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The figures were revealed in a report published by the House of Commons Public Accounts Committee (PAC).

QinetiQ was created out of the Defence Evaluation and Research Agency (DERA) in 2001 as a means of addressing the declining defence research budget, which threatened DERA's ability to maintain its capability.

As well as carrying out research for the Ministry of Defence (MOD), QinetiQ advises the department on the procurement of equipment and manages the testing and evaluation of this equipment.

Weaknesses in the 2003 sale process 

QinetiQ was privatised in two stages: the sale of a minority stake in the business to the private equity firm the Carlyle Group in 2003 and a flotation on the London Stock Exchange in 2006.

PAC concludes that the MOD conducted the flotation well in a strong market and used the experience and expertise of the Shareholder Executive to good effect.

There were, however, weaknesses in the 2003 sale process, and the National Audit Office have estimated that the taxpayer could have received £90 million more from the privatisation.

The MOD began the competition for a strategic partner when market conditions were poor and before the terms of QinetiQ's most significant contract had been agreed.

It also eliminated the only trade bidder at a very early stage. These decisions weakened the competitive process for selecting a strategic partner, and Carlyle negotiated a £55 million reduction in the value of the business after they had been appointed preferred bidder.

The department nevertheless agreed to sell Carlyle 2.5 per cent more of QinetiQ than they had specified in their bid.

Incentive scheme 

The Public Accounts Committee says that the MOD failed to manage specific risks relating to the management incentive scheme established as part of the privatisation.

The department relied on Carlyle to design the incentive scheme but did not put safeguards in place to protect its interests, nor did it take specific professional advice.

QinetiQ's management were consequently able to influence the design of their incentives before Carlyle were appointed preferred bidder.

At the date of the flotation the top 10 managers held shares worth £107 million for an investment of just £540,000. The privatisation of QinetiQ was successful in protecting the viability of a business of strategic importance to UK defence interests.

QinetiQ has balanced the decline in the research budget with revenue from other sources and has successfully expanded into the US defence market.

The Committee warned, however, that there were risks to the long-term value for money of the privatisation arising from the MOD’s ongoing relationship with QinetiQ.

New sources of revenue 

“The department envisaged that the privatisation would deliver reduced prices and improved services and will need to develop robust benchmarks to ensure it realises this aspiration,” according to the PAC report.

It points out that the firewalls intended to protect the independence of QinetiQ's advice require active monitoring to ensure they are operating effectively.

The budget for defence research fell by 40 per cent in real terms between 1992 and 1998, limiting the ability of the Defence Evaluation and Research Agency to maintain the breadth of its expertise.

The Public Accounts Committee hails QinetiQ’s success at finding new sources of revenue to balance the decline in research spending and has increased its turnover by 48 per cent since 2003.

The restrictions that prevented QinetiQ from engaging in defence manufacturing contracts were lifted in April 2008.

If QinetiQ is successful in winning more contracts to supply the MOD there will be greater scope for conflicts with its important role of advising the department on the procurement of equipment.

The Committee says that the department needs to actively manage the operation of the Compliance Regime to protect the independence of QinetiQ's advice, which is critical to UK defence interests.

Accurate value 

The report points out that the sale to Carlyle was conducted in 2002, when market conditions were poor and before the future of QinetiQ's most significant long term contract, accounting for about a third of QinetiQ's revenue, had been agreed.

The Treasury had agreed to credit the MOD’s budget with £250 million if the sale was completed before 31 March 2003.

The PAC report warns that the Treasury should avoid creating incentives to press ahead with privatisations when conditions are unlikely to maximise longer-term value to the taxpayer.

The MOD negotiated the terms of QinetiQ's most significant contract, the Long Term Partnering Agreement, at the same time as conducting the sale of part of the business.

Bidders would have been unable to place an accurate value on QinetiQ and Carlyle were subsequently able to negotiate a reduction in the value they ascribed to the business.

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