4 Managing the Sale Process

20.  Private equity transactions are complex, creating risks for Government Departments to manage. Private equity firms are adept at negotiating and are strongly incentivised to pay the lowest possible price for their investment.50 Government departments require the right skills to handle these negotiations.51 The Shareholder Executive was not formed until after the sale to Carlyle had been completed but will be able to advise departments in future deals.

21.  Carlyle's final bid placed an enterprise value of £374 million on QinetiQ but contained significant conditionality. In particular it made assumptions about the value of the Long Term Partnering Agreement, which had not been agreed at that time. It was also subject to the amount of debt in the business, including the pension fund deficit. Neither of these price sensitive factors were settled before Carlyle were appointed preferred bidder, which enabled them to negotiate a reduction of £55 million in the value they placed on QinetiQ.52

22.  QinetiQ had a projected pension fund deficit at the time of the flotation. The Government Actuary's Department had advised that the deficit could be estimated in the range £0-£70 million. Carlyle negotiated an immediate reduction in the value they placed on QinetiQ of £25 million in respect of QinetiQ's pension fund deficit. The Department also committed to pay £45 million into QinetiQ's pension fund if the deficit remained at the time of the flotation.53 This negotiation took place after Carlyle had been appointed preferred bidder and other bidders were not asked how they would value and treat the pension scheme deficit.54

23.  In describing the Long Term Partnering Agreement to bidders the Department made clear that it incorporated two strands of revenue: revenue to maintain and improve test and evaluation facilities and revenue for the provision of individual tests.55 Carlyle negotiated a £30 million reduction in the value they placed on QinetiQ citing a fall in the value of the Long Term Partnering Agreement but did not include the significant value attached to the revenue relating to individual tests in their calculations.56 At the time of the sale to Carlyle this revenue was predicted to be between £50 million and £60 million a year but in 2007 it amounted to £94 million.57

24.  The Department had asked potential strategic partners to bid on the basis of purchasing 35% of the business.58 During negotiations with Carlyle, however, the Department agreed to sell an additional 2.5% of QinetiQ. It received £3 million proceeds for this additional equity, which was eventually worth £27 million at the time of the 2006 flotation.59 The Department could therefore have received £24 million more from the privatisation by adhering to the terms of Carlyle's bid. This calculation assumes that the equity offered to staff under the co-investment scheme comes entirely out of the 35% of equity sold, which is consistent with the deal agreed. Figure 4 shows the value each shareholder would have received at the flotation if the Department had sold 35% of QinetiQ.

Figure 4: Shareholder returns at the flotation if the Department sold 35% of QinetiQ

Source: National Audit Office analysis

25.  At the completion of the deal Carlyle's bid costs of £16 million were fully reimbursed by QinetiQ. This practice is common in private equity deals where the private equity firm is buying 100% of the business. In the QinetiQ privatisation the Department retained a majority stake in the business and therefore suffered a fall in the value of its investment when QinetiQ reimbursed Carlyle. The Department had made clear to all bidders that bid costs would not be reimbursed. It did not verify or validate any of these costs.61

26.  The privatisation has to date generated £576 million in proceeds for the taxpayer, net of costs. The Department still holds a 19.3% shareholding in the business worth £227 million as at 17 December 2007.62 Although this is a significant amount of money, the Department could have generated more from the privatisation. Carlyle's bid was for the purchase of 35% of the business and originally offered management and staff 10% of the equity. By not selling Carlyle the additional 2.5% of the business, restricting the proportion of equity available to management and staff to 10% and then stripping out the impact of the improvement in the market from the returns of senior management the Department's shares would have been worth £96 million more than under the actual deal. The Department would have received £3 million less from the sale by selling only 35% and would therefore have received £93 million more.63 The impact of these changes on the value each shareholder received at the flotation is shown in Figure 5.

Figure 5: The Department could have received £93 million more from the privatisation

Source: National Audit Office analysis

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50  Q 98

51  Qq 15, 95

52  C&AG's Report, para 2.25

53  C&AG's Report, para 2.29

54  Qq 99-104

55  C&AG's Report, para 2.27

56  Q 260

57  QinetiQ Annual Report and Accounts 2007

58  C&AG's Report, para 2.11

59  Q 81

60  The value of the Department's shares in figure 4 is £27 million higher than under the agreed deal but it would have received £3 million less in proceeds from the sale.

61  Qq 36, 80, 119

62  C&AG's Report, para 1

63  This figure is not the sum of the extra proceeds generated under the three scenarios in figures 2, 3 and 4 due to interactions between the assumptions.