THE PRIVATISATION OF QINETIQ
Publication of the Committee's 24th Report, Session 2007-08
Edward Leigh MP, Chairman of the Committee of Public Accounts, today said:
"The privatisation of Qinetiq has been successful in protecting the viability of this business of strategic importance to UK defence interests. But the MOD conducted the deal like an innocent at a table of cardsharps, with the taxpayer the fall guy losing out on nearly £100 million.
"The MOD pushed ahead with the sale at the worst possible time and then weakened the competition among bidders by eliminating them at too early a stage. Carlyle was appointed preferred bidder with major price sensitive issues still unresolved, leaving that firm with an unbeatable hand in subsequent negotiations about the value of Qinetiq. And then the MOD even refunded Carlyle's bid costs.
"The senior public servants managing Qinetiq behaved dishonourably. They sold the idea to the MOD of privatising the business without explaining they stood to benefit, a serious conflict of interest, and later negotiated their own incentive scheme with Carlyle before that firm was appointed preferred bidder. The design of the scheme contributed towards the top ten managers receiving a return on their own investment of 200 times. This is nothing less than profiteering at the expense of the taxpayer. Never again should public servants be permitted to pursue such a self-interested stratagem.
"Their behaviour does not fill me with confidence that Qinetiq can be relied upon to advise the MOD on what military equipment to buy, if Qinetiq is increasingly in the game of supplying that equipment. The Department must be vigilant to guarantee the impartiality of Qinetiq's advice."
Mr Leigh was speaking as the Committee published its 24th Report of this Session which, on the basis of evidence from the Ministry of Defence, Shareholder Executive and the Chairman of QinetiQ, examined the process by which QinetiQ had been privatised and the lessons that can be learned for future privatisations.
QinetiQ was created out of the Defence Evaluation and Research Agency (DERA) in 2001 as a means of addressing the declining defence research budget, which threatened DERA's ability to maintain its capability. As well as carrying out research for the Ministry of Defence (the Department), QinetiQ advises the Department on the procurement of equipment and manages the testing and evaluation of this equipment.
QinetiQ was privatised in two stages: the sale of a minority stake in the business to the private equity firm the Carlyle Group (Carlyle) in 2003; and a flotation on the London Stock Exchange in 2006. The Department conducted the flotation well in a strong market and used the experience and expertise of the Shareholder Executive to good effect. There were however weaknesses in the 2003 sale process, and the National Audit Office have estimated that the taxpayer could have received £90 million more from the privatisation.
The Department began the competition for a strategic partner when market conditions were poor and before the terms of QinetiQ's most significant contract had been agreed. It also eliminated the only trade bidder at a very early stage. These decisions weakened the competitive process for selecting a strategic partner, and Carlyle negotiated a £55 million reduction in the value of the business after they had been appointed preferred bidder. The Department nevertheless agreed to sell Carlyle 2.5% more of QinetiQ than they had specified in their bid.
The Department failed to manage specific risks relating to the management incentive scheme established as part of the privatisation. The Department relied on Carlyle to design the incentive scheme but did not put safeguards in place to protect its interests, nor did it take specific professional advice. QinetiQ's management were consequently able to influence the design of their incentives before Carlyle were appointed preferred bidder. At the date of the flotation the top 10 managers held shares worth £107 million for an investment of just £540,000.
The privatisation of QinetiQ was successful in protecting the viability of a business of strategic importance to UK defence interests. QinetiQ has balanced the decline in the research budget with revenue from other sources and has successfully expanded into the US defence market. There are, however, risks to the long-term value for money of the privatisation arising from the Department's ongoing relationship with QinetiQ. The Department envisaged that the privatisation would deliver reduced prices and improved services and will need to develop robust benchmarks to ensure it realises this aspiration. The firewalls intended to protect the independence of QinetiQ's advice require active monitoring to ensure they are operating effectively.