UKG100042628
UKGI00042628
Shareholder
Executive
HM Government
Post Office Ltd
Annual Review
November 2011
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Contents
+ Executive summary
Business overview
Long term strategy
Operating performance
Valuation
Balance sheet
Management
Government stakeholders
Shareholder Executive role
Traffic light analysis
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Executive summary
POL faces declining
traditional revenues
and highly
competitive new
markets, while its
current branch
models are
unsustainable
These challenges
must be faced as
POL undertakes a
complex separation
from its parent
Successful outcomes
may permit a
subsequent potential
mutualisation of Post
Office Ltd
@ Shareholder
Executive
_ IRRELEVANT
Market risks
+ Cost levels impact capacity to win key new contracts, especially Government services
+ Mail volume decline affects business over the Post Office network
+ Low interest rates hit financial services
Focus on developing pipeline of new products
+ Digital exception channel for HMG work (face-to-face services for those without computers)
+ Identity verification role e.g. passports and licensing
+ New financial services products
Developing the network
* New fully variable cost models
+ Longer opening hours
+ Smaller footprint in store
Separation from Royal Mail
Need to negotiate contractual terms with RM over distribution of RM products and shared services
Bolstered Board required to challenge and support executives in separation process and beyond
Suitable governance arrangements need to be introduced as the companies separate
Aspiration of a mutual Post Office Ltd once separation and the business transformation envisaged
in the current business plan are complete
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Business overview
Post Office Ltd provides mails services, financial services,
government services and telephony services across a network of
around 11,800 branches.
There are currently 373 Crown Offices (large, mainly urban,
centrally-run post offices) and around 11,500 sub post offices
(privately owned by sub-postmasters and franchises). POL
directly employs 8,500 staff. POL also runs a cash logistics
business.
POL has four main areas of income ~ mails, government services,
financial services and telephony.
(em}
sidy payment
\m Fina
IRRELEVANT ="
\m Government and
ID services
(Other (inc
telephony,
jovation)
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Network of branches operated by Post Office Ltd
100% Royal Mail Holdings plc)
val Mail Holdings pl
rade but holds 100!
Mail Group Lt
cludes the UK letters and
cele business)
fice Ud
wwned by RM Group Ltd)
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Business overview
Post Office is a unique provider of mails, financial and government services across a nationwide network. It has a national
network larger than that of all the UK banks put together, with 93% of the total UK population (and 99% of those living in towns
and cities) living within one mile of a post office.
Post Offices provide a range of services to customers across the socio-economic spectrum, carry out a critical economic function
for many small firms, and often play a significant social role in communities. Over 170 different services are available over Post
Office counters and all but one is subject to at least a degree of compet
ne.evanr}funding from Government for 2011-2015 announced in October 2010, the Govemment requires Post
Office Ltd to ensiire that there is a minimum of 11,500 post offices across the country, and that this network conforms to the strict
access criteria (established in 2007 following a national consultation) which ensure reasonable access to Post Office services
regardless of where people live.
This network requirement hampers the business's ability to operate on a commercial basis and largely explains the areas in the
traffic lights review where the business's performance is sub-optimal: amber for strategy and financial performance; red for
balance sheet risk (also impacted by POL's share of RM's current pension deficit).
Dependence on access to post office services is particularly acute in rural areas where the post office branch is in many cases
the only local retail outlet, but branches are also of real importance in deprived urban communities.
Post Office Ltd is facing increasing competition, especially in the bill payments market, by competitors such as PayPoint. Post
Office Ltd also has to compete openly for Government work.
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Business overview: market breakdown
Market breakdown
Mails Services
+ POLis facing the challenge of declining mail volumes, and separation from Royal Mail. It will be imperative for POL and RM to
successfully negotiate a suitable length IBA before separation. Negotiations are at an advanced stage.
+ POL's product mix in the market will change. As the volume of letters declines they will seek to grow the volume of packages they
distribute.
