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WT, HINA.HAY, 1998y 21:46 DYE SECRETERY OF STATE, FEE o5/10 — rigne hee?
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‘BA/POCL: ICL OFFER OF 13 MAY 1999 :
Summary: The price of ICL's offer is considerably higher than we assumed in our
modelling of B3, with the payments very heavily front-loaded. The NPY of the
Offer is significantly worse than termination. In addition, we are concerned at
Some contractual issues. We have prepared @ counter offer which would involve
sealing back the NPV for ICL, transferring risk back to ICL and introducing more
conditionality to allow further Serutiny of the contracts.
: The offer
The offer from ICL takes the form.of a draft letter for a Goverment Minister to
send to them, enclosing documentation of what the deal means in contractual terms -
by reference to the earlier contracts for the benefit payment card and the heads of
agreement forBl. Signing the letter-as it stands would represent an unconditional
commitment, :
my
Is the deal worth doing?
2. _ IfMinisters do this deal, their decision will be scrutinised very carefully by
outside commentators and by the NAO. The Key questions that Ministers need to
consider are: does it make commercial sense for POCL? Is the contract
satisfactory? And is the price reasonable?
Does it make commercial sense for POCL?
. 3. For POCL, the key commercial issue is the funding gap, which for them is
around £1,2-1,3 billion NPV compared to Option A (though much of thisis
accounted for by reduced payments from DSS). This funding gap dwarfs all other
commercial issues for POCL. It is similar for termination.
4. POCL believe the Horizon hardware.and software is probably sub-optimal —
as the platform for providing network banking and Modern Goverment services,
" but would need several months’ work to have a clearer view.. They are therefore
unable to take a view on whether the Horizon hardware and software is preferable
to the system they might procure following termination.
Is the contract satisfactory? .
5. ICL are insisting that this contract, involving the commitment of many
hundreds of £ millions for five vears.ahead. be siened. within 24 hours of having
Telefax. :
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handed it to us (yesterday evening). .We strongly advise that any agreement be
made conditional on agreeing detailed contractual terms over (say) the next three
months. This would give reasonable time for proper scrutiny of what are
complicated documents. It would avoid a situation in which we have an
unconditional commitment to proceed when unforeseen and unreasonable
requirements might be demanded by ICL in drawing up detailed contracts,
6, There are a number of contractual issues which in any case are not
satisfactory. ICL have attempted to shift a number of risks from them back onto
the public sector, for example, under this proposal, payments for the hardware
would not be dependent on it performing satisfactorily, We will need to ensure
that any counter offer (see recommendation below) addresses these points.
“Is the price reasonable?
7. °. There are two ways to consider the price: *
- how it compares with what we regarded as a reasonable price for B3 in out -
* modelling; . .
- how it compares with the termination option.
Compared with B3
8. ‘The attached table illustrates both comparisons;
9. . It shows that, compared to our modelled B3, the offer is £320 million worse
in NPV terms. This is because:
~ under options A and B1, ICL were prépared to accept an overall NPV loss °
of £126 million. They are now demanding a return of £110 million NPV (ie
an improvement of £226 million) compared with the cost numbers they have
provided to us previously (under an earlier option called BO); .
~ and the remaining £80 million flows from the fact that the current offer
does not include the provision by ICL of network banking services. The
- NPV assumes POCL buy these services from someone other than ICL - so
ICL do not receive any net contribution (profit) from network banking.
They therefore have to inorease their prices on the services they are
providing to compensate. . :
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Compared with termination
10. . Compared to termination, the offer again looks poor value for money.
11... ‘The key issue for Option C is the likely outcome of a termination settlement.
This partly depends on the approach we take to any termination. Treasury
Solicitor advise (and DSS and POCL lawyers agree) that there is some advantage
in taking no immediate steps to terminate the BPC contracts, This means, in
formal terms, the existing contracts continue, leaving ICL to "down tools" or
otherwise acknowledge that they cannot perform the contracts at the original price,
This is the formal background but in practice ICL and the public sector parties
would be encouraged to get round a table and consider terms of settlement as well
as working out the orderly winding down of the contracts, If ICL purport to carry
on performing the contracts, we will not have lost the option of formal termination .
