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.* 1
Treasury Ch:.mbers, Parliament Street, SWIP SAG
! i
/ I
Rad Clark Esq
Principal Private Secretary to .
the Secretary of State .
Department of Social Sect rity
Richmond House
79 Whitehall .
LONDON .
SW1A 2NS 24 October 1998 I
BA/POCL AUTOMATION PROJECT: INDEPENDENT salad
REPORT
The Chief Secretary has aiiked me to senfd you a copy of the report produced by
Graham Corbett at the end of last week. I enclose a copy.
2. Tam copying this lett:r, together with the attachment, to Chris Woolard and
Geoff Moore (DTI), Dav d North and Sebastian Wood (Cabinet Office) and ~
Geoff Mulgan (No 10).
PETERSCHOFIELD
Private Secretary
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ResTitectedb— POALCY K COMMEROAL
Graham Corbett CBE
95 Coleherne Count,
. WITHO 27 PREJUDICE - CONFIDENTIAL
‘ The Right Hon Stephen Byers M >
Chief Secretary to the Treasury
HM Treasury
Parilament Street
London SW1P 3AG
18 October 1988
: e
BENEFITS AGENCY/POST OF ‘ICE COUNTERS AUTOMATION PROJECT
BacKGRouND
On 17 September you appointed me as Independent Advisor to this project with the terms of
feferance set out in Annex A anc a reporting date of 16 October. On 16 October I reported to
i you orally that we had been unal{e to reach agreement on a commercial basis for
proceeding. but that wa had mad 1 considerable progress on the development of a satisfactory
Implementation plan, and we dls :ussed what further steps If any might be now be
considered, in making that rapor. J used the charts attached as Annex B.
This report and Its attachments ¢ dd nothing of subsfance to what I tofd you on Friday, and fs
therofore designed primarily to ¢ st on record the results of my assignment.
1 Charts 4 and S, showing respectively ik tne chlengee aa regards BA snc OGL, pave been omited since ive versie
‘has not been made avaliable to the other p uty ands in any event highly dependent on ine Views taken 88 regards tha cost
Of ACT proceasing in the cass of BA and” selection for the firet time of banking buelness In the case of POCL. Charo
hag sls been omitted.
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The discussions which I held with the parties, and the information developed for
those discussions, were all without prejudice and confidential, and should therefore
only be used with the cons int of all the parties, as should the infarmatian in,this
report
‘THE PATH OF THE DISCUSSIONS - COMMERCIAL
Annex 6 chart 2 provides a g aphical overview of what fappened fn numeric tems. The right
hand number (-2310M) repre ients the NPV of ICL's cash flows over the life of the project
with fulure cash flows discoui.ted back fo October 1998 values at a discount rate of 6.6% .
(6% real plus 2.5% Inflation). Of thls number £232M has bean expended to date. All numbers
on this chart exciude amount to be set aside to a contingency fund. The core case Impact
on [CL was developed by ICL and KPMG (acting for me) on the basis of assumptions agreed
with ail three parties but whic 1 ICL consistently maintained were averly pessimistic as
regards (1) POCL volumes and (ii) a schedule of migration to ACT (20%:40%:40% of the
remaining accounts transfert 1g over the last three years of the contract} that was both
‘sooner and faster than they 113d been planning on. It did not appear to me that that there had
been sufficient (or perhaps at y) real discussion of this key place of information between BA
and ICL. ©
Little work has been done thus far on the effect of commercial sensitivities around the core
case beyond project continge icles. If a deal were to ba done, part of the due diligence
exercise mentioned below weuld be to test the solution for robustness agelnst a range of .
commercial sensitivitles,
On 6 October, very soan afte the care case had been agreed, the public sector bodies
offered contract extensions o° 2 and 4 years for BA and POCL respectively; POCL also
offered to consider picking ug the hardware costs of the refresh that any extension would
make necessary and to exten i payments to ICL over the contract term (now 2009) to cover
banking transactions. (CL anc KPMG evaluated this offer as reducing the NPV deficit from
~£310M to -£242M.
ICL stood by its opening stant 6 of requiring a modest positive ratum® over the whole life of
the project, notwithstanding +t ectearstatementto the vamtrary in your letter of 15 September
to Mr Todd. This would appecr to require a positive NPV of at least £30-60M before
= Tecan of iy managed er rpne rd Ah ere rsasd giao Cant aera DD
yas suggested by ICL curing the cout: eof curdiscussiona. J. an a a
*1n one presentation thio raquirement! ras restated as a “talr chance to breakeven aver tha contract” but thare were later
Indications that this was done without J selr chief negotistor’s consent
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“. contingency, which ts tho left har d side of the chart, ICL did however make.a number of 26
useful suggestions for reducing ¢r sharing tisk.
l emphasised to ICL that accept nca of their objective would bo tantamount to accepting that
the public sector bodles had bea 1 lagely or wholly responsible forthe cost averuns and.
delays and that this was simply 1ot a conceivable proposition within the constraints of the
exercise on which we were enga 3ad and which would not be seeking 10 concem Hself at all
with the right and wrongs of the daims and counterclaims being made by the parties.
By Friday 9 October It was clear that the parties warp stuck despite some progress on BA
termination rights reloase date end on funding fssucs. I was concemed that neither (CL nor
POCL ware taking a sufficiently realistic view, In ICL’s case, of the reat consequences of the
project terminating, and in POG -'s case, of the scale of the commercial opportunities
available ta thom if, but probabls only Jf, the project wentahead. (Indeed I suspect that one
of POCL's problems has besn 1ire lack of a robust business plan to fet them make
Judgements about thelr longer tam future and the sort of investments that they should be
prepared to consider to bring it. 1bout - this Is only now evolving) S
{was also reasonably sure that here was a potential solution which aught to be acceptable to
all parties. Accordingly I undert:.ok to develop my awn view as to what such a solution might
look like and this was delivered to the parilas first thing on Monday 12 October.
