In May 2010, defence and security company QinetiQ embarked on a journey to get its business back on track following two profit warnings in the preceding six months and the appointment of Leo Quinn as CEO.
Quinn, who had previously led banknote printer De La Rue, launched a 24-month ‘self-help programme’, a widespread cultural change initiative that aimed to improve competitiveness and transform the group from a public-sector offshoot to a more commercially focused business that was equipped to meet the challenges of the 21st century. It had been squeezed by government cutbacks on defence spending, and weighed down by its bureaucratic structure and civil service practices, an overhang from its days as an agency of the Ministry of Defence. QinetiQ recorded a £66.1m loss for the financial year ending 31 March 2010 (although underlying operating profit was £120.3m).
Like many companies, QinetiQ had enjoyed the good times of the previous decade, benefiting from an ever-growing defence spend, while not taking the necessary measures to establish the company as a commercial enterprise following its launch in 2001 and subsequent flotation in 2006. So when the recession – and government cuts in defence spending – followed, the pain it felt was acute. It had more UK employees than it could realistically support and they were still employed on civil service terms, meaning the cost of restructuring was significant. Some long-term employees, for example, had redundancy terms that would entitle them to a pay-out of up to three years’ salary.
As the company couldn’t afford to reduce the size of its UK workforce within the existing terms of employment, it had to convince its employees to change their terms of employment and accept new conditions. This meant convincing employees of the benefits of the self-help plan and ultimately around 75% of trade union members voted in favour of halving redundancy benefits. This, then, paved the way for restructuring and a £50m reduction in the UK cost base.
Against this backdrop, QinetiQ’s treasury was charged with securing refinancing for the group’s credit facilities. In 2010, QinetiQ had one large syndicated bank credit facility dating back to pre-flotation that was due to expire in 2012. But we were concerned that the facility was fairly restrictive and we wanted to replace it with a facility based on more normal Loan Market Association terms and conditions, while also extending the maturity. But the two profit warnings had caused market sentiment towards QinetiQ to turn and this was exacerbated by the fact that the company was highly leveraged. Its net debt was 2.5 times EBITDA, something that put it towards the cusp of the sub-investment-grade credits, limiting its attractiveness to lenders.
Against a backdrop of restructuring, QinetiQ’s treasury was charged with securing refinancing for the group’s credit facilities
Together with David Mellors, our CFO, the treasury team took the strategic decision that it was better to refinance when the banks had capacity to support us. So in late 2010, we put out a request for proposal (RFP), inviting our existing lenders to bid for replacing QinetiQ’s credit facility. We soon found that the principal banks that we used for our cash management were unable to help us, so we invited new banks to back the refinancing.
These banks needed to have the capability to support QinetiQ in its principal locations: the UK, the US and Australia. For example, we approached Bank of America Merrill Lynch, where we had a long-established relationship, about refinancing the credit facility and we helped to arrange for the bank to have an opportunity to tender for the group’s cash management business in the US.
The refinancing was a great success: we secured a new £275m, multi-currency, five-year revolving credit facility. And because we had the support of an improved banking group, the terms and conditions of our credit facility were those of an investment-grade company and more in line with market practice than the terms of our previous credit facility. Ancillary business has been gradually realigned to the new banking group in recognition of those banks’ participation in the new credit facility.
QinetiQ has never actually needed to draw on the credit facility since the company has been extremely successful since the self-help programme was launched. After its loss the year before, the group reported a pre-tax profit of £26.6m for the year ending 31 March 2011, followed by a £331.6m pre-tax profit for 2012 with the underlying operating profits more stable.
We soon found that the principal banks that we used for our cash management were unable to help us, so we invited new banks to back the refinancing
As part of its self-help programme, QinetiQ had focused on improving the general health of its balance sheet. At the end of 2009, its net debt was £500m, but by March 2012, this had fallen to just over £100m. A number of initiatives contributed to this, including the suspension of the dividend for 12 months. But the debt reduction has largely been driven by working capital improvements and a pan-QinetiQ focus on cash generation.
Once QinetiQ had generated more cash, we decided to use it to buy back approximately $300m in US private placement debt over a 15-month period from the start of 2011. We wanted to reduce the financial risk of the organisation when we had the cash available to us to do it and we hoped to position the company for the future with lower interest costs.
We invest cash almost exclusively in AAA-rated money market funds that produce low returns. We follow a cautious and prudent investment approach. This is not something that is likely to change in the foreseeable future. Meanwhile, the mass downgrading of the major banks by the rating agencies has meant we have had to revise our rating policies and drop the rating thresholds of our counterparties. ‘A’ is the new ‘AA’ long-term rating, it seems. Nevertheless, rating remains our primary means of counterparty evaluation.
We follow a cautious and prudent investment approach. This is not something that is likely to change in the foreseeable future
QinetiQ’s drive to strengthen its balance sheet has not just focused on debt pay-down and cash management, but also on broader financial risks, including pensions and insurance. QinetiQ’s treasury team plays a vital role in managing QinetiQ’s financial risk profile. This includes its defined benefit pension scheme, which currently is marginally bigger in terms of liabilities than its market capitalisation.
Since the launch of the self-help programme, there has been a noticeable cultural transformation at QinetiQ. It has developed more of a commercial and competitive ethos. But it’s a long journey and the intensity and pace of change has not slackened at all. The focus has now shifted to growing our sustainable earnings through an Organic-Plus programme, but the disciplines that we established during the self-help phase – including balance sheet strength and high cash conversion – will remain.
Technology has played an important part in transforming QinetiQ’s treasury over the past three years. Back in 2009, there was no connectivity between the different treasury platforms and other systems. Our main focus was on foreign exchange management and creating a straight-through process. We changed to 360T, an online trading platform, to process FX and have a bespoke interface that can upload data without the need to rekey.
We have an interface with a Misys platform for matching trades between the business and its banks, delivering straight-through processing for all deals. We also make better use of SAP enterprise resource planning software to improve our treasury management, enabling us to move away from storing data in Excel files. The upshot of this is we have vastly improved visibility and control.
My advice for other treasurers is to be determined when developing new it systems. You do encounter roadblocks and there are always complications. You have to be prepared to make brave decisions and bring in new systems that are more compatible with your processes. We consulted with our banks to see which systems they preferred and which they thought would work best.
Stephen Webster is group treasurer at QinetiQ.