_ under the contracts. : - .
12, I -Under termination, it is difficult to assess the outcome of any litigation or to
assess, at this stage; the settlement cost. IfICL successfully claim that the public
sector parties have terminated the contracts for their own convenience, the liability ©
on them could be as much as £330 million. At the other extreme BA and POCL
could recover damages for ICL's breach up to £200 million, It is likely that the
public sector parties would be liable for some damages and the best assumption for
present modelling is a damages liability of £150 million. This figure is in line
with views of Treasury Solicitor,
13, The table shows that, on this basis, termination, followed by purchase by
POCL of a comparable off the shelf automation/network banking technology, and a
move to ACT from 2003, has an NPV some £200 million better than the ICL offer.
The offer is £400 million worse than termination followed by ACT from 2001.
Conclusion
14. _ The fundamental drivers for ICL/Pujitsu are to get rid of most if not all of
the provision in their aceounts. They therefore need a contract that is sufficiently
unconditional to satisfy their auditors, and with sufficient up front payment to
cover the provision. :
15. As indicated above we would not recommend signing the current contract
without some changes to the terms and with sufficient conditionality to allow
proper scrutiny in the coming months,
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16, We also do not believe the current offer. represents value for money,
compared with what we regarded as a reasonable price for B3, or compared with
termination, -
17. We are preparing a counter otfer, which would have the following features:
~ £270 million improvement in the NPV for the public sector. This could
be justified in terms of the extra profit ICL are now demanding, and/or on
the grounds that the public sector would be bearing additional risk under this
offer. It can also be justified in terns of making the deal better than at least
the more costly form of termination; :
+ Teprofiling of the cash flow, so as to spread it more evenly over the life of
the contract; oe .
~ greater conditionality, to allow change in the light of further scrutiny:
‘~ transferring risk back to ICL,
18. We think it unlikely this would be acceptable toICL. We might want to fall
back a little from this position (particularly on the NPV) in negotiation, But the
bottom line should be no worse than the NPV for termination - it would be hard to _ .
defend a deal which represents worse value for money than what the public sector
could achieve by going elsewhere. We would be exposed by the fact that the
counter offer already has an NPV £160 million Worse than termination followed by
moves to ACT from 2001,
19, Viewed against the Prime Minister’s requirements (Jeremy Heywood’s letter
of 11 May) - see annex B:
- accepting the offer would avoid a row with-the sub-postmaster lobby, avoid
putting ICL’s future in jeopardy, but we do not believe it offers value for
money so would be hard to defend with the PAC;
~ termination might be difficult to present with the sub-postmasters;
depending on the termination settlement, it would have implications for IcL,
but is unlikely to put their whole future at tisk; but would be defensible on
value for money grounds;
~ the best approach would be to put a counter offer - if accepted, it would
satisfy all the PM’s requirements, The vfm test would depend on Ministers
GRO
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deciding that, as a matter of policy, they were not prepared to start amove to .
ACT before 2003.
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“PLE?
AnnexA
COMPARING THE FIGURES
fm NPV at6% [NPY cash costin I 10 yr NPY to
: CSR years_I cashflows I 1C1,2
ICL offer 363 - 538/236/176 I -980 +110
tecommended. 629 471336/212 I -740 "I +126
counter offer _
termination: [$77 182/136/316 I -775
option Cv* .
(ACT from
2003-06)
termination 791 196/150/310 I -459
option C*
(ACT from
2001-04
option B3** 684 203/149/199 I -640 -126
“assumes public sector has to pay ICL -£150m.
**as modelled previously i.e. assuming ICL bear a -£126m NPV loss
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Annex B
Conditions in Jeremy Heywood’s letter of 11 May
“Any solution should meet three key political requirements:
- we did not want a huge political row, with the Post Office or the sub-postmasters’
lobby claiming that the entire rural network had been put in danger by the
Govemment; a
- we should not put ICL’s whole future at risk;
- it would be important to ensure that the Govemment had a fully defensible
position vis avis the PAC,”