+ To improve the customer experience, POL aims to reduce queue times, extend opening hours, and improve the in-branch
experience of customers, focussing on developing ‘Post&Go’ self service kiosks, solutions for small businesses, online mail
support and pre-paid mails.
Government Services
+ POL plans to become the physical channel altemative to Government's own direct channels for those customers who cannot
interact online and for those services which require @ physical touch point, e.g. ID services.
+ POL faces increasing competition from others in this market, and must openly compete to win Government services.
Financial Services
+ POL ims to deliver a proposition which reflects customer needs and preferred channel choices. For example, they are currently
considering a pre-paid debit card and working with DWP on a transactional account providing working credit.
+ This is a highly competitive market in which POL has had some success due to public perception of it as a trusted brand, POL
have been particularly successful in foreign exchange services where it is the market leader.
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Business overview: market share
Mails Fulfilment Royal Mail Accounts
Mails Collections and Returns “15 Bere rere
Financial Services Travel Money 24 M&S Money
Financial Services Travel Insurance 4 Insure&Go
Financial Services Insurance 1 Direct Line
Financial Services Lending 1 High Street Banks
Financial Services Savings 15 Lloyds Banking Group
Financial Services Bill Payments ~35 PayPoint
Government Government Services a1) =
Telephony Broadband 1 BT
Telephony Homephone 2 BT
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Long term strategy
Commercial objectives
+ Strengthen POL's Board, in particular through
appointment of a new Chair and Non Executive Directors
to give increased levels of oversight and challenge.
Separation of Post Office Ltd and Royal Mail to ensure
operational autonomy as soon as possible.
Roll-out of new models - 2,000 Post Office Locals and
4,000 Main Post Offices — over the Spending Review
Period
Eradicate the losses made by the 373 Crown Offices.
Achieve significant growth in government services
income, through providing the face-to-face services that
will stil be required to support a ‘digital by default’
approach to service delivery on behalf of Government.
Maximise profitable revenues from other areas, especially
financial services.
Policy objectives
Key elements of Government policy for the post office
network are:
To ensure no network closure programme and @ minimum
network of 11,500 branches
To ensure the network access criteria are met
To ensure key services are available across the network
To reduce government subsidy for the network over the
long term
Key elements of Government policy for Post Office Ltd are:
+ To support delivery of POL's commercial strategy
+ To develop options for mutualisation of POL
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Long term strategy: ownership
Mutualisation
+ The Postal Services Bill allows for POL to
or be transferred to a mutual
+ Areport commissioned by Government on options for mutualisation of Post Office Ltd was published by Co-operatives UK in
May. The report focuses on how best to transfer Post Office Ltd from Government ownership into a mutual run for the public
benefit.
+ We launched a public consultation in September, to obtain greater detail regarding a suitable model for mutualisation.
‘The consultation document addresses the following key issues:
+ The current structure of Post Office Ltd and its business strategy.
Why Government thinks mutualisation could be a good idea for Post Office Ltd.
(Our belief that the members of the mutual should comprise an equal mix of ‘producers’ (such as employees and
subpostmasters) and ‘consumers’, with no one constituency having an overall majority.
Why we believe that a Post Office mutual could work best without a Government ownership stake, to provide a clear cultural
break from the past, with Government able to continue its relationship with the mutual on a contractual basis.
representative body, and Board of Directors.
Other considerations which we need to take into account before a move to a mutual would be possible, the most important of
which is Post Office Ltd’s financial stability
Government will be issuing its response to the consultation document in Spring 2012.
Our proposal that a possible structure for a Post Office mutual could be a three tier structure, comprising of the membership, 2
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_.... Operating Performance: Overview of 2010-14
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Operating performance: restructuring & organisational changes
Work is underway to move POL from its current position as a subsidiary of RMG to become a sister company
of RMG under a common parent company, Royal Mail Holdings ple (RMH).
This is proposed to coincide with the implementation of the pension solution on 1 April 2012, subject to state
aid clearance.
