NATIONAL AUDIT OFFICE
REPORT BY THE COMPTROLLER AND AUDITOR GENERAL
British Rail Maintenance Limited: Sale of Maintenance Depots
ORDERED BY THE HOUSE OF COMMONS TO BE PRINTED 15 JULY 1996
LONDON:HMSO HC583 Session1995-96 Published19 July1996 29.70 BRITISHML WNTENWCE UMITED: S~E OF WNTEN~CE DEPOTS
This report has been prepared under Section 6 of the National Audit Act, 1983 for presentation to the House of Commons in accordance with Section 9 of the Act.
John Bourn National Audit Office Comptroller and Auditor General 8 Jtiy 1996
The Comptroller and Auditor General is the head of the National Audit Office employing some 750 staff. He, and the NAO,are totaUy independent of Government. He certifies the accounts of au Government departments and a wide range of other puhhc sector bodies; and he has statutory authori@ to report to Parliament on the economy, efficiency and effectiveness with which departments and other bodies have used their resources. BRITISH ML WINTENANCE LIMITED: SALE OF WNTENANCE DEPOTS
Contents
Page Introduction, summary and principal conclusions 1 Part 1: Privatisation as soou as possible h a competitive process 8 Timetable 8 Sales process 10 - Generating interest 10 - Maintaining price tension 10 - Information available to bidders 15 Part 2: Mtitatimg safety, reducing costs and improving efficiency 17 tithin a competitive entionment Safety 18 Restructuring 18 Intellectual property 19 WorMoad contracts 21 Bidding framework 21 Part 3: Obtaining the best possfile market price, taking account of 23 sale costs, habfities, staff iuterests Best possible market price 23 - Sale structure 23 - Valuation 32 - Property clawback 33 Selection of adtisers and costs 34 Indemnities and warranties 35 Staff interests 36 - Assistance to management buy-out teams 36 - Employees’ terms and conditions 36 Part 4 The classification of docmnents as “Not for NAO eyes” 38 Glossary 42 Appendices 1. Objectives of the Secretary of State in relation to rafl privatisation 44 2. Map of locations of depots sold, their main functions and type of 45 vehicle usually repaired at each depot 3. Chronology of main events 46 4. Main participants in the heaW maintenance market 47 5. The issue of cash in the Eastleigh sale 48
6. Relevwt PACrecommendations 50
7. Text of memorandum on BRML classtiled as “Not for NAO eyes” 54 BRITISHML ~NTEN~CE LIMITED: SWEOF~NTEN~CE DEPOTS
Examples of the types of traction and rolling stock overhauled by British Rail Main{e-nance Limited
Class 73Electro-diesel locomotives Third-rail Electtic Multiple Units receiving attention at a BRML depot
Overhead line Electric Multiple Unit being worked on inside a BRML Oriving Van Trailer and InterCity stock on West-Coast Main Line depot
OieselElectficClass56 and Class 91 Electtic locomotives under Diesel Multiple Unit at Glasgow Central BRITISHML ~NTENANCELIMITED SALEOFWINTENANCEDEPOTS
Introduction, summary and principal conclusions
1 The British Rail Board (British Rafl) sold seven maintenance depots controffed by British Rail Maintenance Limited (BRML)to three separate purchasers in April and June 1995. These businesses comprised a small electronic service depot and six hea~ maintenance depots.
2 The hea~ maintenance depots carry out maintenance ad repairs to railway vehicles and components ~ro~g stock) wed in passenger and freight rail activi~, including refurbishment, modifications and co~sicm damage repairs. At the time of the sale they undertook the majority of the hea~ maintenance of British Ra~s locomotive, coach and muftiple unit vehicle fleets and some 50 per cent of the total mwket for hea~ maintenance. The electronic sefice centre at Stidon repairs, tests and cahbrates electronic equipment used on traction and ro~ng stock.
3 Gross proceeds totalled 532.3 miltion after adjustments to reflect changes in net assets from the 17 September 1994 audited balance sheet, on which final bids were requested, to the balance sheet at 31 March 1995 in the case of one of the maintenance depots and the electronic sewice centre and 27 May 1995 for the other depots (see Figure 1). Payment to British Rail of E2.7 million in respect of these adjustments was received in stages following the sale. A number of small final adjustments await agreement of the completion accounts which remain outstanding at the date of this report. E500,000 of the proceeds from the sale of the Wolverton and Springburn depots was deferred until 6 December 1995 as British Rail and the Department of Transport ~the Department”) believed that this wmdd lead to a higher overal price. Proceeds could be reduced depending on negotiations bemeen one of the purchasers, ABB, and the European Commission on the length of a covenant which restricts British Rail and their subsidiaries from expanding their heaW maintenance activities,
(fro) Chafl Leacon ABB Customer Suppoti Dmited. 19.08 IIford Doncaater
Wolveflon Railcare Limited, a BabcocWSemens joint venture 5.7 Springburn
Eastleigh Wessex Traincare Limited, a management buy-out team 7.15
Electronic service centre ABB Customer Suppofi Umited 0.38 This figure shows the tots proceeds for Btitish Rail’s sale of their six heay Total DrOCeedS 32.31 maintenance depots and the Swindon Electronic Sewice Centre Source: British Rail Vendor Unit Completion Accounts Summaw29.3.96
1 BRITISHML ~INTENANCELIMITED: SALEOF~NTENANCEDEPOTS
4 The actual proceeds of the sale remained with British Rail as at Juoe 1996 but benefited Government as they reduce British Rai~s overa~ level of fidebtedness to the Government. British Rail incurred sale costs of S2,81 2,000 and tie Department sale costs of approximately S274,200, in total approximately 9.6 per cent of proceeds, of which approximately 8.7 per cent is attributable to British Rail and 0.9 per cent the Department. These costs include the costs of advisers fees for restructuring the depots in preparation for sale.
5 The sales were conducted under the provisions of the Railways Act 1993 ~the 1993 Act”). This Act sets out the Secretary of State for Transport’s objectives for rail privatisation overall (see Appendix 1) Specific objectives for the sale by British Rail of the seven BRMLbusinesses were set by British Rail after consultation with the Department and are set out in paragraph 8 below.
6 British Rail prepared the businesses for sale and sold them, subject to the consent of the Secretary of State. They were responsible, with their advisers, for the marketing of the businesses, analysing and negotiating bids; and for making recommendations to the Department on key aspects of the sales. Decisions on sale strategy, and the monitoring of progress against sale objectives, were undertaken by the Board of British Rail who are appointed by the Secreta~ of State for Transport. Day to day implementation of the strategy was carried out by British Rail’s Vendor Unit ~the Vendor Unit”) under the oversight of a Board Member. BRMCSheadquarter staff and the management of the depots had no involvement in the sales process (other than the provision of information) but had day to day responsibility for operations,
7 The Department monitored sale progress at a strategic level to seek to ensure that the Secretary of State’s objectives were comphed with in British Rai~s key proposals and made recommendations to the Secretary of State on tbe sale terms proposed by British Rail. The Department relied on British Rail to alert them to important, novel or contentious issues which would not come to the Department’s notice through their normal, strategic monitoring.
Sale objectives 8 The specific sale objectives of British Rail, agreed with the Department, were:
a) To transfer the depots into the private sector as soon as possible by means of a competitive process;
b) To maintain safety, reduce costs, and improve the efficiency and viabihty of the depots within a competitive environment for the provision of heavy railway maintenance services; and
c) To obtain the best possible market price, taking due account of sales costs, staff interests, and the need to minimise habihties in the pubhc sector.
9 An important consideration arising out of the statutory objectives for rail privatisation set out in the 1993 Act was to provide opportunities for employees to acquire an interest in the ownership of the depots in which they were employed. This was reflected in the tiird objective above.
2 BRITISHML ~NTEN~CE LIMITED: SALEOF WINTENANCE DEPOTS
Scope of 10 The National Audit Office examined whether the Department and British Rail National Audit achieved the sale objectives, fo~owed best practice in the organisation and Office management of the sales and had regard, where appropriate, to examination recommendations of the Committee of Pubhc Accounts in relation to the handhng of privatisations.
11 The National Audit Office also investigated the classification of papers in the Department as “Not for NAO eyes” following the leak of a document relating to the sales which had been so classified by the Department (see text of document at Appendk 7).
12 The National Audit Office’swork included an examination of the Department’s papers and discussions with their staff. The Comptroller and Auditor General is not the external auditor of British Rail and has no access rights to the papers and officials of British Rail, other than information held by the Department. Discussions, however, also took place with British Rail, West Merchant Bank (their financial adviser), Price Waterhouse (who as well as acting as Reporting Accmmtant on the sales also carried out an investigation on British Rai~s behalf into the sale of the Eastleigh depot) and other parties involved in the sales.
13 The National Audit Office also had discussions with Ernst& Young and accompanied Ernst & Young iu their discussions with other parties in connection with a study commissioned by the Department on the sale of the depots. The National Audit Office are gratefti for the assistance provided by British Rail and other parties, and also to their advisers on this transaction, PanneU, Kerr Forster.
Structure of 14 Parts 1, 2 and 3 of the report examine how far British Rail and the Department the report met each of the specific sale objectives set out in paragraph 8 above. Part 4 deals with the classification of papers in the Department as “Not for NAOeyes”.
Principal 15 This section sets out the principal findings and conclusions in the report in findings and relation to the objectives and in relation to recommendations by the Committee conclusions of PubHc Accmmts and the principal findings and conclusions arising out of the National Audit Office examination of the classification of documents as “Not for NAO eyes”.
Objective 1: transfer to the private sector as soon as possible by a competitive process
i) The origiual tisnetable for completion at tie end of December 1994 turued out to be ambitious. The sde of the eletionic service centie was fiahsed iu Apfi 1995 and those of the hea~ maintenance depots in Juue 1995. There were a seriee of delays, each k itseMreasonable, which gave some bidders reason for complakt. These in part reflected over-optilsm iu the Vendor Unit’s timetables. EarHer appreciation of the Mely length of the eventual delay may have helped the Vendor Uuit iu their strategic thinking in relation to the handhg of the sale and wotdd have been helpfti to bidders. (paragraph 1.3)
3 BRITISH ML WNTENNCE HMITED: SALE OF WNTENANCE DEPOTS
ii) British Rail succeeded in attracting interest from a wide range of interested parties. (para~aph 1.8)
iii) Mthough a number of parties were interested in buying some or aU of the hea~ maintenance depots, in tie later stages of the process there was little effective competition between bidders, This was partly because of British Rail’s desire to sell the depots to a number of parties, to avoid selling some combinations of depots together and not to close the Springhurn depot. Mso, some potential bidders may not have been prepared to participate because of concerns about the success of the wider rail privatisation programme, ABB and Railcare negotiated significant reductions to their second stage bids, suggesting that price tension at that stage was not strong, despite the efforts of the Vendor Unit to avoid letting the purchasers know that they were effectively (although not formally) preferred bidders, Despite the reduction in their bids, the prices offered hy ABB and Railcare were still superior to others. (para~aph 1.10)
iv) Potential bidders did not receive the same information in relation to tbe businesses. The arrangements for the management of information flows agreed by the Vendor Unit led to some external bidders not having knowledge of financial forecasts (from non Vendor Unit sources) which other bidders had, The Vendor Unit did not always seek to obtain details of the information provided to each bidder in the due dihgence process. Other material information that was made available to some bidders in the course of their due dihgence was not made available to au bidders, as is usual in such sales, (paragraph 1.21)
v) The National Audit Office consider that in future sales the vendor shmdd:
a) inform all potential bidders of how the sale is to he structured at the outset so as to avoid possible confusion;
b) attend, or arrange for its financial advisers to amend, all meetings between potential bidders and management of the business;
c) ensure that all potential bidders receive the same material information on the business for sale: and
d) ensure that information made available to potential bidders comes from a minimum number of sources. BRITISH RAIL MMNTENANCE LIMITED: SALE OF MAINTENANCE DEPOTS
Objective 2: maintain safety, reduce costs, improve efficiency and viability of depots within a competitive environment vi) The framework for safety has not changed and the purchasers have acknowledged their obhgations under the relevant legislation and regulations. (paragraph 2.6) vii) British Rail structured the businesses in a way that cotid be expected to provide competition and put downward pressure on heavy maintenance costs. (para~aph 2.8) tiii) British Rail agreed some changes to the framework for access to inte~ectual prope@ that cotid be expected to a~ow competition to increase. (paragraph 2.11)
k) British Rail developed contracts that a~owed for competition beween depots whilst providing for an adequate forward workload to help ensure the viabih~ of the depots in the short to medium term. To achieve the contracted workloads depots had to give heavy discounts to customers. (paragraph 2.20)
x) The eventual sale to three separate purchasers estabhshed a competitive structure for the newly privatised businesses. (para~aph 2.24)
Objective 3: best possible market price, sale costs, staff interests, liabilities
xi) The proposed treatment of cash balances was not made clear in the Information Memorandum. Mthough it was set out ti the draft sale and pmchase agreement, not au the fial bidders appreciated the proposed &eatment. This was partly because they had no expectation that significant cash balances wodd be generated and partly because it had been agreed that changes in net assets, including cash, betieen tbe date of the audited balance sheet against which purchasers were asked to bid and completion wodd lead to an e@valent change in the agreed purchase price. Between the date at which the Vendor Unit asked purchasers for their initial bids (September 1994) and the completion balance sheet dates ti March and May 1995 cash rose from about S1 miRkm to about El 7 mi~on. It is genera~y considered to be good practice for cash to be extracted before sale as the vendor can then he more certain of receiving the best value obtainable for the business and the cash. If the BRMLsales had been structured from the outset to allow cash to be extiacted, British Rail might have been able to obtain higher proceeds. In any case, the National Audit Officebeheve that extraction of cash wotid have been desirable as it wotid have meant that there codd be no doubt that value had been achieved for it. (paragraph 3.2)
5 BRITISHML ~NTEN~CE LIMITED: SALEOFMNTENANCEDEPOTS
xii) The National Audit Office note that two changes have been made by British Rail to the procedures for the handhng of subsequent sales. In pardctiar, at the point of sale, any surplus cash in the balance sheet is to be retained by the Board or other arrangements are to be put in place to a~ow British Rail to obtain the benefit. This is made clear to au bidders from tbe outset. (pma~aph 3.28)
xiii] The National Audit Office commend these procedures to vendors genera~y. In addition the National Audit Office consider that the Vendor Unit shotid monitor the financial performance of the business throughout the sale process so that changes in financial performance can be communicated to au bidders,
xiv) The National Audit Office consider that obtaining valuations wotid have been helpful to British Rail and the Department in the sale of the BRML depots:
a) to provide quantified comparators against which they cmdd have judged bids; and
b) to assist in negotiations and inform decisions, especia~y as competition was not strong.
