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Buy low sell high

Friday, November 23rd, 2007 at 1:18 pm Written by:

I am not an accountant. Not many of us down among the non-owning-sharedealing-banking classes are. So there’s no one looking out for our interests when people at the top loot the public treasury and saddle the state with highly ill-conceived projects that are nevertheless very profitable.

Remember, it’s about money. And nothing else. If they get their hands on truck-load of snake-oil, it doesn’t matter what it can and cannot cure, they will do whatever it takes to sell it. Even if it means we have to build a police state.

What I’m saying is that the money-grubbing going on over the sale of QinetiQ matters. It’s a sign of what our politics is all about. QinetiQ is about weapons, programmable CCTV cameras, ID equipment, and dumb-ass airplane seat detectors that are supposed to tell from the shiftiness of your body whether you are a terrorist or already dead. They’ll think of something. It could be worse. If they were invested in a medical company, we we could have been infected with smallpox vaccines, as opposed to an invasive infestation of security cameras and fingerprinting equipment. After some wikipedia background hacking, it was good to see how the current CEO connected back to previous knowledge I had about a PR firm whose New Zealand office battled for the eradication of old growth forests, as documented in this book, which made quite an impression on me.

So what’s the deal here? The sale of these valuable state assets — whose value becomes much greater after the snake-oil sale campaign is in full swing — to an extremely well-connected business was transparently undervalued. Disappointingly, the Government Ministers have had a habit of covering it up. They mess with your mind because all the evidence of serious corruption gets inverted. No wonder we never understand. You see, the three-fold increase in value shortly after sale is not because someone we were ripped off; it’s merely a sign of how excellent the directors were at managing the company! The bigger the discrepancy, the better their qualities! It’s like seeing someone in a stolen Jaguar, and concluding that, dang, he must get paid well for his job. Let’s hire him. The Secretary of State for Bombing told us two years ago that the National Audit Office decision to investigate the situation was purely routine. No one had reason to suspect anything. Why do politicians even bother to lie like that?

Luckily, the NAO report, which got published today, was useless. It’s all misleading numbers, confusing statements, technical history, and no account anywhere that people had lied.

My favourite moment is on page 17:

1.21 The opening balance sheet of QinetiQ is set out in Figure 5 overleaf. This was prepared in line with accepted practice and as such the value of shares in joint ventures that were commercially exploiting intellectual property did not reflect their potential to generate future revenue. The Department held share capital with a book value of £346 million and long-term loans amounting to £156 million.

And here’s the table from Figure 5

Tangible fixed assets: £548million
Current assets: £240million
Current liabilities: -£230million
Provisions: -£56million
Long term loans: -£156million

Total share capital: £346million

As I said, I am not an accountant, but I think most people who read paragraph 1.21 would have subtracted the £156million from £346million and imagined a net value of £190million, although the £156million had already been taken away once to get that number.

Boring, isn’t it?

Numbers and accounts are so naturally confusing that it’s relatively easy to put people off from understanding them if you want to. Not only was the £346million an under-valuation (excluding all the inventions in the pipeline), those who were arranging the purchase wanted to sell it even cheaper than that.

But first, a few words on this value. The deal was sweetened by the transfer of a lot of government land that had been obtained by the Ministry of Defence during the second world war. The net worth is easy to guess. In 2002, the MoD was willing to divulge some figures when asked in Parliament. By 2006, when asked about this formerly publically owned land, the Secretary of State told whoever asked to go jump in a lake, by giving the corporate address of the CEO, knowing that he was going to say that it was none of anyone’s business.

But of this under-estimated value, the civil-servants concerned were determined to ensure that their future benefactors (the Carlysle Group) was not going to pay a fair price even for this. Some MPs noticed: Carlysle was paying £42million for 31% of something which accountants had valued at more than £300million. In a Select Committee meeting on 21 January 2003, we read:

Gerald Howarth MP: Mr Youngkin told us a moment ago, as you heard, that his group is paying £42 million for a third of the equity. If I can ask you the question that they were not able to persuade us of the answer to. If the net assets of the company are £312 million, that is net of liabilities, which presumably includes the £140 million owed to you under those loan notes, therefore the free capital, if you like, is £312 million, can you explain to us as laymen why is Carlyle paying £42 million for a third stake in a company which has a capital value net of debt of £312 million?

