Examination of witnesses (Questions 104 - 119)
WEDNESDAY 3 JUNE 1998
MR A JUKES, MR S ANDERSON and DR J PRIDEAUX
104. We now welcome the representatives
of the winning bidders, Mr Anderson, Managing Director of Porterbrook,
Mr Jukes, Managing Director of Forward Trust Rail, formerly Eversholt
Leasing and Dr Prideaux, who used to be Chairman of Angel and
is now a Non-Executive Director. Welcome everybody. We normally
have hard bitten permanent secretaries in front of us who know
the procedure here-you have one sitting behind you actually. If
you have any difficulties with procedure or any questions do not
hesitate to interrupt and ask me if there is a problem for you.
May I also ask you in answer to questions to be as brief as you
can be within reason? If people want elaboration they will come
back to you. For the purposes of pace in this meeting it would
be helpful if you could be brief. As I ask questions I shall give
you a reference in the National Audit Office report. If you have
that with you it may help you, but I will normally give you the
information anyway. I shall start with a question on paragraph
2.46 in the NAO report which shows that there was only one external
bidder left in the final competition. Were you unduly negative
to the various external bidders about the ROSCOs' future prospects,
so discouraging external bids and leaving the way clear for you
to buy the ROSCOs cheaply?
(Mr Anderson) No, not at all. We
were represented by Hambros in every meeting we had with external
bidders and we answered any questions they had. We tried to point
out the ups and downs in the business as we were by law due to
(Mr Jukes) No, I do not believe
we were at all. All parties had access to the same basic information.
We presented what we had done with the company up to that point
and answered questions on what we thought the prospects of the
company to be. There were risk areas and certainly the Networker
Express part of our transaction was a risk area. We made bidders
aware of the risks in that area. That is the only specific which
I would identify.
105. That was the only risk you identified.
(Mr Jukes) The only area in which
our concerns were particularly high and events have borne out
106. Mr Anderson, what risk areas did you
highlight to outsiders?
(Mr Anderson) We highlighted the
design and endemic faults as being perhaps a problem; problems
which may appear on the train which would be the responsibility
of the ROSCO.
107. Others will no doubt come back to that
question. Paragraph 2.63 shows that soon after privatisation GRS
sold their right to part of Angel's income flows for an amount
which was virtually the same as the total sale price paid to the
Department-within £6 million of it. You were left with the
remainder of the business which you sold later for £395 million,
which you obviously got for £6 million. Why did your bid
to the Department not include any value for the rest of the business?
(Dr Prideaux) It is fair to say
that our bid fully valued the ongoing lease revenue after the
end of the initial leases, despite some suggestions to the contrary.
108. What was the elapsed time between the
GRS sale and your purchase?
(Dr Prideaux) About two years.
109. In paragraph 2.56 I see that your backers
told the NAO they would not necessarily have been deterred from
bidding if the Department had insisted on provisions for sharing
in gains made from the on-sale of the companies, but that this
might have reduced the sale price. What would your reaction have
been to clawback provisions on the profits you made, after you
had achieved a minimum level of profit?
(Mr Jukes) That is a very hypothetical
question because a clawback was at no stage part of the terms
which were on offer and to be frank I cannot remember an occasion
when there was any discussion of the implications of a clawback
for the way in which we might bid and the way in which we would
value the company. I do not find it easy to give any quantified
response to your question.
110. Let me break it down for you. Most
management buyouts envisage a future onward sale, that is where
most of the profitability for a management buyout is normally
crystallised. In assessing this you will have made some judgements
as to being able perhaps to improve the business, I do not know
what your plan was, and sell it onwards at some point and therefore
have an expected level of profitability. In a sense that would
have been material to the way you assessed your bid price, would
it not? Are you with me so far?
(Mr Jukes) Yes.
111. Had there been a clawback arrangement,
clearly there would have been a reduction in that expected forward
price. If the clawback had been set at a level that was well above
where you expected to get a return, you would not expect much
of a reduction. If, however, it had been set to take half of your
expected return, you would have had a reduction. If you want to
take it in pieces, let us start with what you expected to make
on the sale when you bid.
(Mr Jukes) I do not think we had
a specific number in mind. If I may run back to the process as
it was in 1995, we were going through a very tightly timed bidding
process, we assembled a large and quite complicated consortium
which had to get an understanding of the business and of the risks
and other issues associated with the businesses and we had to
reach a point where we decided what number to bid. I remember
a meeting on 27 September 1995 with the consortium members sitting
round a table when there was a discussion about what number to
bid. I understand fully the theoretical analysis of what return
you expect but we came to a number with which the group was comfortable.