The Department and British Rail and their respective advisers beheve that such valuations wotid not have provided satisfactory comparators. (paragraph 3.29)
Classification of papers as “Not for NAO eyes”
xv) Not seeing the document classified as “Not for NAOeyes” attached at Appendix 7 did not hamper the National Audit Office’sstudy of the sales at that stage because the National Audit Office had akeady asked about the position of cash balances. But most of the subject matter would have been relevant to the study. The Department have confirmed that as the document itself states, it was their intention to set out their concerns to the National Audit Office once they bad a clearer understanding of the issues involved. (para~aph 4.6)
xvi) There are several areas where the Department’s procedures need to be strengthened. There has been only hmited action by the Department to follow up the recommendations made in internal audit’s 1994 report. (paragraph 4.8)
xvii) The Department provided the National Audit Officewith a fist of “Not for NAO eyes” files which had been archived but this did not record if and when files had been de-classified and a number of the files examined were still marked with the “Not for NAOeyes” designation. The Department
6 BRITISHRAIL WNTEN~CE LIMITED: SALE OF WINTENWCE DEPOTS
also provided the National Audit Officewith a Est of documents currently classified as ccNotfor NAOeyes”. The National Audit Office found that seven of these appeared on both the classified and de-classified tists, demonstrating there is confusion in tbe Department as to which files have been de-classified and those that remain “Not for NAOeyes”. (para~aph 4.9) xtili) Examination of internal audit’s report and working papers also revealed several areas where improvements are needed. In their 1994 report internal audit recommended that the Department shodd ensure that al file holders are told when files are de-classified. The Department have not actioned this recommendation and it has heen raised again by internal audit in their February 1996 report. There remains a risk therefore that files are not being made available to the National Audit Office. (paraWaph 4.10) xti) A large number of the “Not for NAOeyes” files examined by both internal audit and the National Audit Office contained papers which were outwith the criteria but which had been copied onto the files for completeness. In addition the National Audit Office found that genuine ccNotfor NAO eyes” papers were often not labelled as such and were not coded to show which particdar criteria they fe~ into. (paragraph 4.11) xx) The Department are responding to these findings. N “Not for NAOeyes” files recorded by the Department’s records management division will be examined by Jdy 1996 to identify those which shotid be de-classified. The Department have informed the National Audit Office that currently they have 78 correctly classified “Not for NAO eyes” files. The Department have issued a revised guidance note to au staff setting out the procedures for classifying and de-classi~lng ccNotfor NAOeyes” papers. In future, files being de-classified wi~ be marked accordingly computer records wi~ show when this occurs. And an annual check will be carried out by the Department, in addition to internal audit’s review, to ensure aU relevant files have been de-classified. The Department will also fo~ow up recommendations made in Internal Audit’s recent report to improve their record-keeping of “Not for NAOeyes” papers. (paragraph 4.12) xxi) As part of their departmental monitoring the National Audit Office check the operation of these procedures to ensure that files are de-classified promptly. The National Audit Office also examine the contents of de-classified files to check that they faUwithin the criteria set out in paragraph 4.1 and had been correctiy classified as ccNotfor NAOeyes”. (paragraph 4.13) BRITISHML WNTENANCE LIMITED: S~E OF WNTENMCE DEPOTS
Part 1: Privatisation as soon as possible in a competitive process
1.1 The location of the BRMCSmaintenance depots and their main fmctions are set out in Appendix 2. They were among the first of British Rai~s businesses to be privatised following the passing of the Railways Act 1993 ~tbe 1993 Act”). Preparations for sale began before the 1993 Act was passed but at a time when the indust~, including the businesses’ main customers, was already undergoing extensive restructuring in preparation for privatisation.
1.2 In assessing whether the objective of achieving privatisation as soon as possible in a competitive process was met the National Audit Office examined, in particular, whether British Rail, following consultation with the Department shout the overall strategy, had:
a) set and maintained a reahstic timetable; and
b) devised a sales process that:
. attracted interest from the widest possible range of suitable interested parties;
. developed a framework for negotiations with bidders that maintained effective competition and facilitated the achievement of maximum value, taking into account the overall objectives; and
. treated all potential bidders (including those from management-led consortia) in an even-handed manner, making available the same information to all bidders in a timely fa$hion,
Timetable 1.3
reason for complaint, These in part reflected over-optimism in the Vendor Unit’s timetables. Earher appreciation of the Wely length of the eventual delay may have helped the Vendor Unit in their strategic thiikmg in relation to the handhg of the sale arid would have been helpfti to bidders.
1.4 British Rail completed the sale of the Swindon electronic semice centre in April 1995 and tbe sales of the six heavy maintenance depots in June 1995. Completion was later than the target date of31 December 1994 which was the target date agreed by British Rail and the then Secretary of State for Transport
8 BRITISH OAIL MMNTENANCE LIMITED: SALE OF WINTENANCE DEPOTS
which was pubhshed in the Information Memorandum. The main delays in the sales of the heavy maintenance depots were caused by unanticipated difficulties in agreeing contractual terms between the businesses and their customers; a change in merchant bank advisers when British Rail’s financial adviser, La7.ards, d~cid~d not t.n cnntinue to be involved in the BRMLsales process: the need to give bidders adequate time for due dihgence; the time needed to conclude negotiations of service contracts with the different parts of British Rail, and more time than expected for more complex and detailed negotiations on sale terms relating to indemnities, inte~ectual property rights and a covenant restricting competition. In the case of the electronic sewice centre, the delay was principa~y caused by the length of time taken to agree suitable arrangements relating to property between the owner, Railtrack, and the purchaser.
1.5 There was not an exphcit decision to delay the completion of the sales until June 1995. Instead a series of delays occurred. The initial delay was a result of protracted delay in finafising contracts with the depots’ main customers, the RoRing Stock Leasing Companies, Freight Companies and the National Supply Centre. The date for receipt of second stage bids, for example, was changed at the request of some bidders, who said they needed more time to carry out due dihgence, from 6 December 1994 to 20 January 1995. The Vendor Unit decided that the delays were essential if they were to keep all the bidders committed to the sale process. Some bidders told the National Audit OffIcethat they found the number of delays frustrating. Railcare, Wessex Traincare and Layhne considered that they had arranged their own affairs to ensure that they met the timetable and thought it inequitable that the timetable was changed because others had not managed to do so. Wessex Traincare told the National Audit Officethat in addition this had an impact on the length of time that workload guarantees were in place and in significant additional advisers’ costs.
1.6 The National Audit Office consider that an earher appreciation of the likely length of the delay to the timetable might have helped the Vendor Unit’s strategic thinking in relation to the handling of the sale, for example, in relation 10the mmlitoring of financial information that was carried out. The Vendor Unit have told the National Audit Office that their decision not to monitor tbe financial performance, including the cash position, of the depots after the 17 September 1994 interim audit, was on the basis that bids were made on an agreed balance sheet at that date and would be subject to adjustment to reflect changes in the value of net assets between that date and the date of completion.
1.7 The key events leading up to the sales are summarised in Figure 2 overleaf. BR~ISH ML WNTENANCE LIMITED: SWE OF WNTENANCE DEPOTS
July 1993 Depatiment announces Btifish Rai~s intention to sell July 1994 Information Memomnda available to interested paties Sep 1994 Indicative offers received Ott1994 Shoti-tist of Mddem agreed Oec1994 Tsrget date for sales completion Jan 1995 Second stage offers received March 1995 Revised Mds requested June 1995 Sales completed (su~ect to a~ustments based on completion accounts This figure shows the key not flnahaed at June 1996) dates in the timetable for Btitish Rail’s sale of their Source: British Rail maintenance depots
Adetailed chronology is given in Appendix 3
Sales process Generating interest 1.8 British Rafl succeeded tiattractig interest horn a wide range of interested parties.
1.9 Lloyds Merchant Bank on behalf of British Rail, identified and contacted 10 potential interested parties in 1992, Eight of these expressed an interest. In November 1993 Lazards, on behalf of British Rail, issued an 18 page preliminary briefing document to 55 parties and this ehcited 17 responses. To try to ensure that all interested parties were aware of the forthcoming sale, British Rail also advertised tbe sale in the Financial Times and the Economist in Jdy 1994, As a result of this marketing, British Rail received 79 responses from interested parties in eight countries (including the United Rngdom), of whom 58 received the Information Memoranda.
Maintaining price tension .:ti~ough,a :u~er:ofpa;~s-fer,e. ~ie~stedirtiumg.~omi—___ :r:a~of ~he..:::.,, “ 1.10 hea~ maintenance depots;inthelater.stages’of the process there was~ttfe effective competition between bidders. This was patiy because of British Rai~s desire to sen the depots to a number of parties, to avoid seRing some combtiations of depots together and not to close the Springbm depot. Aso, some potential bidders may not have been prepared to participate because of concerns about the success of the wider rafl privatisation prosramme. ABB and Raflcare negotiated si@lcant reductions to theh second stage bids, suggesting that price tension at that stage was not strong, despite the efforts of the Vendor Unit to avoid letting the purchasers know that they were effectively (tithough not formany) preferred bidders. Despite the reductions in their bids, the prices offered by ABB and Railcare were sfl superior to others.
1.11 British Rail had a strong preference against sehng the Eastieigh and Chart Leacon depots to one purchaser and a less strong preference against seRing the Ilford and Wolverton depots to one purchaser as they judged these
10 BRITISHML mNTENNCE LIMITED: SALEOFWNTENANCEDEPOTS
combinations codd lead to a purchaser gaining a monopoly of particdar types of heavy maintenance. British Rafl wotid have been prepared to do eo in certain circumstances. British Rail dld not agree specific criteria for deciding on what these might have been in advance of a need to take decisions but told the National Audit Officethat they wotid have needed comfort that arrangement wodd be made to aflow for satisfactory competition in the industry. In the first stage of bidding, British Rail received indicative offers from eleven bidders by the deadfine of 7 September 1994. Four parties bid for one maintenance depot only and two for aU six maintenance depots, with the remaining biddere making offers for a combination of businesses.
1.12 British Rail, tith the agreement of the Depatient, initia~y shorthsted five of the bidders but added a sixth (Layke - a management buy-out warn) to the het after Layhne convinced British Rafl that their financial backing was sound and that their bid was robust. Tbe shorthst wae agreed on the basis of prices offered, financial strength and backing, coverage of depots, and the quahty of the bid fin terms of perceived abfity to defiver tie reqtired services). A management buy-out bid of E1.2 miMon for the Springbnrn depot was not put on the shortlist. This was primatiy because, in the judgement of British Rail, they dld not have the necessary financial strength and backing to guarantee the continued viabihty of the business, paticdarly as demand for the depot’s services had faUen during the course of the year and British Rail were concerned about tbe impact of closure on employees.
1.13 The six bidders for the maintenance depots that were shorthsted are identified in Figure 3 overleaf. British Rafl and the Department told the National Audit OfRcethat they thought it possfile that some potential bidders might have been discouraged from bidding because of concern over the prospects for the privatisation of the wider rail industry. Four of the six bidders put in bids for combinations of depots. The depote covered under each option put forward by bidders are marked with an asterisk.
1.14 The only second stage bids for Springbnrn were as part of bids for au the maintenance depots. These were unattractive to British Rafl and the Department on competition and financial grounds. British Rail generated further titerest in Springburn on the part of Railcare and Brentford Electric. Layhne and Wessex Traincare told the National Audit Officethat they were never approached by the Vendor Unit about the possibtity of purchasing Springburn. Both said that they wodd have given the matter serious consideration had such an approach been made. Raficare subeeqnently bid for the Springburn and Wolvertmr Depots at a value of S8.5 miRion, an effective reduction of E2.5 m~on in the value of their bid for the Wolverton depot alone; 81 mfion of the reduction was to cover significantly higher connection charges at the Wolverton depot than had been anticipated, and S1.5 miRion to take into account the agreement to take the Springbnrn depot. This El.5 miRimr compared to British Rai~s estimate of the closure cost of Springburn of some E3.9 miRion and the initial management buy-out bid of 81.2 milhmr that was rejected.
11 BRITISH WL WINTENANCE LIMITED: SALE OF WNTEN~CE DEPOTS
Leacon Em
ABB option 1 , , 35.0 , option 2 , 30.0 option 3 ‘ , 20,0
Railcare option 1 * . 16.0 option 2 * 11.0 . option 3 * . 12.0
WessexTraincare , 5.0 (management buy-outteam)
GEC * , . . , 10.0
Brenfford E[ecttic option 1 ‘ . . 10.0 . * option 2 ‘ . . 12.0
Laytine option 1 * , 12.1 (management option 2 * . 8.5 buy-out team) option 3 ~ 8.5 option 4 , 3.2
The figure shows the range of ‘ depot bid for second stage bids covering those for individual businesses and for Soume: British Rail combinations of depots
115 The Vendor Unit, with the approval of the British Rail Board and the DeDa~ent then entered into detailed discussions with three bidders - ABB,Railcare and the Wessex Traincare management buy-out team. These were chosen on the basis of price after tating into accomt competition considerations. The bidders were not given preferred bidder status - British Rail referred to them as “incipient preferred bidders” - utfl end Aprfl 1995 when, to affowtie for constipation to take place titb the trade miens at national level, British Rati issued a press notice statig tith whom British Raflwere in detaifed discussions. The Vendor Unit beheved that this helped maintain price tension on the parties. Mticles in the trade press support this as the identity of bidders was often identied accwately but there was specdation as to the depok they had an interest h and whether they woufd be a~owed to purchase certain combtiations of depots.