Colin Balmer: Can I take this question in two parts. First, Carlyle will be paying us in the order of £40million, as I said the exact figure will depend on the completion accounts, but they are also allowing us to be repaid by the company the debt that I have described, so Carlyle are in effect paying us £140 million to £150 million but they are not having to provide cash from their own shareholders for all of that. The company will be worth less because we have taken our money out. As regards the balance sheet value of the assets—

Gerald Howarth MP I am sorry, I am going to stop you there because they will not have taken their money out because the figure of £312 million is net of the debt, the liabilities are in the accounts at £251 million as creditors falling due in one year, so that is already accounted for, is it not? We know that the company has been valued at £500 million but after you deduct the liabilities, of which the £140 million to £150 million due to you in the loan notes is a part, the net result is that we have still got assets on the books of £300 million where you have got two-thirds of the action and Carlyle, plus the employees with their, in my view, rather small stake in privatisation, they have got the rest. Therefore, they have paid £42 million for assets worth £117 million.

Colin Balmer The asset values on the books are recorded in the company’s accounts. From the figures you have correctly quoted and as was disclosed by the Minister in a Parliamentary question the net asset value is £312.5 million as at 31 March last year, those are the closing accounts for the company at that stage. The directors of the company made clear in a note to those accounts that the valuation of the assets was done on a depreciated replacement cost basis, a perfectly normal process, which is not the open market value of the assets. Had an attempt been made to assess the open market value of those assets the director’s view was that the assets would have been worth substantially less than that, by more than £100 million. The view at that point in time of the net assets of the company was £312.5 million less a substantial amount if you tried to sell the assets in the market place. That is the asset position. What Carlyle have done—

Gerald Howarth MP That is phoney accounting, is it not?

Colin Balmer: No, that is perfectly normal accounting and those were the notes disclosed by the company in its accounts and passed by their auditors. The figure for the opening balance sheet that year had previously been agreed by the National Audit Office but the closing accounts were agreed by the company’s new auditors KPMG. The figures have all passed normal audit processes. The question about what Carlyle or whoever we sold these shares to should pay is a different question. Clearly an asset value is one consideration that one would take into account. Other things to take into account, and this will clearly weigh very heavily with Carlyle are: What happens to this company in the future? What will the future performance be? What future requirements are there going to be for capital investment? What future liabilities might arise in other circumstances and what cash can the asset base be expected to generate in normal trading? The amount of cash that the company should generate over a longer period discounted back to today’s value is a more normal way of valuing companies at a point of sale and our own advisers suggested that is probably how Carlyle or anybody else would have valued the company. I do not know what value Carlyle did put on any of those calculations, that is their business, they simply gave me the enterprise value at a figure of about £500 million on the assumption there was neither debt or cash in the company. The underlying value is about £500 million. Clearly there was a mixture of debt and overdraft and cash holding so at any point in time the working capital movements would mean that the actual value would be less or more than £500 million, probably less than £500 million taking account of those liabilities. If you work that calculation through and you take account of what we think the working capital balance will be and we take account of the debt the company owes that is how we get down to a number which generates a flow to us of about £140 to £150 million.

Gerald Howarth MP You start off by saying there is an underlying value of £500 million, the balance sheet shows net assets of £312.5 million but you say that the directors reckon that an open market would be about 100 million less.

Colin Balmer More than £100 million less, they actually said £113 million.

Colin Balmer was a Finance Director at the Ministry of Defence. Now he is the Managing Director of the Cabinet Office at “the centre of government, making government work better.”

For whom?

1 Comment

  • 1. 99buckets » Buy low&hellip replies at 23rd November 2007, 7:08 pm :

    […] in the market place. That is the asset position. What Carlyle have done— … sourced here No Comments yet &raqu […]

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