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ShEx Board 5 May 2011 (11)10
Portfolio Unit Development
Purpose: To seek agreement from the Board to changes to the way we monitor
and control our portfolio companies.
1. Introduction
Anthony Odgers was recruited in October 2010 in the new role as Head of Portfolio,
with an objective to improve and move forward the performance regime for the ShEx
portfolio of companies.
This paper proposes a realignment of the Portfolio Unit, providing more intensive
focus on a smaller range of the bigger companies, and where resources allow, smaller
companies where we have had a major historic involvement. For the remainder, we
would provide financial monitoring - and ad-hoc support on an “as needed” basis.
2. Initial observations
i) ShEx does not have the level of resources necessary to give all our companies the
ideal level of attention
ShEx is not realistically going to be able to take on significant additional resources in
the short term; we may struggle to replace the senior non civil-servant capabilities we
currently have, at the same time as the need for transaction expertise is increasing
significantly.
Conclusion: We need to focus our resources where we can have the highest impact,
while remaining available to all portfolio companies to address emergencies or
transactions. We may need to recruit some additional senior private sector resource if
we are to go on to a number of large company boards.
ii) We do not have a detailed enough tracking of the performance metrics of all our
portfolio companies
ShEx tracks general financial performance and performance against budget and
business plan, has performance and dividend targets for individual assets and
performs valuations on a rolling 2 year basis. While focused on the big policy issues,
we do not have the fullest range of detailed private equity ownership disciplines.
Standards across the portfolio vary and not all of the company teams have a detailed
understanding of key performance indicators and drivers for revenue and cost or
credible benchmarking. This limits our ability to set challenging but realistic targets
for the management teams. We also do not track well measures of how well or cost -
effectively the companies are delivering their policy objectives. Finally, not all
companies have a 5 year business plan with key drivers identified.
Conclusion: ShEx need to collect more, more timely and better information from our
portfolio companies. In particular, we need to measure achievement of policy
objectives explicitly. This will tie in to helping policyholders define better what they
are purchasing.
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iii) Focus on the companies alone is not enough
Unlike companies in a private equity portfolio, our portfolio companies are affected
by an environment where:
- Government departments are often poor customers, buying services with
relatively junior people insufficiently clear as to what they are buying and
with short term objectives in mind;
- many of our portfolio companies are small in terms of the owning
department’s budgets, sponsoring policy staff change frequently and in any
event are not well trained to deal with commercial matters; and
- Treasury is not prepared to commit irrevocably multi year cash to fund
companies or purchases by departments from companies.
The companies themselves are incentivised to be defensive of resources and build up
fat so that they can survive when spending restraint hits, with no inbuilt
counterbalancing incentive towards profitable operation. Companies themselves are
also, in general, poor at thinking of their policyholders as customers and pro-actively
developing interesting and well costed products that meet policy objectives.
As such a large amount of ShEx portfolio time is spent focused on how companies
interact with their government customers — and this is critical to the position of our
companies. For example, more time is spent on the data companies addressing the
threats and opportunities in free data than in any independent benchmarking of
company performance. The failure of the FSS was to a large part due to a policy
vacuum and the failure of the procurement regime, which ShEx identified but, despite
repeated attempts, was unable to change. There is a further example in the Post
Office case study later.
Conclusion: We spend a large amount of time working with the various government
stakeholders rather than just spending time with our portfolio companies and it is
essential that we keep doing so. However, we do need to help our companies and
their customer departments set up more effective commercial relationships with each
other and thus reduce our role as middleman.
iv) ShEx doesn’t always have the position it needs to monitor and challenge
effectively
A Board seat, or at least an ability to attend Board meetings, is likely to be important
to understand the business in detail, to be able to point out the government related
issues to the Board as a whole, and to have the most credibility with executive
management. We do not sit on the Board of some of our biggest portfolio companies
(e.g Royal Mail, Post Office, NDA).
Conclusion: We should look closely again at our Core portfolio companies (see later)
and aim to take Board seats unless there are good reasons not to. We will need clear
terms of reference so that companies and departments know our role as owner — not
customer. A seat on the remuneration committee in particular will help drive the link
between ownership, objectives and management. (While we can help guide portfolio
companies as to how best to interact with policyholders / government customers, we
will not hold that role within ShEx.)