12 BRITISH~L MNTENANCELIMITED: SALEOFMINTENANCEDEPOTS
1.16 Fi~e 4 shows the difference between the preferred bidders’ second stage bids and the final prices s~se~ently agreed after negotiation (before completion adjustments).
m 30.00 17.74 (12.26) Chati Leacon Doncaster IIford
m 8.50 6.00 (2,50) Wolvetion Sptingburn
m 5.00 5.60 0.60 m Eastleigh This figure shows the changes between second stage Mds and Total 43.50 29.34 (14.16) final pflces agreed after negotiation, but before completion adjustments Source: British Rail
1.17 4BB negotiated a significant reduction in their original bid price on the basis of the following:
. additional staff travel costs - British Rafl asked bidders to commit themselves to pay for free staff travel for all employees at the depots at a cost per person, per year, of be~een S375 and S775 depending on the location and grade of the employee. ABB’sbid had been based on a cost of S220, which was what they had agreed to pay on the acquisition of BREL (formerly known as British Rail Engineering Limited) in 1989. The Vendor Unit agreed a reduction of El .03 milhon, compared to ABB’s original proposed reduction of 51.985 mi~ion in respect of this item;
● pay award - British Rail awarded employees at the depots a 2.5 per cent pay award in the week before completion of the sales in fine with that on offer to au other employees and due from 1 April 1995. ABB sought a El. 2 milhon reduction in the purchase price because the award did not require any improvements in working practices, which they told the National Audit Office that they would have sought if they had made the award. British Rail agreed a reduction of El milhon in the price origina~y bid;
. European Passenger Sertices contract - ABB sought a reduction of S2 milhon in price or an indemnity against loss in respect of a contract betieen tbe Doncaster depot and European Passenger Semites, which they feared would be a loss-maker. British Rail agreed a reduction of El.2 million in tbe price originally bid;
13 . additional Rtitrack connetion charges - ABB sought a reduction of S360,000 in price in respeti of higher Rafltrack connection charges thm had been e~etied when second stige bids had been made md unce~in~ over their future level. British Rafl agreed a reduction of E280,000 in the price originaRy bid;
. withdrawd of pre-completion indermdty - MB asked for an indemnity of f430,000 which woufd re@e British Raif to hear the cost of fiabiRties for defetive work undetien prior to completion. British Rafl agreed instead to a reduction of 2250,000 in the price origina~y bid;
. restrictive competition covenant - ABB asked for an eight year covenant restritig British Rti and their subsidiaries (for so long as they remain subsidiaries) from expanding their heaW maintenance activities. British Rti had aheady agreed not to reopen depots that had closed. Bfitish Rafl were otiy prepared to agree to a five year covenant. ABB sought a price reduction of S9 miRion in return for agreeing to a five year covenant but agreed to a reduction of fi5.5 mWon. ABB sought informal European Commission approval in Jdy 1995. ABB and British Rafl agreed that British Rafl wotid make a repayment f the European Commission only approved a three year covenant. ABB we *O entided to an unspecified level of compensation if the European Commission re@e any other materiaJ amendments to the covenant. If the two parties cmnot agree on a level of compensation then they can go to arbitration, which wotid he conducted by a FeUow of the Institute of Chartered Accountants of England and Wales;
. potential environmental htifities - as part of ABB’sagreement to the proposed treatment of these potential habihties a price reduction of S3 miRirm was agreed against E3.25 Won asked for.
1.18 ~ese are signiRc~t reductions. However, British Rail and West Merchant Bank consider this was the best position obtainable in the fight of the Government’s re~ements wd the re@ements of the remainder of the industry. Both the Vendor Utit and MB told the National Audit Officethat the eventual position was not influenced by ~B’s acknowledgement of the release of British Rail and thedepots from a covenant and to change the terms of hcences relating to BRECSintellectual property rights, both of which restricted them from competing with BREL (see paragraph 2.16 below) but the Vendor Unit told tbe National Audit OfRcethat ABB would not sign tbe relevant documents until all the negotiations were complete.
1.19 Raflcare’s El 1 milhon bid for Wolverton was reduced by S2.5 mi~on to take into account higher than anticipated connection charges at Wolverton and their agreement to take on the Springburn depot and by a further S2,5 miRion in respect of failure to agree fully on tbe terms of indemnities and other matters arising during due diligence.
1.20 Wessex Traincare’s second stage bid for the Eastleigb depot was expressed as f16miklon, including El miRion of profit which they estimated wotid be made before completion and retained by British Rail in accordance with the net asset
14 BRITISHML MAINTENANCELIMITED: SWEOFWINTENANCEDEPOTS
agreement under which increases in the value of net assets (through the generation of profit) wmdd benefit British Rail. The Vendor Unit assessed their bid, therefore, as being for a value of E5 millon, In subse~ent discussions, Wessex Traincare increased their bid to S5,4 miltion. In negotiation they also agreed to pay Cl 10,000 for additional redundancies to be funded by British Rail and E90,000 in fieu of interest on the Eastleigh depot’s loan account with British Rail, for the period from 1 April 1995 to completion.
Information available to bidders
1.21
agreed by the Vendor Unit led to some external bidders not having knowledge of financial forecasts (from non - Vendor Unit sources) which other bidders had. The Vendor Unit did not always seek to obtain details of the information provided to each bidder in the due dfigence process. Other material information that was made avaflable to some bidders in the course of their due dfigence was not made avaflable to aUbidders, as is usual in such sales.
1.22 In accordance with the sale objectives, providing opportunities for managementiemployee buy-outs was an important part of the sales process. The management buy-out bidders, because of their special position, inevitably had a better knowledge of the businesses than other bidders. British Rail and the Department were concerned, nevertheless, to ensure that management-led consortia did not gain any unfair advantage over other bidders as a result of this position,
1,23 The Vendor Unit issued a code of conduct for management buy-out teams which re~red managers involved in buy-outs to register their interest with the Vendor Unit and to indicate the type of information that they could give their prospective financial backers. Members of management buy-outs were excluded from particdar decision-making processes, for example, on the restructuring of the depots before sale or on investment spending.
1.24 N bidders were furnished with Information Memoranda and an Accountant’s Report in respect of the businesses for sale and had access to key documents which were contained in the Data Rooms. However, certain supplementary information was made available to bidders in the course of their due dihgence, which was not made available to au bidders. Potential bidders did not, therefore, au receive the same information in relation to the businesses:
a) the Managing Director of the Vendor Unit issued instructions relating to the negotiations, including ones in respect of dea~ngs with management buy-out teams, to Vendor Unit directors and managers. The Vendor Unit negotiator responsible for the BRMLsales was not issued with these but told the National Audit Office that he retied on discussion at sales seminars, advice from financial advisers and control from Vendor Unit directors and the British Rail Board in deciding on the availahifity of information;
15 BRITISHWL MNTENANCEUMITED: StiE OF~NTENANCEDEPOTS
b) representatives of the Vendor Unit or their advisers were not present at all due dihgence meetings with bidders and details of the information given to each bidder were not always sought by the Vendor Unit. A comprehensive record of information requested and provided was not available at the start of 1996, some eight months after the sale despite being part of the Key Audit Trail Documentation procedures that the Department had asked to be put in place. The Department were relying on comphance with these procedures to ensure that the sales were being conducted in accordance with the Department’s agreed position on acceptable practice. The Managing Director of the Vendor Unit had assured the Department that these procedures were in place and were being worked to;
c) British Rail told the National Audit Officethat, in their view, au material information had been made available in writing to bidders by the Vendor Unit. British Rail categorised information into three types; that available in tie Information Memoranda, that available in the Data Rooms, and that supphed in the course of due diligence. In tils last case, bidders only received information if they asked for it and, as a matter of agreed procedure, this was not made available to other bidders. As a result the National Audit Office are aware that information on forecasts of cash balances was made available to some bidders in the course of their due diligence but not sent to all bidders, as would be usual in such sales. In addition, tbe National Audit OffIceare aware that other significant information was given to some but not all bidders;
d) information on the historical pattern of cash generation was available to external bidders only on request in due dihgence meetings. Information on forecast cash build-up was available to external bidders on request, during due diligence, after 11 November 1994 when British Rail authorised depots to release this information, if asked for. One of the successful purchasers told the National Audit Officethat they had no idea of the forecast position. A management buy-out team bidder, led by the BRMLheadquarters Finance Director, whose bid did not succeed, told the National Audit Office that they were fully knowledgeable about the forecast cash position at the end of the year.
16 BRITISH RAIL MAINTENANCE LIMITED: SALE OF MAINTENANCE DEPOTS
Part 2: Maintaining safety, reducing costs and improving efficiency tithin a competitive environment
2.1 The objective to maintain safety, reduce costs and improve the efficiency and viabihty of the depots within a competitive contractual framework for the provision of heavy railway maintenance services had important implications for the structure of the businesses and the sales process.
2.2 Mthough the depots carried out the majority of heavy maintenance for British Rail, they only had shout 50 per cent of tie total heavy maintenance market in 1993/94. Ml manufacturers of railway vehicles are potential providers of maintenance services. The principal other players in the market are set out in Appendti 4 and include a number of major companies. In addition, some fight maintenance depots owned by Train Operating Companies undertake a small amount of heavy maintenance work. Nevefieless there was httle effective competition at the time of sale in certain sub-sections of the depots’ market because of geographical and technical factors. In addition, there were certain restrictions on the ahihty of the depots to compete for major work arising from the existence of a covenant and ownership of certain intellectual property rights hy ABB, following the sale to them of BREL in 1989 (see paragraph 2.16 belOw).
2.3 British Rail and the Department were concerned that in planning and executing the sales and in setting the commercial framework for the businesses, the decisions that they took should lead to an increase in competition and efficiency, insofar as consistent with the other objectives. British Rail and the Department told the National Audit Office that the sale of the depots to a number of parties was, accordingly, their strong preference.
2.4 Mthough the continued viability of the depots was also an important consideration, British Rail and the Department told the National Audit Office that, in some circumstances, they might have decided not to sell a depot or might have allowed a depot to close. Tbe issues that they would have taken into account were the implications for the sale of the other businesses if any were to be retained in the pubhc sector, the extent to which potential purchasers of the RoMng Stock Leasing Companies would have desired private sector supply of maintenance, closure costs, the competition effects of closures and the impact on industrial relations and the rest of the rail privatisation programme of a significant closure in the first set of major sales. The only case where this became a tangible issue was in respect of the Springburn depot, where these factors pointed to sale for a negative consideration.
17 BRITISHML WNTENNCE LIMITED: SALE OF WNTENMCE DEPOTS
2.5 In examining whether the objective to maintain safety, redu=osts and improve the efficiency and viability of the depots within a competitive environment was met, the National Audit Office examined, in patictiar, whether British Rail, following consultation tith the Depa~ent on the overafl stiategy, had:
a) as part of the sale process, structured the businesses and the commercial framework (including that relating to inte~ectual property) in a way that cmdd be expected to maximise competition and put downward pressue on costs:
h) developed contracts that allowed for competition be~een businesses whtist providing for an adequate foward workload to ensure viabih~ in the shofi to medium-term;
C) provided for the existing safew framework to be maintained;
d) developed a bidding framework that a~owed sales to a number of paties.
, .$. -.~~~~:.: .:-:: ~- -~~: ~---~—=------Safety 2.6 The framework for safety has not changed,apd tie .ptichasers have: ‘ ‘ ~‘:‘“,’“! acknowledged their obhgations tinder the relevant’ le@slation and re~ations.
2.7 The safety of the operation of the depots is contained in provisions in the Factories Act 1961, the Health and Safety at Work Act 1974 and subordinate legislation (including the Railway (Safety Case) Re@ations 1994). This framework has not been changed as a result of the privatisation of the depots. ARbidders, as part of the conditions of bidding, acknowledged the safety framework in place.
:BAti5h Railstiuctied tie,,bu5ine55e5-(~:a:waythatc0Jd-beexp:c~edto,,'., >,: Restructuring 2.8 provide competition and put downward presske on hea~’rnaintenance costi.
2.9 British Rail created BRMLin 1987 as a result of a review of their manufac~ing andmaintenance po~cy. By1993falhng demand, largely asaresult oftbe purchase of new rolling stock which required si~ificantly less hea~ maintenance, had led to a consolidation and closme pro~amme reducing the nmnberof hea~ maintenance depots from tilrteenin 1987 tothesix that were eventua~y sold. An electronic service centre at Easfleigh was closed dom at end 1993/94 and its work kansferred totheelectronic semicecentieat Swindmr,
2.10 Studies completed by Uoyds Merchant Bank in August 1992 and by Mc~sey in March 1993, on behaKof Btitish Rail, suggested thatthe workload was Wely to continue to decline but that sale to a trade buyer or buyers or management buy-out teams was feasible. In March 1994 and March 1995, in accordance titb estabhshed practice, British Rail reduced manpower at the depots prior to the sale to match expected workloads for the fo~owing year, 293 employees were made redundant in 1994/95 at a cost ofsome E5.2miWon, broadly sitiar to the number and cost of redundancies in the previous year, leaving the total
18 BR~lSH ML WNTEN~CE LIM~D: SWE OF WTENANCE DEPOTS
numbers of employees in the hea~ maintenance depots at 15 Apti 1995 as 3,411. This had been foreshadowed in the Morsnation Memoranda. The hwitation asking for second stage bids informed bidders of tie maximum and minimum number of employees that British Raii proposed to make redundant in March 1995. It asked for bids on the basis of the maximum nmnbe~ with an indication of the impact on tieir bids of the minimum number. These redundancies had been achieved on a voluntary basis. me successti purchasers told the Nationaf Audit Officethat they were concerned that they had lost some of tie more eWerienced employees. Wessex Traincare told the National Audit Officethat tier compulsory redundancies wotid be essential to achieve productivity gains necessaW to sustiti the bueinees.
Intellectual 2.11 property
2.12 The depots rely on certain drawings, technical formation and other “inteUetil property” rehting to the ro~g stock that they setice b mrry out their day to day work and to compek for new business. Rohg stock not manufactured by British Rafl or BREL was ruanufatied mder procurement contracts with third party manufacturers, In some of these contracts the third party retimed the relevant irste~ectual property rights ad, in some cases, British RaiYsrights are unclear, for example because of missing documentation (partictirly in the case of inte~ectad property wfich originated many decades ago) or because of changes in ownership of the third party. Despite the bck of chrity about come of the righti, British Rafi told the National Audit Office that they encountered no si@cant difRtities in performing maintenance h the relevant vehicles prior to sale.
2.13 The efficiency and viabfity of the depots and the extent to which they can compete with other phyers after pnvatiation is dependent on the framework put in place for access to the re@ed inte~ectual property whether owned by or hcensed to Btitish Rafl, BREL or other third parties.
2.14 The purchasers were given access to inte~ectual property righ~ owned or hcensed by British Rafl (including to those where British RaiYsrights are unclear) through a “universal hcence” - a non-exclusive Ecence, which aUows the depots -ted access, in perpetuity, to the relevant titeUectual property, The cost to the depots of substimg ti the organisation that adsrsiiters the new system has not yet been settled. Where the titi~ectual property is owned by BREL or other third parties, it is the responstii@ of the owner of the relevant ro~g stock to obtain the intellectual property on the depote’ behaM.
2.15 Bidders were warned in the Information Memoranda that there were potential problems in rehtion to some third party inte~ectual property rights. Raflcare at one time considered asking for a reduction in price hr respect of possible problems.