My proposal ts set aut (a Annex: C. It sought to provide to ICL a modest (2% IRR) retum on
Its future cash flows after contlr gencles {to which Intra group profits should also be
contributed), I estimate that this equates to a pre-contingency NPV over the life of the project
Of -£154M.
However, during the weekend shan my proposal was being put together a number of late
madelling changes were comin} through from ICL, the most Important of which Is referred to
In the ‘Comments’ column for I3m 1,1 of the schedule to my proposal. These adjustments
wore subsequently shown to be valid and the actual effect of my proposal was therefore to
raduce the NPV to only -£203t.. Although for the reasons explained below this difference has
fever come back onto the tabl:- for discussion, I have shown In the addendum to Annex C an
example of how this could havi: bean corrected - largely by applying lower price deflators -
had a further concession been hought appropriate.
On Tuesday 13 October both EA and POCL said they would be prepared to seek to put
\ogether a deal on the Ines coi Aained in my proposal, but ICL's position was essentially
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= unchanged. ICL's letter of 13 O xober setting out their position (and repeating the ‘breakeven’ - +
formula) is attached as Annex.
Later that day POCL agrecd wil the PO board a Proposal whereby POCL would offér to buy
Immediately assots requirod for the project (primarily equipment for Installation In post
Offices) believed to be valued a around £100M and also to settle a dispute over aspécts of
installation for £20M, thareby ps siding £120M of cast towards the funding tssue which had
” beena continuing concem for Ii. I was Informed af this canfidantially first thing on
Wednesday moming, 14 Octobi r and counselled that it should nat be put to ICL unless and
until {CL were prepared formally to abandon thelr insistence on a positive retum/braakeven
‘aver the life of the project. This advice was taken and [CL ware merely advised by Mr
Sweetman that POCL did have 1 further proposal to make but would only do so following
ICL’s agreement to abandon the ¢ previous stance. ICL. again remained unmoved, so this
further suggestion has not been out to them, nor for the same reason has my own addendum
to my proposal. I would In any e"ent seriously doubt that both of these Proposals should have
been made, so the summary chi rt shows the £120M reducing the previous -£203M NPV to
-£83M. It should also be noted tl at the mechanics of the POCL offer had stilt to bo worked
out and there may ultimately hat e been some countervailing reduction in (ater payments to
IcL. : .
There was no further change Ini 1¢ position between the parties when the without prejudice
discussion month came to an end at midday on 16 October.
‘THE PATH OF THE DISCUSSIONS ~ Pf OGRAMME AND PROJEOT MANAGMENT I88UES
Soon after my appointmant we a stablished a working group of the programme directors from
each of the parties working unde -the chairmanship of the Director of the Horizon
Programme Office (HPO), now § tuated. within POGL, and with PA Consulting keeping close
to and guiding their discussions, >A’s final report as of 14 October is attached as Annex E
together with the HPO's high lev 1 end-to-end plan for the programme which has been signed
Off by all parties. Attention (s drs yn to the generally cncouraging overall summary at the end :
of the PA report, but also to the ne continuing high risk area of acceptance procedures, both.
the definition of the tests themse ves and the consequences of failure. AS indicated on chart
6 of the package at Annex 8, ac: eptance specification sign-off (now due between 8 :and 22
November) must be achleved be fore any settlement could become binding on the parties.
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FUNDING
Loan facilities of £200M have be 1n exhausted and additlonal finance of over £300M would
be needed to complete the proje:4 were no changes to be made to the contract
ICL have taken the stance that It paront company Fujitsu is not prapared to play any further
‘part In supporting ICL or Pathway In refinancing current losses or in ‘financing the contract
going forward, and that therefore slither the public sactor bodies have to make the Project
financeabie on a non-recourse bs sis-or provide finance thomselves. Ihave equally .
consistently insisted that this Is at unrealistic position to adopt and that any solutlon that *
Seeks to place the burden of own: ship on the public sector bodies is totally untenable,
Annex B chart 7 refers). The pub {o sector bodies had agreed to explore a number of
relatively minor steps that might f elp to make the project more financeable.
Valso believe that In insisting on a solution Involving no write off In (CL’s or Pathways
accounts, ICL seem to be excass! rely concamed about the Implications of these accounting
tatters upon their relationship wit Fujitsu and on thelr plans for the flotation of {CL, while at
the same time taking a surprisingl; relaxed view of the Implications of contract termination
and litigation on both. If there fs to be any further discussion of ways forward it will be
necessary to have direct discussia with Fujitsu to understand better the Pressures which ICL
may be under,
THE WAY FORWARD
Ihave formed the strong view dur ig the last month that the continuation of the Project is
likely be of Teal benefit from a nur ber of angles - Post Office customers; POCL, bothasa
business and as a social service, ad all those dependent an it; {CL's reputation and future;
and that of Its employees and sub- :ontractors. I also believe that tho proposals made during
the last month, particularly f the flr al POCL offer were to bo extended in whole or In part,
Should provide enough of a positivi: incentive to {CL to proceed with the project as compared
with the consequences to them of is fallure. However confident ICL may claim to be as to
the strength of their contractual cas, I belleve they are significantly underestimating the
time, the cost and the uncertainty cf litigation on this scale and of its consequences for their
business. plans, \ ant aware however that these and other scenarios are the subject of
separate enquiries,
If there were to be a solution on the lines of my proposal, I would draw attention to items 8, 9
and 10 of the schedule to Annex C, (cunning sores’ list, past Claims and due diligence) all of
which will be crucial. I would alsa u ge that as soon ss 8A can be satisffed that it has a
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system which works both on test and In practice, consideration should be given to reshaping
the contracts so as to take BA oi t of the contractual foap and pasition them as a POCL
client.
