Report by the Comptroller and Auditor General Ministry of Defence: Further Examination of the Sale of Royal Ordnance plc Ordered by the House of Commons to be printed 20 June 1989 Her Majesty’s Stationery Office, London S7.90 net 448 MINISTRY OF DEFENCE: FURTHER EXAMINATION OF THE SALE OF ROYAL ORDNANCE PLC 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 Comptroller and Auditor General National Audit Office 19 June 1989 The Comptmller 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 use their resources. MINISTRY OF DEFENCE: FURTHER EXAMINATION OF THE SALE OF ROYAL ORDNANCE PLC Contents Pages Summary and conclusions 1 Part I: Background and Scope of NAO Examination 8 Part 2: Site Valuations before Sale 11 Part 3: Post-Sale Developments 18 Part 4: Intellectual Property Rights 21 Glossary of Abbreviations 22 Annexes A. Report by Gerald Eve and Healey and Baker 23 B. Report by Royal Institution of Chartered Surveyors 67 C. Statement by S G Warburg Securities 69 iMINISTRY OF DEFENCE F”ETHSR E- ATION OF m SALE OF ROYAL ORDNANCE PLC Summary and conclusions Background 1. In April 1987 the Government completed the privatisation of the Royal Ordnance Factories by selling Royal Ordnance plc to British Aerospace plc by private treaty, following competition. The Public Accounts Committee (PAC), in their 48th Report of Session 1987-88 (HC 206), reviewed the Ministry of Defence [the Department)‘s arrangements for the sale on the basis of a Report by the National Audit Office (NAO) published in November 1987 (HC 162). The Committee recognised that the sale achieved the Government’s objective of transferring the Company to the private sector within the prescribed timescale and noted that certain offsetting expenses had to be placed against the realised price of El99 million. The Committee noted the possibility that the Royal Ordnance sites at Waltham Abbey and Enfield might be redeveloped and expressed concern that British Aerospace could make a substantial gain on the sale or re-development of these sites without benefits accruing to the taxpayer beyond the amount received for the sale of Royal Ordnance as a whole. 2. In late 1988, there were various media reports on speculation on the possible under-valuation of assets owned by Royal Ordnance at the time the Company was sold to British Aerospace. These comments were based on a research report produced in August 1988 by a securities firm which attributed values totalling !Z462 million to the three Royal Ordnance sites at Enfield, Waltham Abbey and Patricroft. The media also commented on the claimed under-valuation of certain Intellectual Property Rights transferred by the Department to Royal Ordnance prior to its sale. The NAO have carried out a further examination of these aspects of the sale of Royal Ordnance. Findings 3. The issues examined and the main findings and conclusions are summarised below. (a) Whether the Department made adequate arrangements for the valuation of Royal Ordnance sites prior to the sale of the Company and for the protection of the taxpayers’ interest (i) The Department and Royal Ordnance obtained professional valuations of Royal Ordnance land and buildings, on both an existing use and alternative use basis, as at 31 March 1984. An updating of these as at 31 December 1985 was commissioned in preparation for the proposed public flotation of the Company; this was produced in July 1986 (paragraphs 2.1-2.10). (ii) After the Government’s decision, announced in June 1986, not to proceed with the proposed flotation, and the sale of the Leeds factory to Vickers plc on 4 October 1986, the Department’s Merchant Bankers, Rothschild, prepared an Information Memorandum which was issued to 17 prospective purchasers of Royal Ordnance in October 1986. This showed the existing use valuations at 31 December 1985 but not the alternative use valuations, because although by then the closure of Waltham Abbey had been announced 1 MINW’RY OF DEFENCE: FURTHER EXAMINATION OF THE SALE OF ROYAL ORDNANCE PLC and some other rationalisation of factories was likely, the alternative use valuations for Waltham Abbey and for all sites were less than the corresponding existing use valuations (paragraph 2.15). (iii) The Department recognised that a higher immediate return might be realised by selling assets piecemeal, but since the Government’s intention was to sell Royal Ordnance as a going concern, they invited bids for the Company on this basis. Rothschild advised the Department that in these circumstances it was for the prospective purchasers to make their own assessment of the value of the Company’s assets (paragraph 2.11). (iv) British Aerospace and two