19 BRITISHWL WNTENNCE LIM~ED: StiE OF WWENANCE DEPOTS
2.16 When BREL was sold to ABB in 1989, British Rail agreed to:
a) a covenant which, except in certain limited cases, for ten years prevented British Rail and their subsidiaries from carrying out certain major repair and maintenance work to vehicles built by BREL; and
b) a hcence restriction which restilcted who cotid carry out major modifications, on the basis of BREEs ownership of the relevant inte~ectual property:
. where the inte~ectual property was created before 1984, a competitive tender must he held and BREL included in the tendering process; and
. where the intellectual property was created after 1984, the work must be done by BREL, unless they refuse to do it or propose to charge an unreasonable price,
2.17 British Rail and ABB expected that the covenant would not apply to the heavy maintenance depots once they were privatised and Wls was stated in the Information Memoranda. After second stage bids were submitted, however, British Rai~s legal advice was that here could have been a case for the restrictions to continue to apply. ABB agreed in the course of negotiations on the sale to release British Rail and tieir subsidiaries from the covenant on tendering, to a variation in the BREL hcence so that access to inte~ectual property created after 1984 is treated on the same basis as that created before 1984 and to issue a letter of clarification about the exclusion from the provisions of the BREL licence of some work carried out at the Eastleigh depot.
2.18 Wessex Traincare told the Vendor Unit tiat they would not have proceeded titb their bid h the absence of these changes, Railcare said that they wodd have reduced their bids if ABB had not made this variation. ABB told the National Audit Officethat they sought no director indirect compensation for these changes. The Vendor Unit told the National Audit Ofice that ABB wmdd not sign the relevant agreements, until the sales negotiations were finahsed.
2.19 Some purchasers have expressed dissatisfaction or concern over tie new system. These relate in part to the cost of obtaining drawings (some of the purchasers had heen under the impression that they would not have to pay for access to the intellectual property). In addition, the time taken to obtain an item requested sometimes had an adverse impact on a depot’s abihty to compete for maintenance work. There was also concern over the possible logistical problems in some years time when ro~ng stock manufactured after 1984 by BREL would be due for heavy maintenance. At this time the relevant owuer of the rolling stock would have to ask BREL to release the intellectual property to allow a tender for the heavy maintenance to take place. BRITISHRAIL MAINTENANCE LIMITED: SWE OF MAINTENANCE DEPOTS
WorHoad 2.20 contracts
2.21 British Rail agreed four year workload contracts (beginning 1 April 1994) with the Rolling Stock Leasing Companies, who are the depots’ major customers, the bulk freight companies, Rail Express Systems, Rail Freight Distribution and Railpart, on behalf of the depots. These contracts were intended to ensure:
a) that the depots had a limited period to estabHsh themselves before being subject to full competition; and
b) that customers had a period of continui~ of supply, whilst being able to put in place new arrangements for future work;
The Office of Fair Trading and the European Commission dld not have any objections to the contracts on competition grounds.
2.22 The RoRing Stock Leasing Companies’ contracts gave each depot a guaranteed level of core work from 1 April 1994 to 31 March 1995; and 100 per cent, 80 per cent, and 60 per cent of that for 1995/96, 1996/97 and 1997/98 respectively. Prices in these contracts were based on an increase of 2.5 per cent to take into account the introduction of a new system, under which the depots give Welve month warranties against faulty workmanship. Thereafter prices were to vary by reference to the Producer Price Index (PPI) minus 3 per cent in respect of staff costs and by 80 per cent of the change in the PPI for other costs, The contracts also specified changes to prices if changes in volumes of work occurred. The delays in the sales process meant that for approximately 15 months of the contract the depots remained in British Rai~s control rather than the 9 months originaHy planned. This reduced the benefit of the guaranteed workload to the new owners, Moreover, one purchaser has said that to achieve the volumes agreed, they have had to concede significant discounts.
2.23 The Doncaster depot had a tio year contract with the bulk freight companies ending in March 1996 with prices in the second year varying by 80 per cent of the change in the Retail Price Index. Three depots had WO year contracts and tio depots a one-year contract with Rail Express Systems,
Bidding 2.24 frame;ork
2.25 As referred to in paragraph 1.11 above, British Rail decided not to sell Eastleigh and Chart Leacon and, to a lesser degree, Rford or Wolverton to one purchaser, except in exceptional circumstances, as these combinations had a monopoly of particular types of heavy maintenance. Layhne told the National Audit Office that the Vendor Unit had confirmed that their bid for Ilford and Wolvertmr presented no difficulties on this account,
21 BRITISHML WNTENNCE LIMITED: SUE OF~NTENMCE DEPOTS
2.26 British Rail and the Department agreed that the depots shotid not be marketed as one unit but that bidders should be encouraged to put in bids for individual depots or any combination of depots. British Rail and the Depatient constited the Office of Fair Trading and requested confidential guidance on the sale of the depots. Clearance was given in early April 1995. At tbe same time, ABB obtained informal clearance from the Office of Fair Trading for their purchase of Rford, Chart Leacon and Doncaster.
2.27 No analysis of the potential impact on proceeds of a decision not to se~ aU or a combination of particular depots to one bidder was carried out by British Rail and the Department. British Rail told the National Audit Officethat this was because no combination of bids was precluded, including a sale to one bidder. It is notable in this context that the bids that were received showed that greater proceeds would be achieved by sale of individual depots rather than by a sale of all to one bidder.
2.28 Mthough British Rail and the Department were prepared to contemplate a sde of au the depots to one bidder, and indeed shortilsted GECMsthom, who made it clear that they were only interested in purchasing all the depots, they very much regarded this as a second best solution.
2.29 In the view of British Rail, the Department and their advisers, the eventual sale to three separate purchasers estab~sbed a competitive structure for the newly privatised businesses.
22 BRITISHML MAINTENANCELIMITED: SALEOF MAINTENANCE DEPOTS
Part 3: Obtaining the best possible market price, taking account of sale costs, habilities, staff interests
3.1 There is some overlap between the achievement of the objective of selhng the depots as soon as possible in a competitive process (which is discussed in Part 1) and that of achieting the best possible price, taking due account of sale costs, staff interests and the need to minimise habihties in the pubhc sector. That is because maximizing the competition between bidders and maintaining price tension is a crucial element in obtaining the best financial terms. In assessing whether this objective was met, the National Audit OffIceexamined, in particular, whether British Rail, following consultation with the Department about the overall strategy, had:
a) to achieve the best possible price:
. agreed a sale structure, including the most appropriate treatment of cash balances in the businesses, to aUow mmimum value for the businesses to be achieved;
. developed a marketing programme and se~ng process that generated interest and maintained competitive pressure on bidders throughout (discussed in paragraphs 1.8 to 1.20 above); and
. carried out a thorough valuation exercise;
h) monitored and contro~ed sales costs and minimised the issuing of warranties and indemnities to purchasers;
c) assisted management and employees to bid in the sales;
d) agreed to any changes to employees’ terms and conditions on sale to the purchasers
Best possible market price 3.2
continued ,..
23 BRITISHWL ~NTENANCELIMITED: SALEOFMNTENANCEDEPOTS
Ma~g~T$g~~~gmi-;au$;;ig$$~:$gen:-
'~~c~arig+&irinetassets,1,~clu@g!$4sp;!VeW.eeritE?da!e of tbs. a~dl!ed<.(?.: :;.,/ ,.,,,’. ,.:::-7 ..,:,,,.:.: , :, , .::..-”.. ,,, .: ., b~ifice .she~t :agiinSt yhi{$~~,c]a;ers’we.re,~ ske;dto :b1d:mdCOrnPl?~6Q .,: ~ wotid lead to an equivalent cha.rige“inthe agreed pWchase ‘piice~:Be@een: ~ the date at which the Vendor Unit asked purchasers for their initial bids (September 1994) and the completion balance sheet dates in March and May 1995 cash rose from about S1 miUion to about El 7 mitfion. It is genera~y considered to be good practice for cash to be extracted before sale as the vendor can then bc more certain of rccoiving the best valuo obtainable for the ,“ business and the cash. If the BRMLsales had been structured from the outset to allow cash to be extracted, British Rafi might have been tile to obtain higher proceeds. In any case, the National Audit Officebeheve that extraction of cash would have heen desirable as it wotid have meant fiat there codd be no doubt that value had heen achieved for it.
3.3 The National Audit Office commissioned advice from PanneU, Kerr Forster in relation to good practice in the conduct of trade sales of subsidiary companies, [t is Pannell, Kerr Forster’s view that removing all cash balances from a business before sale is generally considered to be good practice. Where this is carried out the vendor can he more certain than if it is not, of obtaining the best value for the business and the cash. This is because tbe vendor is sure of obtaining full value for the cash that is extracted. Bidders, under this structure, during the development of their bids are obhged to make their own judgement about the financing required for the ongoing operations of the business. This may weti vary between bidders depending on the strategic “fit” with their own business and their plans for tbe business for which they are bidding. Variations will be reflected in their financial analyses and amounts bid. Any funds which comprise working capital will, of course, need to be re-injected by the purchaser, who may be expected to take account of the cost in the bid, including the financing cost. If working capital costs are not disclosed fu~y, a bidder’s estimate is likely to err on the side of caution,
3.4 An alternative approach is for the vendor to make their best estimate of surplus cash (cash not required for the ongoing operation of the business) and to extract it. The main difference of this approach is that the vendor rather than the purchaser makes a judgement about what is surplus, mere cash is to be leti with a business it is particularly important that the level is monitored carefully throughout tbe sale. If it is forecast to be greater than planned, that would require investigation and, where appropriate, further negotiations with the bidder to extract value for it. British Rail have received advice from their advisers, West Merchant Bank, that they would not have received higher proceeds if the sale had been structured to allow cash to be extracted.
3.5 The treatment of cash balances was not made clear in the Information Memoranda, In the cases of the Chart Leacon and Rford depots it was stated that cash in the 31 March 1994 balance sheets wodd be extracted. The balance sheets at the other depots showed only small amounts of cash since BRML Headquarters, which was not for sale, held the cash balances for these depots. Paragraph 9.33 of the General Information Memorandum stated:
24 BRITISHWIL WINTENANCE LIMITED: SALE OF MAINTENANCE DEPOTS
“If the relevant company owes any other financing debt (i.e. other than by way of normal trade debt) to BRB or BRMLthis will he settled by the purchaser on Completion. Similarly, if the relevant company has any credits (other than normal trade credit) outstanding with BRB or BRML, these will be paid hy BRB/BRMLon Completion”.
The Vendor Unit and West Merchant Bank told the National Audit Office that, in their view, this makes the proposed treatment of cash clear. Furthermore, West Merchant Bank drew tbe attention of the National Audit Office to the balance sheets in the Information Memoranda which showed a separate tine for cash with no suggestion that it would be excluded.
3.6 The National Audit Office and their advisers consider that potential purchasers would have required an intimate knowledge of the BRMLbusiness to have understood from the documentation that cash was to be included in the sale. Moreover, various statements (and omissions) in the General Information Memorandum could have led bidders to assome that cash would not be transferred with the businesses:
. The Executive Summary states that “At 31 March 1994, after adjustments to efiminate .,.cash balances (El 5 milfion) consohdated net assets were some f59 million.”
. A statement in paragraph 9.1 refers to tbe assets and fiahilities to be transferred without mentioning cash.
. A statement in paragraph 9,15 states that the hank accounts of all the businesses form part of BRMLor British Rai~s overa~ banking arrangements and that purchasers will need to set up new banking arrangements suggesting that cash will not transfer with the businesses on sale. (This statement was subsequently modified in the draft sale and purchase a~eement to include tbe transfer of bank balances held by the Board to the purchasers.)
. In the A~uendix. . deahng with summary financial information the figures given for “Total capital employed”, which is invariably taken to be ~quivalent to net assets, includes (with the exception of Chart Leacon and Ilford) only tbe petty cash held at the depots.
3.7 The position was made clear in November 1994 after second stage bids bad been asked for and tbe draft sale and purchase agreement circulated. This was drafted on the basis that cash balances would remain with tbe businesses and that net profit between 17 September 1994 (the date of the balance sheet on which bidders were asked to make final bids) and completion would benefit British Rail. These arrangements were modified as a result of discussions with bidders, resulting in a final agreement which stated that purchase prices would be adjusted to take into account changes to net assets be@een 17 September 1994 and the completion balance sheet dates (31 March 1995 for Eastleigh and the Swindon electronic service centre and 27 May 1995 for the other depots). On this basis, any increase in cash balances over this period due
25 BRITISH ML W~ENANCE LIMITED: SWE OF WNTENMCE DEPOTS
to net increased profits would effectively have benefited British Rail but increases as a result of changes in the composition of net assets remained with the purchasers. A significant proportion of these were due to increased habihties in the on-going trading activities of the businesses and accruals for British Rail commitments, relating, for example, to profit-related pay,
3.8 BRMLheadquarters management received management accounts for each of the depots and submitted consohdated results to British Rai~s finance department. From September 1994 to the finahsation of the sales, BRML headquarters management sent this information to the negotiator in the Vendor Unit responsible for the BRMLsale negotiations. The National Audit Office have, however, been unable to identify anyone as receiving this information or for having responsibility for monitoring financial performance over this period. The Vendor Unit told the National Audit Office that they did not regard this information as particularly relevant to the negotiations and they wotid, moreover, have found it very difficult to process it in the time that they had, They relied instead on close contact with the depots and BRMLHeadquarters, to keep them informed, on a general level, about the financial and commercial condition of the businesses. They told the National Audit Officethat they were satisfied with this on the basis that the bids were based on the balance sheet at 17 September 1994 and changes in the value of net assets be@een that date and completion were to be reflected in equivalent changes to purchase prices.
3.9 The pattern of business and cash flow was such that the depots usua~y built up cash at the end of the year, although as referred to in para~aph 3,13 below tils wotid not necessarily have been obvious to tbe external bidders. The original timetables for the sale envisaged completion before the last quarter of the financial year, when cash balances usua~y accumdated. In the event the six heavy maintenance businesses were sold with combined cash balances of S16.9 milhon, an increase of S15.9 million between 17 September 1994 and the completion balance sheet dates (see Figure 5 opposite). Of this S15.9 miRion, E2.7 million was the result of an increase in net assets after adjustments for provisions, which is to benefit British Rail, and El 3,2 miRion was the restit of changes in the composition of net assets (a detailed breakdown of this information is not available).
3.10 The increase in cash balances between 17 September 1994 and the completion balance sheet dates gives rise to concern over whether ffl value was received for the heavy maintenance depots. In the case of the depots bought by Raflcare the cash generated between these dates was some E4.5 milhon against proceeds of S5. 7 million. For ABB the cash generated was E6.4 milhon against proceeds ofS19. 1 milhon. For Wessex Traincare, the cash generated was S5 milhon against proceeds of S7.2 miRkm.