were
I am profoundly disappointed tha: we have been unable to reach our primary objective and
will continue to hope that some \ ay of bringing thts project to frultion may yet be found. We
Spoke on Friday of the, possibility. of a new Inttlative even at this late stage from ICL. In the
meantime, the progress made or programme Issues will be of real and enduring benefit if the
Project continues, and perhaps si'me of the commercial discussions will have served to
sharpen the participants’ views a the realitles.
For myself, I would like to, pay tril ute to the hard work that all those Involved brought to our
endeavours, not only those atten: lng our meetings but the many athers who were providing
Input and back up.
{ assume that your office will han'lle circulation of this roport and its altachments to those
who need It, and accordingly it Is sopied to no one else at this stage.
- Yours sincerely. if By
Annexes .
A Terms of Reference
= Charts used for presentat on on 16 October (less nos 4,5 and 9) .
c Independent Adviser's Pr »posal dated 11 October .
D ICL letter dated 13 Octobir .
E
PA Consulting Group's summary of programme risks + high lavel end-to-end plan
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. CONFIDENTIAL
Benefits Agency/Post Office € counters Automation Project
Terms of reference for Indepindent Adviser
The Government wishes to appuint an independent adviser to facilitate discussioris between,
the parties to the Benefits Agen :y/Post Office Counters automation project (Benefits Agency
@A, Post Office Counters Limited (POCL) and ICL Pathway (ICL)).
The adviser will report to Minis xs via the Chief Secretary to the Treasuty, Stephen Byers.
The immediate objective will be to report to Ministers within one month, by 16 October, on:
- whether there is 1.commercial basis for proceeding with the project which is
acceptable to the parties; - ; =
- Whether there is 1a place a satisfactory implementation plan with a detailed
timetable for cor pleting the Project;
- any further actior which woulc
of the project
eed to be taken to ensure successful delivery
The role of the adviser will be tc: Bee
- convene and chai ‘discussions between the parties;
- commission pape s and proposals from the parties;
- independently ap) raise the parties’ claims and contributions;
- produce compromise proposzils to assist the parties to identify common
ground; ‘ “
- take such other ac:ion as he thinks fit to establish an acceptable basis for
continuation; .
- ensure the parties srovide information necessary for the analysis of alternative
options, * ° .
The adviser will have no power t:) bind the parties, who will retain full authority to agree or
not agree any proposals made. by the adviser or any other party. 2
Ifthe Project continues there is li zely to be a continuing role for the adviser in facilitating
progress, “es :
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- HORIZON PROJECT _
REPORT TO CHIEF SECRETARY
by INDEPENDENT ADVISER,
-” :, GRAHAM CORBETT
16 October 1998
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_ Headlines I
far eztet Gam eset-190~
No agreement, no movement by ICL, and parties
lai apaci, vui:
. » reinstatement of LA target (not communicated to
parties)
> possible POCL offer (not communicated to ICL)
Progress on programme issues and acceptance —
High level of routual suspicion I
ICL ‘chink of light?
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The path of the discussions
Impact on ICL - £m NPV over whole project
30-60 0 7 - (83) (154) (203) (242) . (310)
i 1
I cb uraepencnus
1 J .
ICL POCL offer TA target TA "Initial public Core
position - (not yet made) (not yet offered} proposal _ sector offer case
*
NB All numbers exclude contingency - proposed by ICL to be shared 50/50 with sponsors if released
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} ICL Position
eee
Modest, positive IRR over contract, by means of:
> contract extension
> price increases
Opportunity for profit on incremental business’
Remaining risks under Pathway’s control
> resolution of programme/acceptance issues
> solving ‘running sores’
Contract terms to allow non-recourse funding
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Programme issues
Overall plan and high level critical path agreed
. A amantha alinnane an roallant (cineca Panel)
FOP AULD DELP pepe Ves avery (wane
> but uncertainty down to +/- 4 weeks
Acceptance process
> progress made, but still high risk
> must be resolved before agreement
Programme generally de-risked
> other outstanding issues lower risk
-» significant progress made during discussions
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Refinancing
tal @ZIET Gat §=SSETr.190-e2
Never has been a limited recourse project. ,
s alkerarm calind an cumnant Af Thalitens mens
" GLYYOYO Lusiver ULL Rouppure MAL’ “nee g.0up
Will continue to be the case, so:
>» Fujitsu investment essential
> sponsors need assurances Over financing
iS]
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Opportunity for finatice cost savings I 3
> as project risks are overcome.
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The way forward? I
IfICL abandoned present stance...
