NATIONAL AUDIT OFFICE REPORTBYTHE COMPTROLLERAND AUDITOR GENERAL TheSale of ScottishPowerand Hydro-Electric ORDEREDBY THE HOUSEOF COMMONS TO BE PRINTED IO JULY 1992 LONDON: HMSO 113 f6.55 NET THESALE OF SCOTTISHPOWERAND HYDRO-ELECTRIC 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 3 July 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 range of other public sector bodies: and he has statutory authority to report to Parliament on the economy, efficiency and effectiveness with which departments and other bodies have used their resources. THESALE OF SCOTTISHPOWERAND HYDRO-ELECTRIC Contents Pages Summary and conclusions 1 Part 1: The companies and the sale 6 Part 2: Achievement of objectives 8 Part 3: Control of costs 20 Glossary of terms 23 Appendices 1. Electricity industry restructuring in Scotland 24 2. Authorised supply areas of ScottishPower and Hydra-Electric 26 3. List of the principal advisers and contractors appointed by the Department 27 THESALE OF SCOTTISHPOWERAND HYDRO-ELECTRIC Summary and conclusions 1 In June 1991 the Scottish Office Industry Department (the Department), acting on behalf of the Secretary of State for Scotland, sold 100 per cent of the shares in the two Scottish electricity companies Scottish Power plc (ScottishPower) and Scottish Hydro-Electric plc (Hydra-Electric) for just under E3.5 billion, payable in two forms: nearly g2.9 billion from the sale of shares, and some SO.6 billion from the staged repayment of injected debt. In preparing the companies for the sale, the Department wrote off some El billion of National Loans Fund debt. 2 The sale was the last stage in the Government’s programme to privatise the electricity industry in Great Britain. It followed the sale of the twelve regional electricity companies in England and Wales, in December 1990, and the partial sale of the two generating companies, National Power and PowerGen, in March 1991. 3 The Scottish companies generate, transmit, distribute and supply electricity. They face competition from each other, and from other companies, for the generation and supply of electricity to customers in Scotland. Each of the Scottish companies has the monopoly of the transmission and distribution of electricity within its authorised supply area. They may also compete in the electricity generation and supply markets of England and Wales. 4 The companies were floated on the London Stock Exchange. The Department offered for sale some 1.2 billion shares at E2.40 each, payable in three instalments. 5 The Government’s overriding objective was to complete the privatisation of the electricity industry in Great Britain within the lifetime of the Parliament. Within that overriding objective, the Department sought in relation to the Scottish sale: to maximise net proceeds; to achieve a modest premium on the issue price in the period following the start of dealing; to promote individual share ownership, firstly in Scotland, but also in the United Kingdom as a whole; and to encourage share ownership by individual company customers and employees. 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. The National Audit Office examined Departmental papers, held discussions with Departmental officials and advisers, and consulted senior executives of the two companies. The National Audit Office were assisted in their work by Hambros Bank Limited. Achievement of 7 The National Audit Office’s main findings and conclusions are: objectives On the overriding objective of completing the iale to timetable (a) The Department achieved the privatisation of ScottishPower and Hydro- Electric by June 1991, selling all their shareholding in each of the companies (paragraphs 2.2 to 2.4). 1 THESALE OF SCOT’I’ISHPOWRAND WDRO-ELECTRIC On maximising net proceeds subject to achieving a healthy aftermarket Method of sale I$) The Department decided to sell the companies by~floating them on the London Stock Exchange as they considered that this method of sale would best meet their objective of promoting increased individual share ownership, while maximising sale proceeds through creating competitive tension between individual, institutional and overseas investors (paragraph 2.6). Valuation of the companies: assets (cl The Department reviewed the bases on which the companies’ fixed assets were valued, and carried out a revaluation exercise which included identifying properties which might have significant alternative use values (paragraphs 2.10 to 2.16). (d) The Department introduced clawback provisions on property with the aim of enabling the taxpayer to share in future gains from property disposals or deemed disposals by the companies (paragraphs 2.17 and 2.18). Debt (e) Both companies inherited