26 BRITISHWL ~NTENANCELIMITED: SALEOFMAINTENANCEDEPOTS
Depots bought by ABB
0.6’’’:.,’’’” 1:5 0,9 (0,3)’ “ 2.9 3.2 1.0 3.3 2.3 m 7.7 m
Depots bought by Railcare
(0.1) : 3.0 3.1 (0.6) O.B 1.4 m G z
Depot bought by tbe management buy-out Team
Eaatleigh : ‘“~73 ;‘” ‘“la:@* ““ 1.6 0,4 5.4** 5.0 7.2
Total for all ‘;59.2;’’’” “ ‘“’ 61.9 2.7 1.0 16.9 15.9 32.D dapots
Source: British Rail
‘ Comp/etionadjustmentshavenotyetbeenfinalisedforABB.ltisnotpossibletoallocatethesaleaconsidemtiontoeachdepotasthebid was for more than one depot without an under&ing breakdown. ‘* Forthe Eastleigh Depotthecompletion balancesheetdate was31 March l995not27Mayl995
This figure shows the completion adjustments and cash generated in the depots bemeen September 1994 and May 1995 compared to the net proceeds.
3.11 Thekey issues are:
a) if the sale had been structured from the outset on the basis that cash was to be extracted, might higher proceeds have been obtained?
b) given that cash balances were to be left tith the depots, whether any part of the cash generated be~een 17 September 1994 and tbe finahsation of the sales in June 1995 wassurplus cash generated, forexample, througha sustainable change in working capital and, if so, whether British Rail might have been able to receive higher proceeds in respect of this surplus cash.
27 BRITISH ML WINTENANCE UMITED: SALEOFWNTEN~CE DEPOTS
3.12 In addressing these wo points, the National Audit Office examined:
a) whether bidders could have worked outthehkely accumulations of cash balances in 1994/95 on the basis of previous years’ experience;
b) whether bidders were clear tiatcash wastobe lefiinthe bustiesses and whether during the bidding process they were aware of the forecast increases at the year end;
c) whether this information might have influenced the prices bid.
Information on historical year end cash balances 3.13 The National Audit Officefound it very difficult to obtain information on pre-1 994/95 year end cash balances because on sale, management information transferred to the purchaser and the relevant records were stored on archived computer files making retrieval difficult. British Rail told the National Audit Officethat bidders had access to an Accountant’s Report rather than a fuR Long Form Report. The former did not contain information on historic cash flows which thelatter would have done. External bidders therefore, had virtually no access to information on past cash flow information until they carried out due diligence, when it would have been available if they had asked the depots to provide them with it.
Bidders awareness of cash build up and retention of cash by purchasers on sale 3.14 For the reasons set out in paragraphs 3.5 and 3.6 the National Audit OffIce consider that bidders did not receive clear information on the treatment of cash balances at the start of the sale, Furthermore, this issue was not clarified in the invitation letter asking for second stage bids of 24 October 1994. The relevant information on the treatment of cash was set out in the draft sale and purchase a~eement circulated in November 1994 prior to the receipt of second stage bids on 20 January 1995.
3.15 A management buy-out team whose bid did not succeed, led by the BRML Finance Director, told the National Audit Officethat they were clear that cash was to be retained in the businesses and were aware of the forecast increases in year-end cash balances, They had taken these forecasts into account in deciding on the value of their bids.
3.16 Aualysis of Wessex Traincare’s business plan submitted to the Vendor Unit in February 1995 shows that it was based on negligible cash in the balance sheet of the depot at sale. The management buyout team have told the National Audit Office this was done to demonstrate that the management buyout team had a viable plan showing sufficient financial backing to ensure adequate working capital requirements, irrespective of cash levels on transfer of the business. Confirmation that they were aware that cash balances were to be left with the businesses at sale was contained in a letter to tbe Vendor Unit in February 1995.
28 BRITISHML MAINTENANCE LIMITED SALE OF WNTENANCE DEPOTS
3.17 Two of the external bidders had not fn~y appreciated the proposed treatment, This was because cash did not appear to them at the time to be a major issue. ARthe successfd bidders told the National Audit Officethat their prime motivation for submitting bids was the strategic location of particular depots and future profitabi~ty based on the net present value of future casbflows. The extent of cash in the businesses was not a major factor in determining their bid prices. They had not considered a change in cash balances or the composition of net assets as being Hkelyto be a major issue. The companies said that they had focused on the audited accounts of 17 September 1994 and were content that proceeds would be adjusted in the completion accounts to reflect changes in the value of net assets betieen 17 September 1994 and completion,
3.18 On 11 November 1994 the Vendor Unit sent to each final bidder, turnover and operating profit summaries for the period to 15 October and the latest forecast outturn for the year 1994-95. Tbe covering letter noted that the data was produced as a standard part of each depots’ period reporting package. A note to depot accountants of the same date sanctioned the release all the outturn data, including forecasts of cash balances, included in the period 7 business reports (relating to the 15 October 1YY4balance-sheet), Prior to this the Board had been reluctant to release forecasts for technical and legal reasons,
3,19 Information on forecasts wmdd have been available to those shortlisted bidders who conducted due dihgence visits to the sites, provided that they specifically requested the information, However the Vendor Unit has no record of requests made nor documents provided to confirm what different bidders saw. Railcare confirmed to the National Audit Officethat they had no knowledge of cash forecasts for the year end, They said that cash had rarely featured in discussions and they were surprised at the magnitude of cash balances at the Springburn and Wolverton depots on the completion of the sale.
3.20 ABB told the National Audit Office that that they had to apply persistent pressure on the Vendor Unit to obtain out-turn forecasts, Railcare’s discussions with the National Audit Office confirmed this saying that they had had considerable difficulty in obtaining information from the Vendor Unit genera~y, British Rail told the National Audit Office that during the course of the sale and the setting up of the contractual framework with the Rolling Stock Leasing Companies and others, there was considerable risk of changes to budget plans and out-turn forecasts. This made them very reluctant to provide any out-turn forecasts until these were firmly estabhshed (see paragraph 3.18 above). As referred to in paragraph 3.19 above, Railcare were frustrated by the delays in the sale process and said that their surprise at the changed cash position at the year end was in part due to the timetable problems experienced, ? The degree to which knowledge of improved cash balances would have led to higher proceeds 3.21 The National Audit OffIceconsider that the treatment of cash balances in the sale was only clear in November 1994. At.this point, the sale arrangements provided for cash balances to be retained by the purchasers on sale and for any change in net assets be~een the 17 September 1994 balance sheet (on which
29 BRITISHML WNTENANCELIMITED: SWEOFUNTENANCEDEPOTS
second stage bids were based) and the completion balance sheets to lead to an equivalent change in the proceeds payable. From November onwards, therefore, if there was any surplus cash (cash which at the time appeared not to be needed for the running of the business) for example, through lasting improvements in working capital, this would have been for the benefit of the purchaser. Changes to the sale arrtingemeIIls arter this point to aHow B1-itish Rail to benefit instead would have been very di~cdt to negotiate.
3.22 If, from the outset, however, tbe sale had been structured so that cash balances were to be extracted, then British Rail would have been certain of getting value for tie cash. As explained in paragraph 3.3 above, bidders wmdd then have had to make their own assumptions about the financing of the business. To the extent that cash had been extracted and was not judged necessary by the purchaser for the on-going operations of the business (i.e. to the extent that surplus cash has been extracted) the vendor cotid have benefited from this. The issue of whether surplus cash existed is, therefore, of crucial importance in determining whether full value was achieved in the sale. The National Audit Office, in conjunction with their advisers Pannell, Kerr Forster, investigated cash movements be~een 17 September 1994 and completion for all the depots to try to determine whether there was surplus cash in tbe balance sheets and the possible impact on proceeds. The analysis was carried out for the Eastleigh depot on the basis of information provided by Wessex Traincare, the successfti management buy-out team. Equivalent information was not requested from external purchasers.
3.23 As stated in paragraph 3.17 above, the successful bidders assessed the level at which to bid primarily by reference to the strategic location of the depots and the net present value of future cash flows. ABB and Railcare told the National Audit Office that cash balances were not an important part of their assessment. If tbe extraction of cash balances before the sale had been provided for at the outset then it is, therefore, possible that British Rail might have received higher proceeds from the sale of these depots.
3.24 GECNsthom, through their advisers, Arthur Andersen, told the National Audit Office that they might have put in a better bid if they had knom that significant cash balances were to exist and were to be left with the companies on sale. This would have depended on tbe nature of the cash build up, partictiarly if it had resulted from sustainable improvements to working capital. They had taken a strate@c approach to the possible purchase and valuation of the companies and had not looked closely at the cash position and the prospects for improving working capital but their bid had been on the basis of no significant net cash being left with the depots.
3.25 As referred to in paragraph 3.16 above, Wessex Traincare’s business plan, underlying their hid, was on the basis of no cash in the business at sale completion. From details in the business plan there appears to have been sufficient external funding to sustain the trading activities of the depot. This suggests that, had British Rail decided that the depots were to be sold tithout cash and made this clear to bidders at the outset, British Rail might have been able to obtain the benefit of the surplus cash if it existed. Wessex Trainware told
30 BRITISH ML WINTENANCE LIMITED SALE OF WNTENANCE DEPOTS
the National Audit Office that their bid was based on the value of the assets, that they were aware that cash was to be retained and would have reduced their bid if any other treatment had been proposed,
3.26 From the information avaflable to the National Audit Office, there is no evidence of improprie~ in the purchase of the Eastieigh business by the management buy-out team nor is it clear whether thoro was an clcmcnt of surplus cash in the business. Any judgement on this depends on whether the year-end cash balances were temporarily high and then ran down in the 1995-96 financial year. The National Audit Office have no access rights to this information, Tbe National Audit Office are aware, however, that cash continued to build up to S5.9 milhon in April 1995 before falhng to E5.6 million in June 1995. Wessex Traincare told the National Audit Officethat all this cash was required for the ongoing operations of the business and, moreover, the issue of surplus cash was only relevant on the basis that a different sale structure was in place, and not under the net asset agreement,
3.27 To assess the extent to which a surplus may have existed in the Eastleigh depot, the National Audit Office used data from the business plan prepared in February 1995 by the successful bidder and submitted to the Vendor Unit. Based on the assumptions contained in the plan, the National Audit Office calculated that there could have been a cash surplus of some El. 5 milhon at the depot by 31 March 1995 (assumptions and detailed calculations are shown in Append& 5). This was based upon projections contained in the plan showing a maximum funding requirement for the ongoing operation of the depot of fO.2 milhon. The figure was revised upwards by the National Audit Office and their advisers to S0.5 mi~lon to provide a contingency element for any unexpected fluctuations in activi~ levels. Wessex Traincare do not agree with this analysis arguing as stated in para~aph 3,16 that the business plan did not include cash to demonstrate to the Vendor Unit the financial viabih~ of the buy-out team’s bid, They also consider that to be prudent, the business would require some S2 million cash to finance working capital rather than tbe EO.5 mil~on estimated by the National Audit OffIceand their advisers,
Changes in practice by British Rail . . ..—. Y , : , ~—:--”-’-’”” 3.28 , Fo~ofig;~~B~M~~al~~~~~dor. Umt have ‘told the Natiorial Audit’Office, that ‘MOSpeC&CC&arigqS’haVe been”rnadeto the,han~ngof trade sales bY British Rail in respect Ofcash. Each tie an update or decision making paper is presented to the Board a fuR set of current financial data (ficluding cash flow) is also protided. At the petit of sale, any surplus cash in the balance sheet is retained by the Board or other arrangements are put in place to allow British Rail to obtain the benefit. This is made clear to all bidders from the outset.
31 BRITISH ML ~NTEN~CE LIMITED: SUE OF MNTENANCE DEPOTS
3.29
performance; and
b) to assist in negotiations and inform decisions, especiaUy as competition was not strong.
The Depaflment and British Rail and their respective advisers beheve that such valuations would not have provided satisfactory comparators.
3.30 In their report on the Sale of Rover Group to British Aerospace plc (First Report 199 1-92), the Committee of Public Accounts stated that they expected the (vendor), before entering negotiations, to make their own comprehensive valuation of the undertaking to be sold. The Committee noted that this might be achieved in a number of ways, such as by reference to a reahstic estimate of the business’s future earnings or to tbe worth of its capital assets. Tbe subse~ent I Treasury Minute (Cm 1819, Februa~ 1992) agreed that it might be appropriate in some cases to employ benchmarks in assessing tender bids, but argued that a proper valuation was a market valuation after full competition. Where such benchmarks were employed they stated that they should be weighted with other factors including the objectives of the sale. i
3.31 Lloyds Merchant Bank told British Rail in 1992 that it was not possible to put a value on the depots. In March 1993, British Rail received a range of valuations from McKinsey as part of their analysis of the options for the depots (see paragraph 2.10 above). These examined the possible options, based on discounted cashflow analyses. Three of these options were on the basis of an early sale without any significant restructuring and gave a range of values, depending on the discount rate, the return on sales that might be achieved and in one case, the payback period assumed from -S20 millon to E40 milhon. These analyses assumed no guaranteed workload contracts. No further valuations were carried out and British Rail and the Department sought to achieve the best possible market price, consistent with the other objectives, by a competitive bidding process and negotiations with bidders.
3.32 British Rail and the Department told the National Audit Office that they dld not utifise benchmark valuations of hkely proceeds because they considered that the lack of comparable companies in the private sector meant that such valuations would have Ettle value. Moreover, British Rail considered that they had two options only sale in a competitive process or closure. The latter was ve~ much an option of last resort. They did not see value, therefore, in cawing out valuations.
3.33 They decided that the benchmark, if competitive bids were not received, was I the cost of closure. This meant that they would have been prepared to pay a bidder to take on a depot, in certain circumstances, if the payment was less BRITISHWIL MAINTENANCE LIMITED: SALE OF MAINTENANCE DEPOTS
than the cost of closing down the depot. Estimates of closure costs were made, In the case of the Springhurn depot, the cost of closure (S3.9 mi~ion) was used to assess an effective negative offer for the company in the final stages of the bidding process (see paragraph 1.14 above).
3.34 The National Audit Officeis not convinced that it was not possible to car~ out valuations due to the lack of comparable companies (for example, in terms of type of business and prospects). The bidders and McMnsey valued the businesses hy discounting the net present value of projected cash flows of the businesses, on a range of assumptions, adjusting the results of their analysis to take into account specific factors, such as their view of the strategic fit with their own businesses and the likely synergies achievable.
3.35 The National Audit Office believe tiat valuations of the businesses, even if not formal benchmark valuations, could have informed negotiations with bidders and wodd have been useful in decision-making, particularly in relation to the options as to how best to sell the businesses.
Property clawback
3.36 British Rail put in place clawback mechanisms to a~ow the Government to share in the benefit of the development of the depots’ property portfolio. The percentage agreed in each case differed between purchasers, depending on their negotiating position.