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v) The environment for successful management for Government owned businesses
is deteriorating but the environment for privatisation is improving
Reduction in government spending makes HMG a less attractive customer and most
of our businesses will need to look to the private sector for growth and / or restructure
to meet lower revenues. All of this requires strong management and private sector
capability at a time when there is renewed focus on reducing management pay and
incentives and reducing the use of specialist consultants who would otherwise take
some of the strain.
At the same time there is a greater willingness from the centre to push for private
sector investment / outright privatisation as seen in the creation of the PEX (A) sub-
committee.
Conclusion: we should take every opportunity to explore ways to promote private
sector involvement where it makes sense.
3. Proposed changes to our approach to portfolio companies
Core and Light Touch involvement
We would propose two levels of involvement with assets: Core and Light Touch.
Core involvement for ShEx would usually include a seat on the board; providing
direct advice to Ministers; acting as the primary company (as opposed to policy)
driver within Government; and having the ability to incentivize management — i.e.
having the key input on management targets and any linked remuneration.
Light Touch involvement for ShEx would usually consist of quarterly meetings with
companies; a board dinner; steering the strategic dialogue (as opposed to formally
driving performance); involvement in significant investment decisions; spotting storm
clouds and being more involved in a crisis; and involvement in transactions and
management change.
This does not mean that ShEx will materially reduce its level of monitoring on Light
involvement companies or its level of commitment when they need us for a
transaction or in a crisis. It does mean that we would step away from some of the day
to day hand holding for companies and their owning departments for the smaller
portfolio companies, an also the commitment of resource to new small companies that
might otherwise come into the portfolio (e.g. from MoD or DH).
Core should cover the assets where we are able to have the biggest impact, e.g. with
enterprise value of more than £1bn and ShEx having the ability to exercise all or most
levers, together with (resources permitting) those assets where we have historically
been heavily involved. To the extent that we do not have the necessary resources, we
should look to transfer those smaller assets where we have historically spent a lot of
time but where the value we can now add is limited (e.g. possibly Royal Mint) to the
Light Touch category.
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Provisional Split of ShEx Portfolio
On the basis of the above criteria, a split of the portfolio would look something like
the following.
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Core Light Touch Exit (already actioned)
NDA BNFL (but Board seat) Actis
PDC Channel 4 BWB
Royal Mail ECGD NI Water
Post Office FSS PUK
Student Loans NATS (if residual stake) UKAEA
Urenco NNL Tote
CDC? Scottish Water
Green Investment Bank? Working Links (Keep
Board seat for R&D)
UKHO
Smaller core (resource
permitting):
Eurostar
Land Registry*
Met Office*
Ordnance Survey*
Royal Mint
* May be part of PDC
There is significant activity within the Core portfolio. We are driving the creation of
PDC and will ensure that the correct governance is set up from the start. As POL
separates from the Royal Mail, we will take a more significant direct role in the
governance of POL. We have no direct governance position in relation to the Student
Loans Company at present, but if clearance is given for the sale process, we anticipate
that we will need to become significantly more involved in its governance (or at least
that part of it that is charged with collecting the loans). DFID is in the process of
redefining the mission and governance of CDC, and we are discussing with DFID the
role ShEx would play. Finally, we are involved in the set up of the Green Investment
Bank and will look to have the right ShEx involvement from its start.
We would expect the portfolio and the allocation between Core and Light Touch to
evolve over time dependent on ShEx resources, company / departmental needs and
the identification of other government companies where we may be able to add
material value. Entities such as Network Rail, the Big Society Bank, the MoD
procurement company, the Environment Agency, and possibly certain health assets
might at some future date be worth considering for inclusion in the portfolio.
PROTECT - POLICY AND MANAGEMENT
ShEx Board 5 May 2011 (11)10
ShEx Investment Reviews
ShEx currently performs an annual, and an interim, investment review for assets in
the portfolio. Following the split of assets into Core and Light Touch involvement
categories, investment reviews would differ for each category (see appendices 1 and
2). For Core assets, we would expect detailed annual investment reviews with higher
visibility of policy delivery, key business drivers, an updated annual valuation, a
better definition of the risks and opportunities for the company, and key targets for the
year. There would be a update quarterly. Light Touch asset reviews would involve
less detail and we would retain our bi-annual valuation regime. The focus would be
on performance against target and any emerging risks and opportunities that would
likely require more significant ShEx involvement. We would continue to use the
Traffic Light checks but the expectations may well be different for Core and Light
Touch assets.