= Could envisage asreement around:
WU a wee aw
> reworked IA proposal - with some relaxation of price
deflators
.« > pethaps all or part of POCL offer
_» subject to overall VFM test
« Before binding heads of agreement:
> agree acceptance tests and ‘process
> complete lower level critical path analysis -
> wrap up ‘running sores’ and contract points
“> due diligence and satisfaction around funding
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To RICHARD CHRISTO Ich sat te e
GEORGE McCORKELL BENEFITS AGENCY §
PAUL, RICH POL. 5
FROM GRAHAMGORBETT _-—INDEPENDENT ADVISER 8
41 OCTOBER 1998 5
. HORIZON PROJECT - INDEPENDENT ADVISER’S PROPOSAL TO THE PARTIES (‘THE PROPOSAL’) ~
As we digcusged on Friday I am nqv forwarding my Prqposa] for the parties’ consideration, fince in one way or another it will be disagreeable fo all parties '
u has, as I requested, feflected deeply on tha commercial realities surrounding yopr decision on whether or not to Peat it, These
i
trust thal each of y
8 rd cllons should, Peuggest, pave included at tdast the issugs for each party shown In the table helow, In my opinion {here is stil! not a sufficiently realistiq
s view being iohen of the: flevasating effgcts that would he likely to follow our failure to reach a settlement.
a DPSIDES FROM SETTLEMENT . DOWNSIDES FROM NON-SETTLEMENT
12 TeLPainway I eonjinualion of business'strategy * . T—T [hq assyrance that sporisors pill npt hold (Ck to contragt :
iS plalform fo new businéss opportunities immediate financial copsequencas for ICL#Fujitsu (including Incremental
facilitates refinancing . exil costs andi cross guarantees)
: cost, dglay and unjcertqinty inhergnt in litigation
- effec on reputatign and bus{ness oppqrtunities
x effect on flotation plans
a POCL ‘opening up of opportunities for new services Short-term effect on network and difficulty of subsequent recovery
i) scale of potential cost savings from atttomation and cosis, delays and risks of restarting automation project from scratch
5 planneit/controlled fatlonalisattan of network and ~—,, I cost, delay and uncertainty Inherent In litigation
Ss organisation : : :
2 = ——
BA resqive facility agalnst risk of being unable to achipve 100%" I replitieg of aphleving ‘Swift implementation of ACT without bridge
not migeaton . i " provided by gard te .
cost, dalay and uncestalnfy inherent in iitigation
° =
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My Judgement is that there is not fikely to be any other chance of a settlement. If however over the next five d i
(despite the evklence of the fast two weeks) reach an altemative settlement more ‘Sallsfactory to them, 1 Would eelea ee fal wickets
If the Proposal is accepted as the basis of a way forward, we have much wark to do before 16 October. If itis not acce, { i il
wish to have an urgent meeting with Messrs Todd, Roberts and Mathison together by no later than Wednesday rmoring I as ata heii in
that the seriousness of the situation we then face must fake precedence over all previous engagements, " any vew
THE PROPOSAL,
The Proposal is NOT to be taken asa detailed and prescriptive sotutlon, Rather Itis intended fo provide a
minded, aa invited by 16 October tg develop NON-BINDING WITHOUT PREJUDICE Heads of Agreement yc it scepter I they are so
Would be lumed into binding Heads of Agreement within the shortest aossthla fine frame and tharaAac inte anaicant cooate, YP Ministers,
Imustemphasise: . 2 8
- that the Proposal has not been endors; any pf the partjes, nor by HMT, y i
poarenen ost pia ara pd by’ y pf tha partles, nor by HMT, DTT or DBS, nor has it been reviewed by lawyers {or compliance with
- that the cash flow effects of several elements of the Proposal need to be v; ified and cross checked. Late cha ‘ 4
many of véhich were nat immediajely Weak rn The Propgsal Ig sd ontha numbers sal out wt 4, 2 and below, pet operon ee
‘comments’ column, If pubsequent clarificatjon raveats that the ICL nqt cash outflow should have begn less than inated tach need to prope he
comespording adjustments to the extent of {he aeicions being sought af the sponsors and vice versa; ed to propose
. that some Issues need considera Ie further work which can only be done by the parties thamsetves, '
So each party Is invited tq work with KPMG over the next 24 hours (2) fo assemble. a Sef of verified and agreed aymbes and (6) to haye prepared
Sensitivities which one party of another might want fo pursua, In adgition, we shall pf course need {a deal wi
Group on Tuesday and Wennastay. toate for'some nimble reaction, = ne Sept wi he Information coming from the Programme
The various elements of my Proposal are set out In the schedule below. In doveloping them I have sought to i
Public sector offer and which provides ICL/Pathway with a tisk reward, albeit on a oa scale, for conn hee mae so tt Hy carr
ICL. a positive relum over the whole life of the project. To this end, i have sought to procure a positive NPV of some £48M for the period ffom toa i an
before altowing for Interest on cash losses io date. This is calculated at a discount rate of 8.5%, and fepresents an IRR above this assumed cost of ca ia of
236. IF therefore the future cash flows were assumed to be fingnced on a 1:1 debt equity ratio, and if the debt service Cost were to be equal to the discou al °
tale, the retum on the equity proportion would be about 12.5%. I would In practice pred ICL to be able ta refinance its debt shorlly after the project is fly
ow to Feduce ts borrawing cost to perhaps arpund LIBOR plys SObps, The trealment of the benefit from this lower debt service cost remains to
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‘The Proposal woul, if accepted, eliminate all claims and counterclaims for event:
s, actions and omissions to date. The concessi de
would therefore be an indistinguishable amalgam of tl icessions made by the sponsors
heir desire to see the project continue and a ‘no faut’ contribution to the problems of the past,
Vhave taken the view that while the sponsors should do whatever they reasonably can to make the project ‘bankabie’, the provision of finance by them
should not form part of the Proposal, Any exploration of funding being provided in parallel with the Proposal Should therefore proceed independently.