3.37 British Rail, after consultation with the Department, took steps to secure clawback of profits on the granting of planning permission or sale of land with planning pemission except where the development is for railway traction or rolhng stock maintenance. Gains are payable on whichever is earlier - sale of land or commencement of development and is based on the difference between the value of the land before and after planning permission. In the Information Memoranda, a fifteen year petiod, dufing which time 50 per cent of any gains would he clawed hack, was stipulated. After consultation with Government, it was aWeed that clawback provisions would apply for seven years fDllowing completion. Different levels of clawback were negotiated by each bidder, see Figure 6.
Year 1 80 60 50Ya for 7 years less costs 2 70 60 incurred in obtining planning 3 60 50 permission 4 50 40 5 40 30 6 30 20 7 20 10
This figure shows the vaflous Source: British Rail levels of propetiy clawback *share to be reduced by what they expect to spend on remedial environmental work required to obtain negotiated by different bidders plamdngpermission BRITISHWL ~NTENNCE LIMITED: SWEOFmNTEN~CE DEPOTS
Selection of British Rail’s advisers and costs advisers and 3.38 Key advisers were appointed by British Rail without a competition because of costs theil- existing role in l-elation to the Boal-d which made it easier for them to ensure that the timetable was maintained as far as possible. Budgets for the sale were not agreed but sale costs were monitored closely.
3.39 The Department took no part in the appointment or control of British Rai~s advisers. Ministers took into accouut in setilng British Rail’s external financing contribution that British Rail would face such costs. Proceeds were accounted for separately and not scored as part of the external financing contribution.
3.40 British Rail initially appointed Lazards as their financial adviser on the BRML sales, without competition, as they were also their adviser on general privatisation policy and the Director nominated to work on the sales had worked on the BREL sale in 1989. Early in 1994, Lazards indicated to British Rail that they would prefer not to he involved in the sales process. The director that bad been responsible at Lazards for the BRMLsales moved at tiout this time to West Merchant Bank. In Mayl 994, the Vendor Unit appointed West Merchant Bank, without a competition, to advise on the BRMLsales. The Vendor Unit told the National Audit Office that West Merchant BanFs fees overall, including a modest success fee, were comparable to other financial advisers fees.
3.41 British Rail commissioned Price Waterhouse to carry out an Accountant’s Report, audited accounts and other matters associated with the sales. They I were chosen without a competition as they were BRMEs auditors. Their fees were based on rates agreed with British Rail in September 1992 and the Vendor Unit negotiated that there would be no increases in these during the course of the sale. I 3.42 Seven firms were asked to bid for the role of legal adviser to British Rai~s Legal Department. Field Fisher Waterhouse were appointed to this position in early 1995. The lowest bid was rejected for logistical reasons relating to the location of the firm.
3.43 British Rtis toti costs relatiug to the sales (exclutig some smd overhead charges) came to E2,812,000, as set out below in Figure 7, some 8.7 per cent of proceeds.
Merchant banks 1,315 Price Waterhouse, incl audit 676 BR Propsw Board 69 Solicitors ~ncl, BR) 468 Vendor Unit negotiators 120 Other Onclutino Pflntin9) 164 2,812 Source: British Rail This figure shows the breakdown of Bfitish Rai~s costs of sale
34 BRITISHML MAINTENANCE LIMITED: SALE OF MMNTENANCE DEPOTS
3.44 British Rail told the National Audit Office that they did not find it feasible to work to a budget for each sale, They operated a budget for tbe Vendor Unit instead, Two individuals within the Vendor Unit have to sign off invoices, one of whom is the negotiator for the sale.
The Department’s costs 3.45 The Department’s costs relating to these sales comprised fees for legal and corporate finance advice and are estimated to have totaUed E274,200 (see Figure 8 below).
Preparation for sale 26,800 14,000 Sale process 65,600 167,800 This figure shows the breakdown Total 92,400 181,800 of the Depatiment of Transpotis consu Itancy costs Source: Depaflment of Ranaport
3.46 Samuel Montagu and Linklaters & Paines were the Department’s advisers for rail privatisation overall. They were selected by competitive tender and appointed on the basis of hourly rates. The Department did not agree a fixed fee as they could not quantify the work needed and believed that establishing a fixed fee would have risked an inflated fee to cover contingencies or subsequent claims for additional costs, The fees set out above for “preparation” are the Department’s best estimates of the proportion of the cost that should be attributed to the sale of the BRMLdepots. The figures relating to “sale process” are actual results.
3.47 The Department estabhshed a monitoring system whereby key members of the privatisation team were nominated as certi~lng officers, These certified each month that the work carried out by the advisers was reasonable and that they were content for the bil to be paid after having assured themselves as to the reasonableness of the bill, The t274,200 sale costs for the Department represent some 0.9 per cent of proceeds,
Indemnities 3.48 Extensive warranties and indemnities were demanded in the course of the sale. and warranties In negotiation, British Rail and the Department agreed to certain indemnities but not to others. The exact nature of the indemnities and the value of the resulting potential Eahtiities has not been disclosed publicly, in order to avoid prejudicing future British Rail sales. ., 3.49 British Rail gave warranties as to possible tax habilities, to liabilities relating to employees that were not transferred but which might make claims on the purchasers, to undisclosed employees (each depot was sold with a target number of employees. ABB and Railcare sought financial compensation if they
35 BRITISH WL WNTEN~CE LIMITED: SWE OF ~NTENMCE DEPOTS
received more than specified which did not in the event occur), and in relation to missing title to property. British Rail does not befieve that any fiabihties ti~ crystallise under the terms of these warranties. I Staff interests Assistance to management buy-out teams 3.50 British Rail put in place arrangements to encourage management and employee buyout teams to patiicipate in the sales.
3.51 British Rail assisted management and employee teams to bid in two ways - by encouraging them to assess the opportunity to bid and giving them financial assistance towards the cost of making a hid. The Board set up seminars on the privatisation process which included a session on how to become a management (and employee) buy-out team and encouraged managers with buy-out aspirations to hold prehminary discussions with the Vendor Unit who could provide practical suggestions. British Rail hadthepower to provide financial assistance to buy-out teams, and to give them a price preference of up to five per cent in the sales. The Information Memoranda stated that such teams were ehgible for up to S76,000 of assistance, the amount dependent on the stage that themanagement buy-out team reached intie sale process. Successfti management buy-outs had to repay any financial assistance. In the event, British Rail provided the following management huy-out teams with financial
assistance: 1
Q Reynolds (re Springburn) S27,025 Layline (multi site) E76,000 H Smith (Swindon ESC) S39,250
The sum of S21,999 to assist in the successful management buy-out bid for the Eastieigh depot was reclaimed in full.
3.52 The provision to allow preference in price of up to five per cent for management buy-out bids was not, in the event, used. The management buy-out bid for the Eastleigh depot did not trigger this provision as their bid was higher than the other bids received. bother management buy-out team that put in final bids was not within five per cent of the highest bids for those depots.
3.53 Twomanagement buy-out bidders said that therequirement of the Vendor Unit for them to submit a performance bond of several mi~ion pounds (depending on their workload commitment and payable on demand) set them at a disadvantage compared with larger co~orate bidders, where guarantees from the parent company were deemed adequate. The management buy-out bidders considered that this had an adverse impact upon the amounts they cmdd bid.
Employees’ terms and conditions 3.54 British Rail did not in effect agree to any changes to employees’ terms and conditions on sale. The pension rights of employees who were members of a British Rail pension scheme as at 5 November 1993 are effectively protected.
36 BRITISHBAILWINTENNCE LIMITED: SALE OF WINTENWCE DEPOTS
3.55 There wasnochange toemployees' terms andconditions onsale to the purchasers. The rights of BRMLemployees principally stem from European legislation known as the Ac@red Rights Directive which has been implemented in the United Kingdom through the Transfer of Underta~lngs (protection and Employment) ReWlations 1981 andsubse~ent measues which are often co~ectively referred to as TUPE. In addition general employment law, for example in relation to constructive dismissal is relevant. This implied that staff wmdd transfer with their jobs to the new owners of the depots on the same terms and conditions of employment, including rights to compensation for redundancy, that they had with British Rail.
3.56 Thenewemployer isatfiber~ afierthe sale torenegotiate terms and conditions. No attempt was made to Emit a buyer’s ahili@ to negotiate a change in employees’ severance terms, as has been agreed in another public sector sale, to prevent an employee being dismissed for refusing to consent to such a change. In these circumstances an individual cotid have a claim for unfair dismissal but compensation in the event of a successful action might be significantly less than that available under existing severance terms.
3.57 Ajointindust~ occupational pension scheme fortherailway indust~was set up under the authority of the 1993 Act. This gave employees of BRMCS maintenance depots statutory protection of their pension rights, which will be retained ifthebusinesses are further sold on. Staff whowere employ ed asat 5 November 1993, and were members of a British Rail pension scheme, effectively are guaranteed pension rights at least as favorable as the rights that their relevant British Railpension scheme provided on3l May1994, the date of commencement of the Railway Pensions (Protection and Designation of Schemes) Order 1994 and their employer has a legal obligation to provide an ade~ately funded occupational pension scheme which meets those re@rements. Purchasers were rewired to a~ow employees who were members of the British Rai~s shared cost section of the Railways Pension Scheme but who were not employed as at 5 November 1993 to participate in the joint industry scheme. The purchasers were not re@red to allow employees who were recruited after the sale to participate in the joint industry pension scheme unless they came from another railway business and were members of the joint industry pension scheme.
37 BRITISHML WNTENANCE LIMITED: SWE OF WNTENANCE DEPOTS
Part 4: Classification of papers as “Not for NAO eyes”
4.1 Under a long-standing ad agreed convention which Pwhmnent wae informed of in February 1988’, tie National Autit Officehave not had access to papers deabg with the conduct of a department’s business with the National Audit Office and the Pubhc Accounts Committee. Such papers faUinto the fo~owiug four categories:
a) papers dea~g with the responses to National Audit Office en~es and proposals for National Audit Office investigations and draft National Audit office reports;
b) briefing papers for a Accmmtiug Officer’sappearance before the Pubhc Accounts Committee:
c) papers deahg with the contents of Treasury Minutes responding to Pubhc Accounts Committee reports; and
d) papers, including interdepatiental correspondence, about relations with the National Audit Office.
4.2 Instructions on the operation of the convention were issued to depatients by the Treasury h Jtiy 1988. Departments shotid keep a record of W ~es designated “Not for NAOeyes”. Such designations muet be removed horn papers when they cease to be cment and specfica~y, papers relatig to National Audit Office repoti or Pubhc Accounts Committee hearhrgs shotid have the designation removed one year after the publication of the Treasury Minute replying to the relevant Pubhc Accounts Committee report. Wtemal Audit department are responsible for checking the exent of departments’ use of fles bearing the “Not for NAOeyes” designation and whether designated papers correcfly fan tito one of tie four acceptile categories.
Previous interest by the Public Accounts Committee 4.3 In 1993 the ComptroUer and Auditor General provided the Pubhc Accounts Committee widr a note on the use of the “Not for NAOeyes” convention. The Comtittee re~ested this note because e~acts from a “Not for NAOeyes” document outfiuing the working arrangements between offici~ of the Driver and Vehicle Ucensing Agency and the National Audit Office, on a National Audit Office study into Vehicle Excise Duty were pubhshed in the press. The Committee asked the ComptioUer and Auditor General to emphasise to Accountig O~cers the hnpo~nce a~ched to proper adoption of tie
. PAC 30ti Repoti, 1987-88 BR~ISH ML WNTENANCE LIMITED: SALE OF WNTEN~CE DEPOTS
convention and to unrestricted access by the National Audit Officeto departmental papers, in Ene with the powers granted in the Exche~er and Audit Departments Act 1866 and the National Audit OfficeAct 1983, The Committee made it clear that it would be tota~y unacceptable for departments to use the designation on any papers deahng substantively with their pohcies or operations, with a tiew to hampering the work of the National Audit Office.
Treasury reviews 4.4 The Treasury reviewed the arrangements for departmental comphance with the “Not for NAOeyes” convention in 1990, 1992 and 1994. Their first review concluded that departments had introduced the necessaW procedures for ensuring that the designation was not abused and the overa~ conclusion of their 1994 retiew was that the convention was operating satisfactorily within depatiments. The main problem identified was the failure of depatiments to de-classify “Not for NAOeyes” files promptiy. The Treasu~ therefore wrote to depatients in March 1995 reminding them that de-classification shodd take place one year after the publication of the Treas~ Minute replying to tbe relevant Pubhc Accounts Committee report.
Leak to The Independent Newspaper of papers on BRML sales 4.5 On 13 Febmaq 1996 the Independent pubhshed an atiicle about the sale of a British Rail maintenance and engineefig depot at Eastieigh, near Southampton, to a management team &om that depot. An internal Department of Banspofi memorandum leaked to Mr Brian Wilson, MP shadow transpoti spokesman and passed to The Independent, was cited in this aticle, The atiicle explaiued that the memorandum was headed “Restricted - No Copies to be Taken, Not for NAOeyes” and said that a repofi by Price Waterhouse, on behaM of British Rail, had expressed concern that the management team which bought the depot may have done so using cash balances which had accrued while the business was in pubhc ownership. The Price Waterhouse document refereed to was, in fact, a draft.
4.6 In this case the National Audit Office had akeady asked the Depafiment about the position as regards cash balances, in connection with their study of the sale. So not seeing the document produced by the Depaflment and classified as “Not for NAO eyes” ( text at Appendti 7) at that stage did not hamper their study. Nevefiheless most of the subject matter wotid have been relevant to it. I was therefore reassured to have the Depatient’s confirmation that, as the document itse~ states, it was theti intention to set out thek concerns to the National Audit Office once they had a clewer understanding of the issues involved. When the Depafiment received a copy of the final version of the Price Waterhouse repoti, which cotied many of the concerns in the draft and before the Independent aticle wae pubhshed, the Depatiment alefied the National Audit OfRceto the issues, sent them a copy of the repofi and intited them to participate in a study by Ernst& Young of the BRMLsales which they had commissioned.
39 BRITISHML WNTENANCE LIMITED: SALE OF WNTENANCE DEPOTS
Application of the “Not for NAOeyes” convention in the Department of Transport 4.7 In1994, the Department carried outaone-off review of files classfledas ``Not for NAOeyes” following a Parliamentary Question in November 1993 which asked how many “Not for NAO eyes” files the Department held. A review by the Department’s Internal Audit Division wbo are responsible for checking the application of the “NotforNAOe yes” convention found thatthere were 684 such files at that time. Following their review this reduced to 86. Nthough the Department’s records management division amended their computer records to show these as de-classified files to remove any reference to “Not for NAOeyes” the privacy marking used to identify such files was not removed. There is a risk that file holders may continue to treat ahnost 600 files as “Not for NAOeyes” and they may not, therefore, be made available to the National Audit Office.