At that point, the new Inter-Business Agreement will have been agreed, POL staff will become formal POL
employees and new group governance arrangements will be put in place.
We are developing proposals with the companies for the role and constitution of the RMH Board once RMG
and POL have moved to sister companies under the RMH holding company at March 2012.
We envisage that the businesses will remain in the same corporate and tax group, but operationally separate,
until the earlier of an RMG transaction or a POL mutualisation.
Anew Chair and senior non-executive director have recently been appointed in order to bolster POL’s
negotiations in separation discussions. The Board will be further strengthened by appointment of new NEDs.
The company is also deploying a People Engagement plan aimed to ensure that the whole organisation
(including agents) is aligned behind the strategic plan.
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Operating performance: opportunities
+ The major opportunity is network modernisation, converting over half of all post offices into new ‘local’ and
‘main’ models with fully variable pay based on the volume of transactions. POL intend to offer a ~ 40%
increase in opening hours and reduce queue times so that 90% customers are served within 5 minutes.
+ Beyond this, Post Office Ltd will develop a much greater focus on innovation, setting aside funds to develop
new propositions. In particular they will investigate:
— Development of proposition to support universal credit.
= Online mails services aimed at supporting growth in mails.
= Payments solutions which will support the phasing out of cheques (such as pre-paid debit cards).
— Further self-service solutions.
— Development of relationship with Credit Unions to increase financial inclusion.
— Commencement of RBS contract, and possible progress with HSBC and Santander.
+ Of these, the major one is developing its universal credit proposition, which could be aligned with a
transactional account offering potential significant revenue growth.
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2 risks
Operating performance
RISK
MITIGATION
[Terms of separation from RMG jeopardises mail
revenues or impose significant new costs.
IAppointment of new chair and bolstered board
intend to strengthen POL's voice during negotiation
land remove possibilities of conflict.
New Government services and innovation revenues fail}
to feed through sufficiently during the life of the next
strategic plan (to 2014/15) leading to greater POL
ldemand for Government subsidy.
POL has recruited a specialist HMG services team.
IShEx is working closely with OGDs to communicate
post office policy and encourage strategic
Jengagement with POL as a potential delivery
partner on a without-prejudice basis.
[State aid application for payments for 2012/15 and
longoing operation of working capital facility is
lunsuccessful
[Co-operation and close working with the European
ICommission. Approval process is on track.
Transferring POL to mutual ownership will be contingent on the successful mitigation of these risks.
ShEx POL team will continue to monitor these risks through weekly internal meetings and monthly financial
and strategy meetings with POL.
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Illustrative Valuation
Key assumptions
We expect that, upon separation, Post Office shares will be held at zero value in BIS accounts.
Valuation of the Post Office is not something the team undertakes for deliberate reasons; this is an illustrative valuation
constructed for this Investment Review purpose only. It is highly confidential and not for onward circulation.
We have set out some illustrative outputs based on DCF valuation only. (There are no suitable comparable companies or
transactions from which we could produce alternative valuation methodologies.)
Central case: 8% WACC, 1% terminal growth rate, based on the current business plan.
Very indicative figures below.
Including government subsidy and funding for network modernisation
Including subsidy but excluding funding for network modernisation
Including funding for network modernisation but excluding subsidy
[Excluding government subsidy and funding for network modemisation
Hl
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These figures come from POL's most recent business plan of October 2010.
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Balance Sheet of Post Office Ltd: Company. in March 2011
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Board and management
* Quality of management team and board and shareholder relationship are Green in traffic lights.
Significant changes to the top team in recent years. Three MDs during the past two years.
Current MD is Paula Vennells (formerly Network Director since 2007).
Anew Financial Director, Chris Day (former Group Financial Controller, BBC) and new Financial Services Director,
Nick Kennett (former MD, epay) have recently started.
Separation from Royal Mail requires an independent voice for POL within the Royal Mail group governance structure
— ANew Chair of POL, Alice Perkins, has been appointed with a strong public sector background. She is undertaking a board review.