of the other bidders, GKN plc and Trafalgar House plc, have confirmed to the NAO that they had been interested in purchasing Royal Ordnance as a going concern, not for property speculation. They were all aware of the probable need for some rationalisation of sites; they saw the existing use valuations: they were given all necessary information, for example on planning applications, by Royal Ordnance; they were given the opportunity to inspect all the sites and to take into account the potential for development in making their offers. In general their view was that, although there was potential for development of some sites, there would be substantial costs involved and difficulties to be overcome, including the potential need to decontaminate sites on which toxic substances had been used for many years going back in some cases to well before the First World War (paragraphs 2.4, 2.15-2.20). (v) Consultant surveyors, Gerald Eve and Healey and Baker, appointed jointly by the NAO, reviewed the earlier valuations of Royal Ordnance sites by Weatherall, Green and Smith and confirmed that in general terms the valuations were at acceptable levels. The Royal Institution of Chartered Surveyors also reviewed the earlier valuations for the NAO and confirmed that they were in accordance with the standards of the Institution (paragraphs 2.12-2.14). (vi) The NAO’s consultants’ view was that, because important changes in circumstances occurred between the dates of the earlier valuations and the date of sale of Royal Ordnance to British Aerospace, full consideration by the parties involved should have led to updating of the valuations and further advice being sought from Weatherall, Green and Smith shortly before the sale date. The Department told the NAO that, particularly in the absence of any major reason to suppose that alternative use valuations would have altered radically in relation to existing use valuations, it was proper to look to the pressure of competition to guard against any risk of under-valuation, and that accordingly it was for the bidders to make their own assessments in drawing up their offers [paragraphs 2.22 - 2.23). [vii] At the date of sale the closure of the Waltham Abbey site had been announced and planning applications had been submitted in respect of Waltham Abbey and the adjacent derelict northern part of the Enfield site; closure of the Enfield factory was announced in August 1987. The NAO’s consultants considered that, in the circumstances, it would have been prudent and appropriate for the Department to have insisted on a clawback provision in the contract for the sale of Royal Ordnance; or alternatively, it might have been 2 MINISTRY OF DEFENCE: FURTHER EXAMINATION OF THE SALE OF ROYAL ORDNANCE PLC advantageous, if it was practicable, to exclude the Waltham Abbey site and the Enfield site from the sale to British Aerospace. The view of the Department and Rothschild was that the Government’s policy was to sell Royal Ordnance as a whole with all its assets and liabilities and a piecemeal approach would have carried the risk of the less attractive parts remaining unsold and would have involved considerable management, industrial relations and commercial difficulties. They pointed out that both sites were still operating at the time of the sale, as an integral part of the Company’s manufacturing activities. They did not consider any proposals for the Department to retain a financial interest in the Company after its sale. Whilst land transactions in the commercial sector sometimes include clawback provisions, and the NAO noted that the privatisation of the National Bus Company also made use of them in appropriate cases, the Department and their advisers said that there is no evidence that such provisions are other than very rare when a business is sold as a going concern. In the particular circumstances of Royal Ordnance, they considered that the inclusion of a clawback provision would have been regarded by bidders as a significant negative feature in their assessment of the Company, and so would have depressed the proceeds without promising a real prospect of enhanced total value. The Department said that it would also have run counter to their policy of maximising the freedom of the Company to develop its business independently of the Department, which would continue to be a major customer. Royal Ordnance told the NAO that it was still operating at the Waltham Abbey and Enfield sites at the time of the sale and still doing so during 1988; and that, in their view, the Company would have had great difficulty being sold as a going concern without these sites (paragraphs 2.24-2.28).