4.8 In March 1996 tie National Audit Officereviewed the Depa~ent's procedmes, the work of internal audit and examined a sample of de-classified “Not for NAO eyes” files. They concluded that there are several areas where the procedues need to be strengthened. There has been only hmited action hy the Department to follow up the recommendations made in internal audit’s 1994 report. Most of their concerns and recommendations have been raised again in their most recent report, produced in February 1996.
4.9 The Department provided the National Audit Oticewith ahstof``Notfor NAO eyes” files which bad been archived but this dld not record if and when files had been de-classified and a number of the files examined were still marked with the “Not for NAOeyes” designation. The Department also provided the National Audit Officewith a hst of documents currentiy classified as “Not for NAO eyes”. The National Audit Officefound that seven of these appeared on both the classified and de-classified fists, demonstrating there is confusion in the Department as to which files have been de-classified and those that remain “Not for NAOeyes”.
4.10 Examination ofinternal audit's report andworting papers aIsorevealed several areas where improvements are needed. For example, internal audit had identified files that had been correctiy shown as de-classified by the Department’s records management division, but file holders had not been informed of the de-classification. Intheir 1994 report internal audit recommended that the Department should ensure that all file holders are told when files are de-classified. The Department have not actioned this recommendation and it has been raised again by internal audit in their February 1996 report. There remains a risk therefore that files are not being made available to the National Audit Office.
4.11 Alargenumber oftie``Not for NAOeyes'' files examined by both internal audit and the National Audit Office contained papers which were out with the criteria hstedin paragraph 4.1 above butwhich had been copied onto the files for completeness. Internal audit have confirmed tiattiese papers would have been available to the National Audit Office on operational files despite there being no
40 BRITISH ML MMNTENANCE LIMITED: SALEOF~NTENANCEDEPOTS
cross-references to facihtate a check that this is so. Akhough internal audit dld check this by asking holders of operational files to demonstrate that such papers were included it wodd be helpful if they were properly cross-referenced. In addition the National Audit Office found that genuine “Not for NAO eyes” papers were often not IabeUed as such and were not coded to show which particdar criteria they fe~ into.
Future action 4.12 The Department are responding to these findings. An examination of the Railway Privatisation Directorate’s files, carried out in February 1996, by the Department’s internal auditors found that papers were, almost without exception, properly classified and filed. N “Not for NAOeyes” files recorded by the Department’s records management division wi~ be examined by July 1996 to identify those which should be de-classified. The Department have informed the National Audit Office that currently they have 78 correctly classified “Not for NAOeyes” files. The Department have issued a revised guidance note to all staff setting out the procedures for classifying and de-classifying “Not for NAO eyes” papers. In future, files being de-classified wi~ be marked accordingly and computer records will show when this occurs. And an annual check will be carried out hy the Department, in addition to internal audit’s review, to ensure au relevant files have been de-classified. The Department will also follow up recommendations made in Internal Audit’s recent report to improve their record-keeping of “Not for NAOeyes” papers.
4.13 As part of their departmental monitoring the National Audit Office check the operation of these procedures to ensure that files are declassified promptly. The National Audit Office also examine the contents of declassified files to check that they fall within the criteria set out in paragraph 4.1 and had been correctly classi~ed as “Not for NAOeyes”.
41 BRITISH WL WNTENWCE LIMITED: SWE OF WNTEN~CE DEPOTS
Glossary of terms
Accountants’Report the accountants’ repoti in respect of the businesses for sale prepared hy Price Waterhouse.
CompletionBalance the date of the final consideration accounts upon which adjustments to net SheetDate assets were determined (31 March 1995 for Eastleigh and Swindon, and 27 May 1995 for the other depots).
CompletionDate the date upon which the sales were actua~y effected (5, 6, 7 June 1995).
Dataroom a site where prospective purchasers have access to documents relating to the sale of the business.
Discomtedcash flow an investment appraisal technique in which estimated future costs and revenues are expressed in terms of their present value.
Due Wgence a process by which the preferred bidders verify if the facts and assumptions obtained at the time of their bid are still accurate at the time the sale is completed.
ExternalFinancing a ceiling on the amount of finance, whether grant, subsidy or borroting whlcb Contribution a nationalised industry may raise during a financial year to supplement the income from its trading activities,
The General a formal document supplied to prospective purchasers containing general Information financial and other information about the businesses offered for sale. Memorandum
Information the General Information Memorandum plus a formal document in respect of Memorwda each depot giving information supplementary to that contained in the General Information Memorandum,
InteUectuaf Property tbe legal reco~ition of the ownership of new ideas, giving the proprietor the rights right to prevent their exploitation by others.
Management (and the purchase of an entity led by the management (antior employees) in which Employee) Buy-Out some of tbe shares are held by, or on behalf, of existing managers and employees.
Preferred bidder a bidder whose bids were initially accepted by the vendor. FoUowing the selection of preferred bidders, negotiations then took place to complete the sale.
Property clawhack arrangement for a vendor to receive a proportion of any subseWent profit from resale of properties. Such provisions are time-limited.
42 BRITISH ML UNTENWCE LIMITED: SALE OF WNTENANCE DEPOTS
Reference Balance the audited accomts for the depots as at 17 September 1994 upon which Sheet bidders were invited to submit final bids,
Robg Stock one of three rofing stock leasing companies formed as who~y-owned Le~fig Company stisidiaries of BRB. On 1st April 1994, these three companies were vested with the vast majority of the existing fleet of BR domestic passenger ro~lng stock and they are responsible for the heavy maintenance of this fleet.
Sale and Pnrchase a formal legal document spec~lng the detailed arrangements for the sale. Agreement
Stage 2 bidders persons invitsd to submit final bids on 20 January 1995
43 BRITISHML WNTENNCE LIMITED: StiE OF WNTEN~CE DEPOTS
Appendix 1
Objectives of the Secretary of State in relation to rail privatisation
1 The Secretary of State for Transport’s objectives for the privatisation of the rafl industry are laid out in the Railways Act 1993.
2 The principal objective is to secure as soon as, in bis opinion, is reasonably practicable the result that the function of providing railway services in Great Britain is performed by private sector operators.
3 Tbe Act goes on to say that in pursuing that principal objective, the Secretary of State shall have regard to the desirabi~ty of:
a) encouraging competition be~een those who provide railway services;
b) maintaining efficiency, economy and safety of operations in the provision of railway services in Great Britain;
c) providing opportunities for persons employed in railway undertabngs to acquire (whether alone or jointly with others) an interest in the omership of the undertakings in which they are employed; and
d) securing that the disposal takes place on the most favorable financial terms that can reasonably be obtained in all the circumstances of the case.
and for the purposes of paragraph (d) above, financial terms may be regarded as “favorable” no~ithstanding that any expenses incurred in procuring or effecting tbe disposal are not exceeded by any proceeds of sale arising from it.
44 BRITISH BAILMAINTEN~CELIMITED: SALEOFMAINTENANCE DEPOTS
Appendix 2
Map of locations of depots sold, their main functions and type of vehicle usually repaired at each depot
r Doncaster r Diesel-electfic and electric locomotives, ~esel multiple units, overhead line electric ~ik multiple units and hauled coaches. /
Diesel-electric and electric locomotives, diesel multiple units, overhead Hrreelecttic &q ‘L: multiple units, and hauled WolvertOn g$q$% coaches Overhead line electric multiple @#g*j&L@ / units and hauled coachea
Repairs, tests and caflbrates electronic equipment used on traction and rolling stock
\ Chart Leacon w“ “ / Third rail electflc multiple units Eastleigh and diesel electric multiple Electio diesel locomotives, units. third rail electtic multiple units, diesel multiple units, and hauled coaches.
Note: The depots are capable of handling virtually any type of dismantling, maintenance, modification or damage repair of traction and rolling stock, and related components and spares.
45 BRITISHML MNTEN~CE UMITED: SWE OF NNTENUCE DEPOTS
Appendix 3
Chronolo~ of main events
,ul,l,~ Issue of information memoranda. * 7 Septembe ~994 Receipt of indicative bids. t 250ctober~994 Issue of invitation for final bids.
21 Decembe! 994 Updated information on reduction in staffing levels made available to *}I bidders, 4 20 January :995 Receipt of final Mds. [ 3 March 1 ~ 5 Revised final bids requested on the basis of improved workload forecasts. BY 13 Apfil 135I Completion of the sale of the Swindon Electronic Service Centre. 28 Aoril, 1F95 Announcement of preferred Molders for the six heavy maintenance depots.
25/26 May }95 Brifiah Rail Vendor Unit submission to the BRB Executive seehng authotisafion to complete the sales.
“! June 1+ . Secretary of State’a consent to the sale of Chart Leacon, Ilford and \l Doncaster depots,
5Junei99 Secretaw of State’s consent to the sale of Wolverton, Sptingburn and Eastleigh depots.
5 June / 95 Completion of the sale of Chafl Leacon, Ilford and Doncaster depots.
6 Jun kx 995 Completion of the sale of Wolverton and Sptingburn depots. Y 7 June 1995 Completion of the sale of Eastleigh depot.
46 BRITISH ML MAINTEN~CE LIMITED: SALE OF MMNTENANCE DEPOTS
Appendix 4
Main participants in the heavy maintenance market
N manufacturers of ratiway vehicles and related components are actual or potential providers of heavy maintenance services for such vehicles and components.
The following companies are the main firms that undertake heavy maintenance:
ABB Transportation Babcock Rail Bombardier Prorail GECAfsthom Hunslet Barclay Metro-CammeH (part of GECMsthom) RFS Industries
As we~ as the BRML depots, some Eght maintenance depots owned by the Train Operating Companies undertake a smati amount of heavy maintenance for tbe Roffing Stock Leasing Companies and freight companies. There shodd be scope for these to undertake more heavy maintenance work after they have been transferred to the private sector once franchised.
47 BRITISH WL WNTENWCE LIMITED: SWE OF MAINTENANCE DEPOTS
Appendix 5
The issue of cash in the Eastleigh sale
1 Wessex Traincare, the successful management bidder for the Eastieigh depot a~eed to pay S5.6 milhmr for the net assets of the business as at 17 September 1994. At 31 March 1995, the depot contained f5.4 mil~on cash Some El .549 million has been returned to British Rail as a completion adjustment reflecting changes in net assets between 17 September 1994 and 31 March 1995.
Whether surplus cash existed
2 To assess whether there was any surplus cash in the business as at 31 March 1995 the National Audit Office examined the business plan prepared by the management buy-out team and their advisers in Fehrua~ 1995 and which was submitted to the Vendor Unit prior to the acceptance of the revised bid.
3 The National Audit OffIcecompared the change in net assets (excluding cash) shown in the audited and agreed completion accounts at 31 March 1995 with that forecast in the business plan. This analysis is set out in Fi~e 1.
Projected ‘Completion ~ . ~ “ “’ : ‘.’ ~ “ business plan as at balance sheet at February 1995 31 March 1995 Difference fooo fooo fooo
Cash at bank 8 5,376 5,368 Net assets m m m Net Assets less cash 15,218 13,415 (I,8D3) Change in Net asseta excluding caah B
Soume: National Audit ONce
4 To estimate whether potential surplus cash existed as at 31 March 1995 the National Audit Office analysed the projections in the business plan covering the period to March 1998. These showed that the maximum funding required for the continuing operation of the Eastleigb depot over the period, assuming a fnil position as at 31 March 1995, would have been S0.2 million. In order to provide a contingency element, which would invariably be required, this funding requirement was rounded to EO.5 mil~on. The potential surplus cash as at 31 March 1995 was therefore estimated as follows (Figure 2 opposite):
4s BRITISHRAIL MAINTENANCE LIMITED: SALE OF MAINTENANCE DEPOTS
Source: National Audit Office
5 Figure 2 demonstrates that the potential net surplus cash (after taking into account proceeds payable to British Rail) may be estimated as approximately S1.5 million, This balance reflects an estimate of the amount of cash which could be withdrawn from the business without impacting upon future trading or resulting in additional borrowings which would in turn reduce maintainable earnings. The National Audit OffIcereco~ise that as titb any business plan there is always the potential for siWificant and mexpected changes to the actitity leveb of the bushess. The National Audit Officerequested but were not given access to Wessex Traticare’s financial records to ve~ the achievement of the plan.
6 Wessex Traincare dispute the EO.5 milhcm estimate in the National Audit Office analysis. They cite a minimum finding headroom requirement of S2 milHon as quoted in their business plan and against which financing was secured. However, the National Audit Office’sanalysis of the plan also shows that the cash flow projections for 1995-96 reflected a maximum requirement in the month of October 1995 equivalent to S202,000 (S1,858,000 (the external injection of funds) and the closing October balance of S1,656,000). Thus, on the basis of the analysis in the business plan, the National Audit Office believe that EO.5 million appears a reasonable estimate of the funding requirement.
Possible impact on proceeds of surplus cash
7 To the extent that the increase iu cash was accompanied by an increase in net assets be~een 17 September 1994 and 31 March 1995 there wotid not have been an tipact on the actoal sale proceeds. Under the aWeed sale s~c~e, the consideration payable was increased or reduced by the amout of the hcrease or decrease ti net assets betieen 17 September 1994 and 31 March 1995,
8 In formulating their bid the Wessex Traincare buy-out team were clear that they were buying assets which would be the sobject of a price adjustment to represent the change in net assets, including cash, be~een 17 September 1994 and 31 March 1995. However, the business plan assumption was that the cash balance at 31 March 1995 would be just S8,000.
Conclusion
9 The National Audit Office conclude that there could potentia~y have been swplus cash in the Eastleigh depot of some El.5 million.
49 BRITISHML MNTEN~CE UMITED: SWEOF~NTEN~CE DEPOTS
Appendix 6
The Committee of Public Accounts: Previous recommendations relevant to the sale of British Rail’s heavy maintenance depots
In examining the sale of British Rai~s hea~ maintenance depots, the National Audit Office compared the Department of Transport’s actions against previous recommendations made by the Committee of Public Acconnts on the handhng of earfier sales. The relevant recommendations are set out below.
