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23 Nov 07. The National Audit Office reported to day on the Value for Money Report on the privatisation of QinetiQ.

The report examined whether the privatisation of the defence technology business QinetiQ was a good deal for the taxpayer. The privatisation was carried out in two stages – the sale of 37.5 per cent of the business in February 2003 (33.8 per cent to the Carlyle Group and 3.7 per cent to management and employees). The aim of this was to help develop the business ahead of a flotation on the London Stock Exchange, which took place in February 2006. The privatisation has generated net proceeds of £576m and the Ministry of Defence (the Department) still holds a 19 per cent stake in the business worth £235m as at 31 October 2007

QinetiQ has a vital role in carrying out research and advising the Department on the development and procurement of equipment as well as managing the testing and evaluation of this equipment. It also engages in wider commercial activity and since the privatisation has expanded into the US. It was created out of the Defence Evaluation and Research Agency (DERA) in 2001 specifically to allow the majority of DERA’s activities to be privatised. To protect defence interests the most sensitive aspects of DERA’s business were kept in the public sector and a system – the Compliance Regime – was put in place to protect the independence of QinetiQ’s advice to the Department once it had become a commercial supplier.

The decision to split DERA followed wide consultation on the form of the privatisation. Implementing the split was challenging and carried out to a tight timetable. The Department handled this process well. Although the Department did more than was legally required and there have been no legal challenges to date, there were complaints from some elements of the defence industry about the handling of their intellectual property.

The decision to sell a minority stake in the business to a strategic partner, rather than float the business on the Stock Exchange soon after incorporation, was taken in early 2002 in the light of poor market conditions and the absence of a commercial track record. Nevertheless, the competition for a strategic partner began in March 2002 even though the market was poor and the commercial terms of the important Long Term Partnering Agreement (the LTPA) had not yet been agreed. The Department considered that a delay to the privatisation process could have had an adverse impact on long term value by undermining staff morale, damaging customer relationships and restricting QinetiQ’s commercial freedom at a key stage in its development. In recognition that QinetiQ was hard to value and that the timing of the sale would have an effect on proceeds, the Department decided to sell only a minority of shares, in line with relevant recommendations from the Public Accounts Committee and National Audit Office.

Achieving a good price in a sale relies on there being strong competition. Twelve investors were selected to participate in the competition and four wereshortlisted. The difficult timing and complexity of QinetiQ’s business increased the market’s perception of risk and contributed to there being only two compliant bids, in July 2002, both from private equity firms. The Carlyle Group were appointed ‘preferred bidder’ in September 2002, before the detailed terms of the LTPA had been agreed. The sale to Carlyle was signed in December 2002 and completed in February 2003, when the LTPA was signed.

After Carlyle were appointed preferred bidder they negotiated a reduction in the value of the business of £55m, £25m relating to the pension fund deficit and £30m relating to the value of the LTPA. Our analysis shows estimated cash proceeds in the final bid falling by £32m to £155m in the final deal. This was a result of a number of changes including the sale of 2.5 per cent more of the shares than initiall

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