NATIONAL AUDIT OFFICE REPORTBY THE COMPTROLLERAND AUDITOR GENERAL The Sale of the Twelve Regional ElectricityCompanies ORDEREDBY THEHOUSEOFCOMMONS TO BE PRINTED 6 MAY1992 LONDON:HMSO 10 f7.10 NET \ THE SALE OF THE TWELVE REGIONAL ELECTRICITY COMPANIES This report has been prepared under Section 6 of the National Audit Act, 1963 for presentation to the House of Commons in accordance with Section 9 of the Act. John Bourn National Audit Office Comptroller and Auditor General 31 March 1992 The Comptroller and Auditor General is the head of the National Audit Office employing some 900 staff. He, and the NAO, are totally independent of Government. He certifies the accounts of all Government departments and a wide rangeof otherpublic sector bodies; and he hasstatutory authority to report to Parliament on the economy, efficiency and effectiveness with which departments and other bodies use their resources. i THE SALE OF THE TWELVE REGIONAL ELECTRICITY COMPANIES Contents Pages Summary and conclusions 1 Part 1: The companies and the sale 7 Part 2: Achievement of objectives 9 Part 3: Control of costs 23 Glossary of terms 27 Appendices 1. Electricity industry restructuring 28 2. The twelve companies 30 3. List of the principal advisers and contractors appointed by the Department 31 THE SALE OF THE TWELVE REGIONAL ELECTRICITY COMPANIES Summary and conclusions 1 In December 1990 the Secretary of State for Energy sold the twelve regional electricity companies in England and Wales. The Department of Energy (the Department) estimated that gross proceeds will amount to some E7.9 billion, payable in two forms: nearly E5.l billion, in instalments, from the sale of the shares and some E2.8 billion from staged debt repayments. Since the sale the Department have been merged with the Department of Trade and Industry who are now responsible for the matters dealt with in this report. 2 This was one of the largest sales since 1979. It was also one of the most complex, involving the simultaneous disposal of all the Government’s shareholdings in the twelve regional electricity companies, who distribute and sell electricity to customers in England and Wales. The sale introduced an entirely new sector to the London Stock Exchange. It followed a radical restructuring of the electricity industry’s organisation and its commercial and regulatory arrangements. It was the first of an ambitious series of three sales planned in the British electricity sector, to be followed by the sale of National Power and PowerGen, who generate electricity in England and Wales, and the Scottish companies ScottishPower and Hydro-Electric. 3 The twelve electricity companies were floated on the London Stock Exchange by means of a fixed price offer. Shares totalling some 2.1 billion were offered for sale at Q.40 each, payable in three instalments. 4 The Government’s overriding objective was to complete the sale of the electricity industry during the lifetime of the Parliament. Within that overriding objective, the Department sought: to maximise net proceeds; to widen and deepen share ownership among individuals; to achieve the overall recognition that the sale of the regional companies had been a success; and to achieve a modest premium over the issue price following the start of share dealings. 6 This report sets out the results of a National Audit Office examination of how far the Department achieved their objectives for the sale and how they controlled its costs. During the course of their work, the National Audit Office examined Departmental papers, held discussions with Departmental officials and advisers, and consulted the Chairmen and senior executives of three of the companies. The National Audit Office were assisted in their work by Hambros Bank Limited and SRU Limited, strategic market consultants. Achievement of 6 The National Audit Office’s main findings and conclusion are: objectives On the overriding objective of completing the sale to timetable (a) The Department completed the sale of the regional electricity companies by their December 1990 target, paving the way for the generating companies to be sold in March 1991 and the Scottish companies by June 1991 (paragraphs 2.2 to 2.6). 