I have also taken the view that Pathway's immediate and ultimate Parent com
a panies cannot expect to Play no part int
future and I recommend that the Sponsors and their respective Ml
‘ he financing of the i
nistries satisfy themselves as io the financial ability a] Project into the
of Pathway fo Cany the project fonvard
POC 11/1088 psge3 of 7 . WITHOUT PREJUDICE - CONFIDENTIAL.
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SCHEDULE §
_ »
Nature « Detail EMeffect ‘Comments 2
for ICL, 8
(NPY) J
cE}
Core Gase NPV of total Pathway cash flows from 1896. 310 of which -232M already spent, To achieve the target of 2% IRR for
to 2010 future (excluding interest on existing borrowings) the -310 needs to
be reduced by 126M lo -184M (See 4 below). The figure of 310 Is
~ itself subject to review as the reasons for the change from last
week's number of -355 gre still unclear *
i ctTerm I Extend BA to 2/2008 and POCL to 3/2010 80 This value was established by extrapolation from work done last
11 I Contract Term (ICL bearing refresh cost- see belgy). ACT wegk. I heard at 2130 ak Sunday that late ICL. calculations produge
migration over 2005 ~ 2008 at 20:40:40, the apparently extrpordinary resutt that a thre year posiponement
POC. to compensate BA for negaljve effect of the migration to ACT {for which BA's original starting date of
of one year of postponement. I suggest that 2042 was so much criticised by ICL) and a five year extenston of
this'shou(d be phased In from a relatively the POCL contractosult in an additions! LOSS to:ICL of 1241,
earty date to be agreed. : Faged with this sor} of data, I despair, bit to enable the process tq
i 2. . go forward while aksurdities Ijke this arg resolved, I am
: nevertheless Pontiquing with {ha circulation of this Proposal,
42 Banking business to 2010 42 This egaln is a late ICL number, much lower than I had anticipated
POCL (o agree to guarantees at a fevel and therefore subjectin my mind fo the same concems as In 4.1
consistent with reasonably achievable
targets
13 POCI. to accept refresh costs 48 .
21 I Price ‘Cancel 3% pa reduction from 2008 onwards 20 I. The ACT migration programme was not specified in the contract
. anq I believe there ts mesil in ICL’s complaint thatitis -
untpasonable for them to have to cope simultaneously with
reducing volume and price cuts
1
, v
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for Ici,
(NPY)
22 Some increase in volume guarantees from ? ICL is seeking annual fixed fee, Currently guarantees would only
BA to {CL bite In extremls or during the last year of ACT migration, For
further consideration by the parties,
3 I Contingency Establishment of contingency fund to be 44 _ I Quantum for discussion but limited by reference to amount of head
Jointly managed and any surplus released to I butses ftext I room created by foregoing adjustments. intra-aroup arofils
IC} anit ennneare EAIEA t now the mmoosten, Siege 7) qeoqeitrenyu aL EXM NPY ]0.6nd of project - ICL consent to release
of such a fund as an intepral part of the below Of this number being sought) should also be regarded as forming
process whereby ICL might ba expected to : . Par} of his fund, sq that total amount would be £yM. This however
accepl an IRR as law as'2% needs to:be, Taviewed In the light of what now appear to be
. significant additional costs provided for in thg late {CL numbers,
Components and managemeht of fhe fynd to be agre by the
Pajfles before 16 October ‘
4 I Total of above ~184 of which’-232M already ppent, giving a positive 48M attributable Ip
the futurp. Exeluding Intprest on opening borrowings, this
represents the famPeLIRR of P% fOr future cash flows
5 I Programme BA and POCL termination rights to be programme I Note that in P, Copping’s view if this wes a supply contract it would
cancelled at end of NR2 live trat (scheduled I confldenca I be nosmal for perhaps 80% of contract value to become payable at
for 5/7/89) RAB date of 21/12/98, This howaver retates essentially to
Confidence in software rather thar process environment, which
Involves POCL at least as much as ICL. ICL is wanting
. “unconditional acceptance’ by 81/12/98 but {otal confidence Is
undblainable untit NR2+ rollout (April 2000).
.
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* Nature Detail £M effect Comments
for ICL.
4 (NPV)
6.1 I Fundability Fujilsu/ICL to subscribe amount to be reduces max I Some confidence Issues aiready identified = possible acceleration
refinanced into redeemable zero coupon porrowing of acceptance, focus on RAB, joint contingency fund, early
convertible, {or similar) 0 be redeemed out I requirement termination release date - but these unlikely to add upto a
of new bank borrowings as and when project I (flowing fundable proposition by Dec 98
confidence at sufficient level from
seduced
imerest voy . .
6.2 Parlies tg complete thelr analysis ofthe list This shold be completed and ‘signed off within twp weeks of non-
+ I of contract points submitted by ICL to , binding Heads of Agreement
Improve fundability
7 Vict intra-gropp I Intra group profits to the end of theproject XM) Proposal is that thase stjauld be regarded as part of contingency
profits; + are pstimated at xM of xM at NPV (see {und - sée 3 above: a
comment under 3 above) 7 a
@ I ‘Running Sores’ I Fingnelal Implications to be wrapped up - nil Operalional issues to be resojved betwgen the parties within two
Ust within overall settlement (.e no further . weeks of non-binding Hgads of Agreement
adjusiment)
9 I Past claims All past claims and counterclaims would be nl
. withdrawn without admission of ability by
any party and no subsequent claim caukd be
mace by any party In respect of any event,
actlon or omission prior to the date of the
settlement.