— Anew Non-Executive Director, Nell McCausland, has been appointed with a strong retail background that will complement the chair’s
Public sector background.
— We are in the process of recruiting a further NED to POL.
— These appointees do not sit on the Royal Mail board and are independent of Royal Mail in any discussions about separation.
Corporate governance
— Chairman's proposals would assist in making POL combined code compliant on separation,
Remuneration and incentives
— POL MD remuneration set through RM Board remuneration process. HMG also has an approval right over POL executive incentive
arrangements to deliver the strategy agreed in October 2010. When the business separates, new articles of association will give HMG
fuller rights to approve POL Board remuneration directly. Upon separation from Royal Mall, ShEx will join the POL board.
— Bonus worthy metrics are split between financial performance (focus product sales, all product contribution, operating profit, total
operational costs, free cashflow), customer (call centre performance, mystery shopper) and people (staff engagement index, serious
accidents).
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Government stakeholders
Stakeholder Stakeholder interest eases cd ‘ey current issues focreee ay So obtain supped
relationship overcome barriers
+ HMG shareholding * Strong ShEx working * Discussions ongoing re + Maintained close dialogue
. relationship with key mutualisation and will need —_ and sharing of strategy
ENS naling fo bustee] BHM teem to work closely with HMT
+ Accounting and budget ‘on progression of
impact of business proposals
performance
+ Long term risk of subsidy
Cabinet Office + POL procurement * Good working relations + POL's position in providing + Continue to identify and
‘strategy and role in —merit in expanding and face-to-face transactions in target key contacts,
providing transactions to —_renewing post CO light of digital delivery and coordinating with POL
‘support online services. Teorganisations. OPS White paper. where required.
DWP + Contracts with POLfor + Good working relations + POL's role in delivering + Maintain close dialogue and
payment of benefits Universal Credit, the coordinate with POL where
impact of UC on POCA. required.
DfT (DVLA) * Contracts with POL for * Strong working: * DVLA plans to procure a + Maintain close dialogue and
provision of services relationships wider range of face-to-face appropriate procedures
‘services shortly — crucial to during procurement process.
POL's GS strategy.
Home Office * Contracts with POL for + Some relationships in + UKBA procurement * Attempt to expand contacts
(IPS, UKBA) provision of ‘check and place - could be outstanding. with key senior officials,
send’ passport strengthened = Direction on data collection _co0rdinating with POL
applications igi Popeseea where required.
unclear - key projected
revenues for POL.
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Shareholder Executive role
+ 1x Director — Susannah Storey provides overview as head of RMPS Team
+ 1x Executive Director — Will Gibson (90%) is currently covering this post, pending recruitment this winter
[3] x Assistant Directors - Mike Whitehead and Jane Hoy (100%), [Will Gibson (90%)]
1x HEO — Peter Batten (100%)
1 x Fast Streamer — Katie Wake (50%)
Besides pure shareholder issues, ShEx plays a supportive role for POL’s directors, providing a voice within
Government (a major customer) and guidance on political issues.
Generally good relationships with the business and the management team at all levels.
Excellent relationship with HMT team (Polly Payne/Ruth Hannant/James Perry)
Advisers
— UBS will assist in RM/POL separation advice
— Freshfield will assist in separation issues and state aid process
~ Deloitte has assisted with due diligence of the commercial strategy
— POL are receiving advice on separation issues from Linklaters (separately from RM)
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Traffic light analysis
1. Shareholder Relationship
Chair's letter not yet issued. Policy and shareholder
2. Implementation of Shareholder Model management roles are combined within ShEx.
3. Quality of Management Team & Board
Strategic plan may not create shareholder value in the
4. Strategy short term, pending modernisation.
The company doesn't produce positive economic profit as
5: Financial Performance network access criteria exceeds a commercial network.
6. Balance Sheet & Risk Balance sheet is insolvent.
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Appendices
+ Traffic light analysis
+ Chair letter [Draft shortly to be circulated to Chair]
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