1 THE SALE OF THE TWELVE REGIONAL ELECTRICITY COMPANIES On maximising net proceeds Method of sole (b) In floating the companies, the Department took appropriate steps to identify and evaluate a variety of options that might help maximise net proceeds. Introducing major innovations into the chosen method of sale would not have been without risk to achieving this objective, given the novelty of the companies and the considerable uncertainty of the market at the time of the sale (paragraphs 2.9 to 2.16). (c) The National Audit Office recognise these uncertainties but, with the benefit of hindsight, note that if a back-end tender- which the Department succeeded in implementing for the first time in the subsequent sale of the generating companies-could have been successfully introduced in this sale, it would have enabled the Department to share in the increase in the value of the companies which, in the avant, took place during the offer period. In the circumstances at the time of the sale, however, the Department accepted the strong recommendation of their advisers that introducing such measures would have entailed risks to the success of the sale, and to proceeds, outweighing the potential gain. Valuation of the assets (d) The approach adopted by the Department to the valuation of the companies’ assets was reasonable in the circumstances of this sale (paragraphs 2.20 to 2.23). Clawback [e) The Department introduced provision for clawback on gains arising from the disposal of land and buildings between 31 March 1990 and 31 March 2000 (paragraphs 2.24 and 2.25). (f) The Department also considered but did not introduce provision for clawback on profits. The view of the Department and their advisers was, and remains, that the existence of such a provision would have altered the basis on which the negotiations on dividends took place. Their view is that, if profit clawback had been introduced, they would have had a much reduced chance of achieving the levels of dividend that they soughtand obtained, and an increasedchance of havingto sell the companies at a less advantageous yield, and that either of these factors would have had more of a negative impact on proceeds than the potential profits to be clawed back (paragraph 2.26). (g) Overall profit outturn for 1990-91 was 22 per cent (E214.4 million) higher than forecast. The Department note that dividends, which are the main determinant of proceeds, were however set on the basis of underlying profit performance not on the first year profit forecasts, which were necessarily set on a cautious basis (paragraphs 2.27 to 2.30). In view, however, of the limited track record of the companies and the correspondingly cautious basis on which forecasts for the first year were made, the National Audit Office and their advisers, Hambros, believe that it would have been appropriate for the Department to have explored in detail with their advisers whether higher net proceeds might have been achievable by making provision for clawback of a proportion of at least some part of any profits exceeding the forecast for 2 THE SALE OF THE TWELVE REGIONAL ELECTRICITY COMPANIES that first year. Even such a limited clawback would have called for a careful assessment as to whether a provision along these lines could be implemented without greater negative impact either on the dividends which the companies would be prepared to offer, or on the dividend yield which investors would be prepared to accept; and of course for careful presentation to companies and investors. The assessment of the Department and their advisers is that any benefit from such a provision would, in this sale, have been significantly outweighed by the loss of proceeds likely to have resulted from lower dividends or higher yield, or a combination of both. Sale of all the shoreholding (h) The Department kept open the possibility of selling only part of the Government’s shareholding (60 per cent), in case there was a severe deterioration in market conditions. In the event, however, they proceeded with a 100 per cent sale because they saw it as offering the best balance of risk in the circumstances (paragraphs 2.36 to 2.41). Pricing the offer (i) The Department set the fully paid value of the shares at nearly E5.2 billion. In so doing, they sought the best price they thought they could get in negotiating the sale of these new companies during a period of unsettled market conditions (paragraphs 2.46 to 2.52). (j) Following the start of dealings, the market valued the shares at E6.3 billion. The Department’s advisers attribute this to upward movements in the stock market between the time the offer had to be priced, when market conditions were uncertain, and the start of dealings (paragraphs 2.53 to 2.60). (k) The National Audit Office’s consultants, Hambros, agree that most of the increase in the value of the electricity companies above the Department’s target premium was attributable to the upward movements in the market generally, and in particular to the increase in gas and water shares. The causes of these upward movements are likely to remain unclear because they flowed from the investment decisions of a large number of individual institutions. On widening and deepening share ownership Targets/planning assumptions (1) The Department succeeded in meeting their broad planning assumption for the number of individuals who might register their interest in the sale. The Department’s planning assumptions about the minimum level of subscription they saw as desirable, and their initial estimate of the number of applications to be processed, were however exceeded (paragraphs 2.65 to 2.69).