5 ‘
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Detail
£M effect
foriCL
(NPV)
Comments
10° I Due diligence
Prior to Binding Heads of Agreement the
financial data on which this Proposal is
based will be subject to due diligence
As part of the due diligence exercise j propose that a combined
financial model be prepared and kept updated. This will help to
validate the consistency of the parties’ analyses and contribute to
the VFM analyses that will be required of the sponsors
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ADDENDUM TO THE INDEPENDENT ADVISER’S PROPOSAL
As indicated in the comments to 1.1 above there was a late and unexplained difference of £72M inthe fflects of the extension of the contract term. This
difference has pow been pxplained jo my satisfaction and it accordingly becomes appropriate to seek ways of further adjusting the terms of the Proposal to
relnstate my ofiginal intention of a 2% IRR for ICL. for the remaining life of the contract. The table below reproduces the first part of the schedule to the
Proposal with amendments to achieve thjs; the pringipal new proposal being the inffodugtion of a further relaxation of the Price deffators built inte the
contracts (2.3). Given ICL’s continuing insistence on achfeving a break-even over the life af the project, this revised proposal has NOT been communicated .
tothe parties, and Is appended hera solely to indicate that there are ways In which the original alm could still be delivered. All changes fo the Proposal as
given to the pajtles on 12 Octqber are In bold jype. i
SCHEDULE
waiuie . =m cityer ; . Comments
. for ICL ;
. (NPV)
Core Case NPY of total Palhway cash flows from 1996 +310 Of wihtich -232M already spent, To achieve the largel of 2% IRR for
, to 2pt0 : future (excluding interest on existing borrowings) the -310 needs to
d be reduced by 126M ta -184N (soe 4 balaw), The figure of -310 is
itself subject fo review as the reasons for the change from last
week's number of -355 gre still unclear
4.1 I Contragt Term : Extend BA to 9/2008 ang POCL to 3/2010 Az This negative number needs to be seen against the posilive
. . (ICL, bearing refresh cost - see belqw). ACT benefits to 1GL flawing from the contract easton Shon in
migration over 2006 - 2008 at 20:40:40. thesucceedingitems =~
POCL fo compensate BA for negallve effect
of one year of postponement. I suggest that
this should be phased in from a relatively
early date to ba agreed, Fi
4.2 Banking business to 2010 42 . .
POGL {o'agreg (o guarantees at a fevel .
consistent with reasonably achievable i 1 .
targets yo
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Nature Detail £M effect Comments
* for (Ch
(NPY)
13 POCL to accept refresh costs 48
21 I Price Cancel 3% pa reduction from 2008 onwards 20 The ACT migration programme was nol Specified In the contract
. . and I believe there fs merit In ICL's complaint that it Is
‘unreasonable for them to have to cope pimultaneously with
feducing volume and price cuts
Ze Sots Niaeusy Mm yoIUmp guaraMees TOM yt ICL Is seeking annuat fixed fée, Climently guprantees viould only
BA to ICL. ‘ . bit In extremis or during the last year of. ‘ACT migration, For
further epnsideration by the parties, o
23 Further reduce deflators fram 3% to 0.5% 55
- p.a, from March 200% to 2006
3 I Contingency Establishment of contingency fund to be Pi Quantum for discussion but limited by reference 1g amount of head
jointly managed and any surplus released to I but see pext I room crated by foregoing adjustments. Intra-groyp profits
ICL and sponsors 50/50, I see the creation Gol. and I {esIimated at £xit NPV fo end of Aroject~ IC}. consent fo release
of such a fund as an integral part of the below of this nymbeg withheld) should also be regarded as forming part
process whereby ICL might be expected to of this fund, so tha totel amount would pe £yM. The total amount
accept an IRR as low as 2% corresppnds closely to the amount required to meet the
reasonable risks of programme slippage indicated hy PA.
Components and management of the fund to be agreed by the
parties before 18 October
4 I Total of above “184 OF which -2324 already gpent, giving a positive 48M attributable to
the futurp, Excluding Interest on opening borrewings, this
represents the fargetiRR of 2% for future cash fidws *
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I
2@-ocr“1999 NED 19194 -.1D1 Peas
I [s7le/asse 11:02 ~ I ae
Aune xd ‘
13" October 1998 : 5
Mr. Graham Corbett,
HM Treasury, . X
. Parliament Street, :
London.
SWIP 3AG ,
Dear Graham,
I enclose ICL’s proposals on tl.e way forward for the BA/POCL Programme.
This is based upon the discussi¢ ns and presentation we made to you last week,
and continucs to be our positiaa in resolving the commercial and programme
issues faced by the programme.
Yours sincerely re
boo ceeeecpeseneaneeueeesnstnssenesnesnaseneeee gp eevee
R. Christou .
Ce: - Graham Corbett, BA <
P Rich, POCL .
I RChristow
I Director
I
I Commarclal & Logat Affairs
I 26 Finsbury Square
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COMMERICAL AND LE! Piers
f27
~ ICL PATHWAY.