Roles and responsibilities Clear sale responsibilities are established as In all cases where sales take place at one The Department accepts the need for a clear soon as possible be~een the depatiment and remove from the depatiment the roles of each definition of responsibilities in such sales. the vendors (Sale of the Scottish Bus Group paw should be clearly defined at the outset. (Sale of the Scottish Bus Group 21st Report Para 11, HC 884) We are therefore concerned that there was 1993-94, Pars 83, Cmnd 2602 some initial uncertainty in the sale of the Scottish Bus Group aa to the respective responsitihties of the Depaflment and the Group. This was a weakness which should have been avoided, and we will expect depaflments to eatabtiah much more clearly defined roles and relationships in future. (Sale of the Scottish Bus GmuE 21st Report 1993-94, Para 4~), HC 97)
Method of ssle The Governments decision to grant exclusive We recommend that...An~Mng other than full The Government agrees that, wherever negotiating rights to British Aerospace up to and open competition should be the exception, practical and consistent with the objectives for the end of Apri 1988 was based on the view (Sale of Rover Group PICto British Aerospace sale, full and open competition mwimises that the benefitsof competition were PIL 1st Repofi, 1991-92, Para 70), HC51) value for money from the sale of government outweighed by the risk to Rover Group’s assets. (Sale of Rover Group PICto Bfltiah prospects arising from the uncertainty that Aerospace PIG 1st Report HMT, 1991-92, would be associated with a competitive Para 2, Cmnd 509) sale....They were also aware of the advice given by Bating Brothers and Co Ltd..that it was essential to create a competitive market if confidence was to be achieved that the best terms available were obtained. (Sale of Rover Group plcto British Aerospace PIG 1991-92, Para 4(a), HC 9)
50 BRITISH RAIL MAINTENANCE LIMITED: SALE OF MAINTENANCE DEPOTS
(the Department) did not state specifically In any case where pubic asaeta are sold in The Government will continue to make all at the earliest stage that they were interested competition, it is essential that all bidders have relevant information available to bidders in ita only in offers that severed all connections a complate and claar understanding of the futura salea of pubhc assets. (Sale of the Skills between the Depatiment and the seller’s requirements. (Sale of the Stills Training Agency 19th Report HMT 1991-92, purchaaer...aome potential purchasers did not Training Agency; 19th Reporf 1991-92, Para 17, Cmnd 1998) appreciate that the department were prepared Para 2~v), HC 117) to consider bids which offset the restructuring Costa againat the offered price,,, and did not proceed with a final bid, (Sale of the Skills Training Agency 1991-92, Para 32(g), HC484)
The Department sold most of tha skill centres the .... management buy-out team were treated The Department welcomes the Committee’s to a management buy out team, They took on the same basis as other bidders. (Sale of recognition of the steps it took to secure equal proper measrrrea to ensure that the team had the Stills Training Agenc~ 19th Report treatment for all bidders and potential bidders, no unfair advantage over other tidders. 1991-92, Para 2(v),HC117) (Sale of the Skills Training Agency 19th Report (Sale of the Stills Training Agency; 1991-92, HMT 1991-92, Para 18, Cmnd 1998) Para 32(i), HC484)
The company’a management still wished to we consider it an important principle that all The Department agreea with the Commitfeek withhold ceflain information about the terms of sehoua bidders ahordd, as far as possible, be conclusion. The Department betieves that all liCenCeaon grounds of confidentiali~ and given as much information as is needed to serious bidders should be given aa much commercial aensifivity, but the department ensure that there is fully informed competition information aa necessary to encourage took further steps to make as much among bidders, (The Sale of 8tifiah informed bids... Where management information aa possible available to bidders, Technology Grou~ 32nd Report 1993-94, Para participation in a bid occurs, the Department One of the consotia who complained withdrew 2fl), HC273) strives to release as much information as from the sale. (The Sale of 8ritish Technology possible to ensure fairness, (The Sale of Bdtish GrouE 1993-94, Para 12, HC 59) Technology Group 32nd Repoti HMT 1993-94, Para 54, Cmnd 2677)
Marketing In all the merger cases at Barrington and ,., we regard the retiance on “discreet The Government accepts the principle of open Runcorn, and moat of those at Telford, the appmachea” to selected firms as competition when privatiaing functions and parfnera were not selected competitively, unsatisfacto~ and we beheve that pubhcising services and that appropriate and effective In 1988 the departments internal auditors the pflvatisation programme more widely publiciw is a key element in attracting noted that privafiaation at Telford had largely might have secured better value for money ... m%imum competition and so ensuring best been by single tender contracts involving (PtiVatiaafiOn of Work in New Town 8odies in value for money. The Department accepts that, former employeas, (Privatisation of Work in England; 19th Report 1990-91, para 2(vi), where contracta for the privatisation of New Town Bodies in England; 19th Report HC 440) functions are to be let on a competitive basis, 1990-91, para 5(f,g), HC 447) [here should be appropriate pubticiW, (Privatisation of Work in New Town Bodies in Englant 19th Repofl HMT 1990-91, Para 47, Cmnd 1617)
continued,,.
51 BRITISH ML MMNTENNCE LIMITED SWE OF WNTEN~CE DEPOTS
Valuation itiaimpotiant,whatever negotiating Before entering negotiations, we expect the the Government beKevesthat the pmcesa of arrangement are made, for the Government to selting depatiments to make their own determining what is, or is not, a reatisfic price estabhsh as reaflsfic a valuation as possible of comprehensive valuation of the undertaking to for the assets being sold is best achieved by a the undertaking to be sold. The NAO be sold.. such as by reference to a realistic competitive market ..... The Government agrees acknowledge that the paticular circumstances eafimate of the business’s future earnings or to that it maybe appropriate, in some cases, to m histow of an wrdertating may make this the wotih of its capital assets. (Sale of Rover employ a benchmark or range of benchmarks difficult but believe that awareness of this Group plc to British Aerospace PIG 1st Report in assessing tender bids .....The Government fi9Ure would enable the Government to set the 1991-92, Para 7U), HC 51 ) beleves that any such benchmark will be an price against their assessment of the value of aid to judgement only, to be weighed against non-financial benefits. (Sale of Rover Group the o~ecfives of the sale and other factors PICto British Aerospace PIG 1991-92, Para 9, affecting the sale decision. (Sale of Rover HC 9) Group PICto British Aerospace PIQ Ist Report HMT 1991-92,para6,Cmnd1619)
Propetiyvaluation and clawback It was also open to the Oapaflment to include departments should ensure that they have The Treasu~ beheves that within the paticular in the sale contract a clawback provision to up-to-date valuations, including where circumstances of each sale all the appropriate protect the taxpayers’ interests and cover the appropriate, potential development values of options for protecting the tmpayer’ interests in possiboify that there would later be a land and other assets, before a privatisation relation to propew assets are fully considered. substantial increase in the value of the sites sale. Where land is considered to have As regards clawback, a range of considerations sold. The NAVS consultants considered a development potential, setious consideration will need to be taken into account. Its use will clawback provision would have been prudent should be given to all the options for generally make the business less attractive to and appropriate in the circumstances... The protecting the twpayers’ interest, including a potential purchasers, and thus reduce initial Oepaflment and Rothschild did not consider separate sale or the use of clawback proceeds, w~lat future benefits to the the possibitiW of a clawback provision.. they provisions. (~nistry of Oefence: Further Exchequer are necessarily uncertain.. its use believe any such proposal would have reduced Examination of the Sale of Royal Ordnanct needs to be assessed in the tight of..other the immediate proceeds with no real prospect 13th Report 19B9-90, Para 3(v), HC 352) issues enabhng the taxpayer to share in the of increased total return.. .The Depatiment also proceeds of propew development maybe cost believe a clawback provision would have effective as a single change to the terms of reduced the Company’s freedom to develop its sale.. but may not be so if the Governments as commercial business and would have led to a vendor is forced to concede provisions on potential confhct of interest for the Oepaflment downside tisk. (Ministw of Defenc& Further in that it would have retined a financial Examination of the Sale of Royal Ordnanc& interest in as one of its ptintipal contractors. 13th Repofi HMT 1989-90, Para 25, Cmnd (Ministv of Oefencti Further Examination of 1150) the Sale of Royal Ordnancq 1989-90, Para 6, HC448)
continued...
52 financial control In WO inSknCeS the contracts included a We are concerned that additional payments The Department notes the concerns of the terminal bonus on the successful complafion were made to advisers in circumstances where Committee about additional payments made to of the work. The Department told the NAO that there was not a clear obtigafion to do so and certain consultante...The additional payments assessing the performance of these advisers no clear evidence to support the amount paid. reflect reasonable reward under the contracts was necessaflly based on judgement rather (Sale of the Water Authorities in England and for the successful completion.,, (Sale of the than pre-determined performance criteria. Wale$ 7th Report 1992-93, Para 3(xiv), Water Authoflties in England and Wale> 7th (Sale of the Water Authorities in England and HC 140) Report HMT 1992-93, Para 104, Cmnd 2074) Wale$ 1992-93, Para 28, HC 256)
Other work outside the fixed fee arrangements While we note the depaflmenfs reasons for The Department strongly endorses the were also undertaken by the groups main dispensing with competition in this case, we Committee’s view on controlhng the costs of advisers and by other professional firms,.,. In emphasis the need for the proper control of sale of public assets and the use of competitive the group’s view, this work did not lend itself to costs in the sale of pubfic assets. In paticular tendedng.. .The Department believes that, in a99re9a~0fl for separate tender action and was we look to depatiments to demonstrate these circumstances, efficiency and value for not of a scale to warrant further competition. proprie~ and the achievement of value for money gains were achieved through the Total expenditure by the group on such work money through competitive tendeting. group’s limited use of such fhms. (Sale of the amounted to f787,000. (Sale of the Scottish (Sale of the Scotish Bus GrouM 21st Report Scottish Bus Group 21st Report 1993-94, Bus GmuM 1993-94 Para 4.4, HC884). 1993-94, Para 4(xiii), HC97) Para 9, Cmnd 2602)
53 BRITISHML ~NTENANCE LIMITED: SALE OF WNTENANCE DEPOTS
Appendix 7
Text of Department of Transport Memorandum on BRML classified as “Not for NAO eyes’”
Note: This Memorandum refers to a draft of a document prepared by Price Waterhouse for the British Rail Board.
From Mike Fuhr R2BRS 19 October 1995
cc MS Wmms MrWadsworth MrLobo
BRMLPROCEEDS
1. James Jerram agreed that David Redfern should send me the attached draft of the body of the report on a ‘Gpersona~ basis.
2. Mthough the draft makes some damning criticisms of the Vendor Unit, it is woolly and leaves far too many ~estions unanswered. The main deficiency though is that PW were asked to look only at the Eastleigh sale. That is not what I thought BR were doing. Akhough the MBOsale presents a greater risk, we need to know about ABB and Babcock Siemens too. Did they know that there were large cash balances at completion or were they the happy recipients of an unexpected bonus?
The Repofl
3. The key finding is that the Vendor Unit was operating tithout satisfacto~ conduct guidehnes and that neither they nor West MB ade~ately documented the sales, eg:
* WestMerchantBankhavetoldtheNationalAuditOffIcethattheykeptdetifledrecordsof meethgsthattheywereat andhaveshow theseto BritishRaflandtheDepatient and spectiens to the NationalAudit Ofice.
54 BRITISH WIL MMNTENANCE LIMITED: SALE OF MMNTENANCE DEPOTS
Mid page 5 — absence of detailed minutes of discussions with bidders or advisers. a cornerstone of sound commercial practice
Top of page 9 - the decision process in shorthsting the management hid inadequately documented
Mid page 15 provision of information to prospective purchasers - audit files incomplete
Mid page 16 assessment of bids largely undocumented
4. Other points:
Page 7 - suggests that the management team bougbt Eastleigh with BR’smoney
Page 9 — the comment at the foot of the page that BR shotid have considered closure costs cannot be right. We asked for and saw closure estimates,
Page 10 — confirms that the MBOwi~ have known about the building cash balances while they were negotiating the consideration.
Page 11 — says that the Information Memorandum made clear that cash was included in the sale. That needs clarification. The general Information Memorandum for BRMLsaid that indicative offers shotid be made on the basis of the 31 March 1994 balance sheets in the individual Depot Information Memoranda, taking account of cash extraction at Chart Leacon and Ilford (amounting to about E5.5m). The cash balances in the individual IMs, after allowing for cash extracted, totalled less than El OOk.So, as PW say, a decision to change the terms to exclude cash would have been fu~y justified when, during analysis of final bids, the cash generation was evident. But PW add there is nothing to suggest that the sales team Wendor Unit and West Merchant Bank, presumably) even considered this.
Page 13 at the foot, PW remark BRMLas one of the first disposals, implying inexperience. But BR were advised by the same merchant banker who, with Datid Blake, had handled the sale of BREL.
Page 15 - suggests the W were not foHowing the Key Audit Trail Document - WTD - (presumably the same as the “audit fde index”), specifically confirmed by David Blake’s letter to me of 15 February 1995 as having been put into effective operation some months earher. (his letter ends “We are working strictly to the KATD”).
Page 16 – PW say (second indent) that the level of cash in the business may not have been known to all bidders, That needs confirming whether different bidders were treated differently is vital.
Pages 17 and 18 - the section on information available to BRB deals with the Vendor Unit papers put to both to the Board and the Department. PW say (second paragraph, page 18) that tbe cash in the business not being raised for consideration hy Board
55 BRITISH WL ~NTENNCE LIMITED: SWE OF ~NTENMCE DEPOTS
Executive was “crucia~; and that there was no evidence to suggest that the possihili~ of altering the sale terms was explored. But have PW asked any of the key players why the Board was not told about the cash balances?
Questions outstanding
5. PW have not done all the job their remit appears to allow. Some key questions have not been addressed. They should be. My Est - and I’m open to offers is:
a. what about the other depots, including the Swindon sertice centre? (Not within PW remit, but BR need to add it).
b. at what point did buyers, especially Eastleigh MEBO, know that they were getting the cash? Was it factored into bids? If so, when?
c, why did the sales team not expose the cash position to the BoartiDOT?
d. why were W not working to the agreed Key Audit Trail Documentation note and the Sale of Undertakings Procedures?
e, why were negotiations not documented adequately?
f what is BRB’sloss? When did BR HQ reahse what had happened, and was there ever any chance of recovery?
g what process is recommended to preclude recurrence?
f any similar skeletons in other completed sales?
6. I doubt if there is much point in asking such questions of David Redfern. WIU you have a chance of a quiet word with James Jerram, who is running the study? It would also be helpful if you could update Patrick Brown, though only ora~y until we have a final PW report.
7.1 should be grateful if Gerard Lobo could ask Ernst&Young for a view on how much of the proceeds have been lost, on the basis of the PW numbers.
8. I have separately asked Marilyn Waldron to check on progress of the outstanding meeting with the NAO on their study of the BRMLsale. I sha~ not send them the PW draft - there could still be changes. But much better they hear the news from us than elsewhere. Do you and others, Brain Wadsworth, in patilcular, agree that we should forewarn them before, say, the end of next week?
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