Some were wishing to make it a little higher and others feeling
that was top whack and maybe a bit beyond that for their comfort.
We ended up with a number. In that number there was not hard and
detailed analysis of what we expected to sell the company for
in the future and when we expected to sell it and what was the
112. What were the fundamentals you based
the price on?
(Mr Jukes) Inevitably there was
an assessment of the forward cash flows of the business and the
risks associated with that.
113. A net present value of the forward
(Mr Jukes) That was the way anybody
looking at these businesses would approach a valuation.
114. The NAO report says that the money
bid in each of these cases accounted for approximately a net present
value of the guaranteed cash flows.
(Mr Jukes) That makes certain assumptions
about the expected returns and the basis for financing the package.
115. If I may summarise your answer to me,
you had no notion of what you were going to make out of this at
the crystallisation stage of what happens at every management
buyout but you based your bid on a net present value of the discounted
cash flows forward, including the expected return on as yet unfixed
(Mr Jukes) That is correct. It is
fair to say that the way in which venture capitalists look at
these things does have built into it certain assumptions about
the kind of return on the equity which they put into it. I do
not believe that the returns which were assumed in our bid were
inconsistent with normal assumptions of a venture capitalist which
of course encompass acquisitions which are in the end unsuccessful
in terms of onward sale as well as those which are successful.
116. There are not very many of those. In
that case your calculation would not have had anywhere in it anything
upon which a clawback provision would have had an impact since
you were not valuing on an onward sale you were valuing on discounted
cash flow which would not have been impacted by clawback.
(Mr Jukes) I am sorry, I do not
think I agree. I believe the analysis encompasses, as you rightly
said at the beginning, an assumption that in due course the company
would be sold. The returns built into the cash flows or the assumptions
about the returns built into the cash flows assume something about
the returns to the ordinary shareholders as a result of an onward
sale. That is true and if you built into that an assumption about
clawback then that would certainly impact on the price.
117. I am sure others will come back to
you on this. I just want to get very clear for you that what I
am driving towards is what the impact of a clawback arrangement
would have been on the pricing judgement you made. That is what
I am after and that is why I am trying to get a straight answer
about the valuation basis of each of these companies.
(Mr Anderson) We would have looked
at it from a point of view of an internal rate of return. If you
see the structure of our deal there was a substantial number of
preferential shares in that deal which had a kicker of ten per
cent per annum. On top of that then we had the equity which was
fairly small. With the risks involved venture capitalists would
have at least expected to have had a 35 per cent return on the
equity, including the preferential shares, because you were talking
about companies which were not really in a trading position. They
were created but not in a trading position as such. If somebody
had said they wished to take back 20 per cent of the profits,
30 per cent of the profits, we would have deducted that from our
price. We made that clear to the National Audit Office when they
asked us that question. How much that would have been would have
been dependent on the whole scale of how you did the adjustments
118. We will come back to the formula in
a second. That gives me a clear idea. Did you have any assessment
in your original judgement of price how much profit you would
make or what the new price would be when you sold it on?
(Mr Anderson) No, but it is fair
to say that we would have made an assumption that you cannot get
people to put money up unless they can make in the range of 30
per cent; that is fact. The other thing you should take into consideration
when you put some of these deals together is that you have to
get the banking. The figure we put in for Porterbrook was the
maximum amount of banking we could get. In the case of Andrew
Jukes he maybe took a situation where he was looking and deciding
a price. I put in exactly what I could get from the banking plus
what Charterhouse would put up. That is where we landed on our
(Dr Prideaux) You have asked us
two questions. First ours was of course not an MBO so it was not
approached in the same way. In terms of the question of a clawback,
it frankly was a hypothetical question. We had our work absolutely
cut out to get the bid in and our backers satisfied and I have
to say we spent no time at all looking at hypothetical questions.
In terms of how the cash flows and the potential of the company
119. Let me stop you there a second. This
Committee has to look back at the way policy was executed and
make a judgement as to whether or not it was executed well and
whether there are lessons which can be learned for the future.
That means looking at what happened and what might have happened.
That by definition is hypothetical. When Mr Jukes had trouble
with that we broke down the argument into its component parts
and asked how he valued it. We can do it that way. We can go through
the details of valuation if you like. There are two ways to do
this. What I want to try to get from you is your judgement on
the basis of what you know about the mechanism you used to value
the system when you were making your bid.
(Dr Prideaux) I will give you an
undetailed but as accurate an answer as I can on clawback, which
is that it would have reduced the value bid because it would have
reduced the potential upside to all the backers in GRSH. I cannot
tell you by how much because it was not a question we ever addressed.
Otherwise I think I would be risking misleading the Committee.