(a eeecenore ery
Proposed way Forward for the BA/POCL Programme
Lo Introduction
Due to.the way in which the contract has been handled by the sponsors, especially the
Bencfits Agency, ICL is fazed with ever increasing costs, declining volume in full
* pperation, no certainty abcut when full operation will begin and the consequent
impossibility of financing tho. completion of the programme without a thorough
+ restructuring of the originil contract. It is completely inconsistent with the RFT
concept to argue, as Grahanr Corbett has done, that ICL should write off ‘its past costs
and look only to the future Under PFI the contractor's expenditure on the design,
build and finance phases should be remuncrated during the operational phase. In the
- discussions with Graham C‘orbett, ICL has put forward a number of proposals for
solving the problems. This. saper sets out the ICL position. :
In parallel with the HM Tre ssury review, ICL has engaged in confidential discussions
with the Post Office to explure proposals in which tho Post Office would take 2 50%
(less one share ) equity fale in ICL Pathway. Athough such a proposal has merits in
its own right, it could als provide the.key to making possible the wiext stage of
funding for the programme provided that an acceptable commercial deal can be
agreed. The essential points for the equity proposal are described in the attached note
by Sir Michael Butler dated 9 October. :
2. Proposal Objectives
ICL believes any settlemen: naust provide « fair way forward for all partics, and must
provide ICL Pathway with a fair chance to at least break-even over the contract. The
committed funding by ICL to date stands at some £250m, with the expectation that &
further £250m of funds vill. be needed to complete the programms. ‘Whereas
- originally it would have techn reasonable to expect to put non-recourse funding in
place after full acceptanca in July 1997, we are still a very long way from reaching 8
position where this woull be possible, In all the circumstances, ICL dacs not
consider it reasonable to try to make a distinction between the past and the future, as ~
Graham Corbett has sough .to do.
3. Components of th : Solution
In addition to the equity p:oposition there are four key components for an acceptable
solution; contract term, contingency artangements for known and future tisks,
achievement of contractui] acceptance, and appropriate pricing arrangements. Each
component has elements of flexibility, which taken together can provide an acceptable
resolution for ICL Pathwa . This paper desoribes one such combination.
Comm ercial in Confidence and without Prejudice 1
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4. Contract Term
The ‘sponsors have indicatd that they may be prepared to consider a contract
extension with ICL Pathway to end March 2007 for BA and to end: March 2009 for
. POCL, BA state that they wuld migrate all non- ACT benefit payments to full ACT
by the end of their contract, on a 20%, 40%, 40% basis, starting in fiscal year 2004/5.
This amounts to maintainig the period of full operation in which ICL receives
revenues at five years but de ivers a sharp decline in volumes within that period.
POCL’s offer to extend the ¢ ontract to 2009 is much more helpful, especially ifPOCL
and ICL Pathway form:a dys amic partnership to open up now streams of revenue.
Furthermore POCL have indicated that they may be prepared to fund the essential
equipment upgrades and rep acements required in the post office network in 2006,
5. Contingencies for snown and fature risks
_ Discussions between the prties have highlighted and helped define the outstanding
differences on the imple:aentation plan and its detailed timetable ‘for project
completion. The major arca: requiring contingency arrangements are:
- pro;ramme risks leading to delay
-con ractual acceptance including process and sign off
-BA and POCL business volumes
- fraud risk
~ service level agreement penalties
» programme costs
Although the above contingencics are being further refined between the parties ICL
Pathway has included a ccntingency of £100m (£60m in NPV terms) in its business
case to cover the likely cufcome-on these risks, This figure could double if the
acceptance issue referred t below is not resolved.
We recognize, however, ‘hat all parties share a mutual interest in mitigating and a
preventing such risks mi terializing. ICL. Pathway has offered the sponsors the
principles of an incentive ) lan whereby if specified contingencies can be, avoided, the
associated cost savings cait-be shared on a 50/50 basis. This would offer the sponsors
the prospect of cost reductions, and ICL, Pathway the opportunity for a modest return
on its investment in the programme. The main intent, however, is to incentivise all
parties to work together t effect a prompt delivery of the benefits arising from the
programme. This has not+ orked well in the past.
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6. Contractual accept! ace
The speed of the acceptance process has been highlighted as probably the most critical
programme risk. Given our experience since 1996, any revised programme must give
us assurance that the contract will not be terminated at somo date in the second half of
1999 ona relatively minor tuchnical point.
ICL proposes that programnic acceptance must be managed in a staged approach, with
cach stage having its own. self contained, acceptance arrangements. Deferred, or
conditional acceptance, with teomination rights preserved for Ister stages is
unreasonable, ‘
‘We recommend that accept nce of the first stage scheduled to go forward for national
roll-out in July 1999 is batdled as part of tho HM Tréasury review process and is
completed by the end of De sember 1998,
The BA components of this first stago, covering use of the Paymont Card for Child
Benefit, and the Order Bos k- Control Service have beon subjected to extensive joint
testing and have had oper itional exposure im over 200 post offices for very many
months and are known to v ork well for staff and customers alike. ‘There'is no reason
to delay acceptance.
The sooner full-acceptance js achieved the better since non-recoursé funding depends
on it,
7. Pricing Arrangem ents
Given the BA’s desire to get away from the usc of the Payment Card as soon as
possible, and the need for prices to bear some of the burden of the increased costs.
ICL have proposed that th contracted prices set in May-1996 should rise in line with
inflation throughout the ¢ »tract period. This effectively offers the sponsors a fixed
price contract in real term:. .
It would be possible to co sstruct a payment mechanism for BA based upon an annual
fee structure, agreed in ad rance, and based upon BA's best view of volumes aud their
ACT migration plan, This would provide some flexibility to the BA in the speed and
choice of benefits to mign te to the Payment Card, prior to the final migration to ACT.
It would also provide ICL Pathway with a predictable revenue stream.
We see the arrangements ‘or POCL continuing as at present with the only key change
being that the banking volumes are underwritten at 90% of best forecast volumes,
‘This reflects the fact thet achievement of such business rests exclusively with the
business drive within POICL.