high levels of debt from their predecessor boards. The Department sought to maximise proceeds by keeping to a minimum the amount of debt written off, while at the same time ensuring the long term financial viability of both companies. This involved a net write-off of Government debt of E417.7 million (paragraphs 2.19 to 2.25). Profit and dividend estimates and prospects (fJ Following intensive negotiations with both companies, the Department secured their agreement to estimates of profits and dividends for the year ended 31 March 1991 which they judged satisfactory and to positive statements on prospects for dividend growth in subsequent years (paragraphs 2.26 to 2.29). Corporation tax losses (gl The Department wrote off the balance of outstanding corporation tax losses, arising out of unused capital allowances, in each company, amounting in total to s505 million (paragraphs 2.30 and 2.31). Partial or full sale (h) The Department identified a number of factors which pointed in favour of a full sale in June 1991. The Secretary of State decided to sell all the Government’s shareholding in the companies (paragraphs 2.32 to 2.34). Carrying out the sale (i) In carrying out the sale, the Department adopted a number of measures first used by the Department of Energy in the sale of National Power and PowerGen. 2 THE SALEOF SCOTTISHPOWERAND HMRO-ELECTRIC Bookbuilding (j) Institutional and overseas investors were required to indicate, in advance of pricing the offer, how much they would be prepared to invest at a range of yields; this is known as bookbuilding (paragraphs 2.36 and 2.37). Underwriting (k) The Department dispensed with primary underwriting, bearing the risk themselves of failure to secure adequate sub-underwriting of the offer and of the offer being undersubscribed (paragraphs 2.38 and 2.39). Back-end tender (1) A proportion of shares was provisionally earmarked for offer to the highest bidders from institutional and overseas investors after the close of the offer period; this is known as a back-end tender (paragraph 2.40). Implementation of the back-end tender raised additional proceeds of ~C42.25million (paragraph 2.51). Pricing the offer (m) The Department took the view that in pricing the offer at a yield of 5.1 per cent they would maximise proceeds and minimise the risk of exciting excess demand while still attaining their target premium. In deciding not to price the offer at a yield of 5.2 per cent, they accepted a greater risk that the anticipated premium might be eroded over the offer period but judged that risk to be acceptably low. The difference between selling the shares at 5.1 per cent rather than 5.2 per cent represented additional proceeds of ~!Z55million (paragraphs 2.43 to 2.46). Aftermarket premium (n) The premiums at which the shares opened at the start of trading were within the Department’s target range of 5 to 10 per cent of the full offer price, equivalent to 12 to 24 pence. On the second day’s dealing ScottishPower’s shares fell just below the bottom end of the target premium range, closing at a premium of 10.5 pence. They traded mostly below that premium for some months after the sale. Over the same period, Hydro-Electric shares traded mostly at higher premiums. In the six months following the close of the first day’s trading, the share prices of both companies reduced relative to the electricity sector and to the market as a whole and, whilst mostly remaining above the offer price, moved below the aftermarket target premium range (paragraphs 2.52 and 2.53). On promoting increased individual share ownership Incentives for individuals (0) In order to avoid adverse media comment and the risk of an unsuccessful sale in Scotland, the Department offered customers of the two companies equivalent payment terms and incentives to those offered to customers of the regional electricity companies (paragraphs 2.60 to 2.62). Incentives for employees (p) Incentives offered to employees were in line with those offered to employees in the other electricity sales which represented a higher return than incentives offered in certain other past privatisations (paragraphs 2.63 to 2.66). 3 THE SALEOF SCOTTISHPOWERAND WDRO-ELECTRIC Target subscription levels (q) The Department met their target for subscription levels (3 to 4 times the initial public offer) from individual investors (paragraph 2.67). Share allocation (r) 10.3 per cent of the shares offered to individuals were allocated to company employees and pensioners. Customers investing in their supplying company were allocated 35.6 per cent (paragraph 2.70). Share retention (s) 67 per cent of individual shareholders in both companies had retained their shares at 31 December 1991.