4. Case study - Post Office Limited (POL)
Background
POL is a subsidiary of Royal Mail Postal Services (RMPS). It is heavily subsidised
by HMG, but the overall policy objectives are unclear other than a requirement to
maintain a national network of over 11,500 branches and to avoid a post office
closure programme. POL does provide services to a number of government
departments but often finds itself undercut by competitors who are able to look at the
government services on a marginal cost basis. There is a significant change
programme to be undertaken - bringing down the costs of the large Crown post
offices, and changing the relationship with the franchised post offices move more
from fixed to commission based pay. HMG has committed that POL will remain in
Government ownership and may be mutualised.
ShEx has no Board seat (on either POL or RMPS), and the management information
provided to ShEx doesn’t always provide us (or, we suspect the company) with the
early warning mechanisms to understand where financial problems are developing.
Illustration of new approach
As POL disengages from RMPS, we would look to take a more active role, and have
already agreed with ministers and RMPS to take a Board seat once the business
separates from Royal Mail. We have also agreed with the Chair of RMPS that we
will jointly select a new Chair for POL.
As part of our increased focus, we will look to help the company and policy holder
within BIS define what the policy objectives are with greater clarity and we are
developing a proposal to OGDs for an umbrella agreement with UK government
departments that seeks to avoid the situation where individual government
departments are incentivised to reduce their individual costs — only for a larger cost to
be borne by the rest of Government to support the network.
We will also work to improve the quality of management information on, for
example, contracts coming up for renewal, on cost benchmarking and on a set of
metrics to understand if the change programme is going to plan. We have agreed with
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ShEx Board 5 May 2011 (11)10
the current finance director of POL to review the information the Board gets to allow
us a better “dashboard” of indicators, and will use the arrival of a new finance director
within the next 3 months to make sure we (and the Board) have the right level of
information.
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ShEx Board 5 May 2011 (11)10
Appendix 1
Annual and Quarterly reviews for Core assets
Annual Review for Core assets would cover:
Government policy objective (assuming there is one) and how measured /
monitored
Agreed ShEx role with owning Department
Company key activities (brief description) and its non financial metrics
and targets
Company business plan (3 yr historic, 5 year forecast), detailed template to
be provided
Performance against targets — financial / dividend and customer delivery
(to include specifically milestones on major capital expenditure
programmes or restructuring)
Board and management — right Board and Management? - performance
targets and achievement
Opportunities— possibly benchmarking to show efficiency potential, new
products — and strategy to capitalise
Threats / risks — and strategy to mitigate
Valuation — together with movement from last time and explanation.
Level of ShEx resources required
Review of whether the company should remain public sector
Traffic light checks as summary
Appendix showing Chair letter / ShEx terms of reference owner
department.
In addition:
Head of Portfolio to meet Chair
Head of Portfolio to meet owner / policyholder and HMT
Quarterly Review would cover:
Performance against budget
Status and performance improvement actions
“Traffic light” checks
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ShEx Board 5 May 2011 (11)10
Appendix 2
Annual and Interim reviews for Light Touch assets
Annual Review for Light Touch assets would cover:
- Much more detailed numbers including a measure of policy objectives
delivered
- Agreed ShEx role with Department
- Strategic issues/potential problems
- Review of likely ShEx involvement over year
- Valuation every 2"4 year
- Dividend returns to Government
- Whether HMG remained the best owner of the asset
- “Traffic light” checks
Interim Review would cover:
- Performance against budget
- Update on key issues/ShEx involvement
- “Traffic light” checks
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Appendix 3
Current Position on Board Seats (as of Feb 2011)
Core
CDC ? No Board Seat
GIB? N/A
NDA No Board Seat
PDC N/A
Post Office No Board Seat
Royal Mail No Board Seat
Student Loans N/A
Urenco Board Seat
Light Touch
Actis No Board Seat
BNFL No Board Seat
Channel 4 No Board Seat
ECGD No Board Seat
Eurostar Board Seat
Fss No Board Seat (resigned)
Land Registry* Observer Status
Met Office* Board Seat
NATS No Board Seat
NNL No Board Seat
Ordnance Survey*
[Observer Status/Board Seat]
PUK
No Board Seat (though previously had one)
Royal Mint Board Seat
Scottish Water No Board Seat
UKHO No Board Seat
Working Links
Board Seat
*Heavy if in PDC