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So far Graham Corbett aid the sponsors have based their positions on ICL’s
acceptance of writing off its past expenditure as a loss. Moreavaer, given the risks, the
: prospects of profits in the fiture appear dim. This is unacceptable in principle for a
PEL contract and it would make it impossible to secure the financing necessary to
i. complete the programme, ‘Ve submit that ministers now need to agree a framework
which would make reatruct wing of this PFI contract a reasonable deal for ICL and
* give Graham Corbett or sone senior government representative a mandate to settle the
A + problems fast on a fair basis .
a Summary and next sfeps :
:
I
I
\t
I
li
Richard Christou
13" October 1998
Comm rcial in Confidence and without Prejudice
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i COMMERICAL AND LEGAL PAGE 87
MYo/iege 11:02
ICL PATHWAY Dose
“# ICL have no wish to.cut aiross Graham Corbett's efforte to Promate a solution
to the problenis-in the ,BA/POCL programmes. We will therefore concentrate
exclusively on the ICL pn posal for the Post Office to take an cquity stake in
ICL Pathway. Though it could provide the key to unlock the programmo’s
problems, the proposal has merits in its own sight. *
e ICL is not aware of the Secretary of State’s thinking on the future of the Post
Office. But whatever'the sutcome of his review, it seems to us that the Post
Office and Post Office Counters Ltd (POCL) in particular, will need to be
enabled to operate as a nodem, entrepreneurial, commercial business if-its
Jong-term future is to-be as ured.
© Because the ICL Pathway system has been designed with Smart Cards in mind,
it can be developed to setve the Government’s needs for more user-friendly
and cost-cffective dealing with the citizen.. If the Post Office has a major
equity stake in ICL Pathwiy, it will be better placed to help in this process as
well as being able to incnase its eamings, assuring the future of tho POCL
countrywide network, .
« POCL needs a world-class (T system for many of its operations. ICL Pathway
could help to re-enginecr i s business processes to make it more competitive.
ICL would be ready to centribute its own skills in this field, into the joint
venture. ? s
© POCL and ICL working tigether would make a powerful team which could
exploit other new commercial opportunities, including retail banking and
export initiatives for postal systems.
* JCL believes that during the duration of the contract (as agreed in the current
negotiations) the present 12L Pathway management should remain in place.
But ICL would hope that the Post Office would but 50% (less one) of the
shares; and would, of cour!e, welcome Post Office representation on its board;
and would be open to proposals for changes in management structure or
ownership thereafter.
© ICL wishes to take it as an assumption that the present negotiations will ™
succeed, But it needs to pcint out that the consequences of failure would leave
POCL very exposed, Witho 1f a modern IT infrastructure.
Sir Michael Butler
9" October 1998
Commer: ial in Confidence and Without Prejudice
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Risk (*Polnts of Impact on Programme Probability of Management Action in place (14/40/98
issue” Version 4, occurrence as at update In italics)
710/98) 14/10/98 A
Over ast esest~t30-e2
tar
Critical .
4 Speed of acceptance Failure i. complete acceptance In Henne Very high Parties urgently reviewing :
rocess (4, 7a, 7b) timescales could cause one or more of the . e
” , Parties to resort to legal action and Program tstapectin aurea estar
could stop at end '98 or before teaviiéu on an eanier date}
e ta * the process for making acceptance
decision fivork still in Progress on
detailed plans; contingency now
Planned into overalt testing time
Scales)
+ tha consequences of making
decisions (being deat with in
commercial stream)
Major
2 Status of plans for Delay to commencement of go five for Medium HPO reviewing current earlyhbest
NR2+ (6) NR2+ with knock on impacts to multl- CaseMvorst casa forecasis for NR2+ go
benefit card roll-out, specifically to the live (currently 28/2/00,17/4/00 and
oumber of cards and outlets zs 3/7/00) : final view by 13/0/98
Work sti# in process but there fs now
Confimation that the worst case date for
Completion of RAB for NR2+ Is 3* July
2000 taking into account all key
dependencies:
“exw
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t
Risk {"Points of Impact on Programme Probability of Management Action in place (14/10/98 a
issue” Version 4, occurrence as at update in italics) §
7/40/98} 14/10/98 S
3 Service Management Risk that NRO (NR2) will be delayed if Medium POCL reviewing Service Management 2
(2a, 2b} POCL SM not ready plans to identify contingency plans that i
take SM off critical path for NRO “
(NR2).POCE have de-risked NRO (NR2) 9
dependency on service management by
Proposing an atemative interim
arrangement based on existing
capability, with full support centre
coming on-ine later (larget 04/99.)
Also E2E review of service management
is planned. *
Minor .
4 Consistent and Mainly impacts speed of testing and Low Urgent action by HPO to ensure
complete technical acceptance process Sponsors have uniform view of testing
design for key process (Plans now fn place)
products (1) °
5 — scaleability of Unforeseen problems as roll-out proceeds = Low Urgent action by HPO to ensure
Pathway design (3) Sponsors have uniform view of Pathway
M
8
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! CAPS 4.0 ; F
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* 1 - NR2 Es Swks Swks 4wksh 11 weeks Swks 3wksl0wks 4wks ROLLOUT wma I
Peaercaraiag Live Trial : I
2 I Delivery Frame relay I
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3 : Process I
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8 I Lb.Amplementation>- . i
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POCL Support !
Pa y 1
= nd revie 14/6
I roto Acceptance tests and reviews i! ' .
' 4d. Acceptance ™>___Acceplance spec 221 \ 2
I ‘orn VS-13/1098 I *
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