of £30 million was justified. UBS Warburg did not advocate a negotiation based on detailed valuation of the contract as the negotiation covered a range of issues, of which the LTPA was the most significant. We have reviewed the negotiations and consider that the £30million reduction in value was not sufficiently justified and that the commercial value of the LTPA was not fully understood by the Department (see Appendix 5). The
BOX 1 |
The Long Term Partnering Agreement This agreement between the Department and QinetiQ was signed in February 2003. It is a 25-year contract under which QinetiQ operates facilities to provide test and evaluation services for the Department and other customers. In total it is worth up to £5.6 billion in revenue to QinetiQ over the 25years. It comprises two revenue streams: non-tasking revenue that is centrally funded by the Department, and tasking revenue that is contractually distinct and funded by individual customers. ■ Non-tasking revenue covers the fixed costs of maintaining and operating the facilities (including associated infrastructure). The non-tasking revenue is contractually guaranteed and defined in the financial model. ■ Tasking revenue is payable by the customers and covers the direct cost of conducting each trial or test. It is not contractually guaranteed. Previously, customers were charged a portion of the total fixed costs of operating all the facilities, which made each trial or test extremely expensive. This deterred customers from using the ranges which had led to prolonged underinvestment in the assets. The Department believed that the new funding arrangements would act as a powerful incentive for customers to use the QinetiQ facilities rather than other UK or overseas facilities. The contract incorporates review points every five years; at these points the costs of delivering the services over the next five years are renegotiated and a minimum 'step down' in price agreed. |
Department and UBS Warburg disagree with this assertion. They consider that this was a challenging commercial negotiation and do not believe that a different approach would have yielded greater proceeds.
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23 Earnings Before Interest, Tax, Depreciation and Amortisation.
24 Equivalent to an £11 million reduction in the value received by the taxpayer (see paragraph 2.25).