Imrecon

I have been reading the story of MG Rover in the independent inspectors' report published last month by the Department for Business, Innovation and Skills (Volume I and Volume II).  It's a sad story, but an illuminating lesson about when things are set up to go wrong, they go wrong.

The facts

By late 1999, BMW wanted out of MG Rover.  It was persistently and heavily loss making and had become a massive burden.  It was worth BMW paying someone to take it away. 

BMW started negotiations for a sale to a venture capital house (Alchemy) whose plans involved closing down volume production over 3-4 years and continuing with an MG-branded sports car company. 

However, in a frenetic few weeks in April and early May 2000, those negotiations were overtaken by four businessmen, the Phoenix four.  They demanded less cash dowry from BMW, promised to maintain volume production and gained the support of politicians and employees.  On 9 May, the four bought MG Rover for £10.  The business they bought had a net asset value of £740 million and BMW contributed another £502 million[1].  Effectively they had £1.2 billion of assets to play with.

MG Rover was of course still heavily loss making.  It continued to make losses.  The Phoenix four tried but failed to secure a strategic partner to support the development of new models and the company finally went into administration in April 2005 owing creditors £1.3 billion.   

Their strategy might have worked, but it appears the relative lack of experience and competence of the Phoenix four at least hindered negotiations with potential strategic partners.

Were financial rewards the issue?

Over this period, despite failing, the Phoenix four "chose to give themselves rewards out of all proportion to the incomes which they had previously commanded", some £36 million, plus a £13 million return from a £2 million investment in the vehicle financing loan book[2].    The inspectors noted that the four had personally borne "relatively insubstantial" expenditure and risk. 

Unlike many commentators, I do not think the level of financial rewards is the important issue.  They were certainly jaw-droppingly large, but if you sell a large business to individuals for £10, what should you expect?

The bigger issue is about recognising there is a public interest in a business that is important to a regional economy and knowing when and when not to intervene in its sale. 

A service to BMW

MG Rover was liable to go wrong, and go wrong messily causing collateral damage to the owner's reputation, customer goodwill and other relationships. 

So BMW was happy to pay someone to take it away.  This meant that investment risk was not the problem for any new owner.  The problem was reputation risk - a party without a valuable reputation to lose would clearly have a natural advantage and, in Phoenix's case, an overwhelming advantage.  It was a no-brainer for the Phoenix four.  By cleverly playing the local and national political interests and with just enough background to pass as credible businessmen, they could get BMW off the hook and make themselves very rich. 

When reputation is a disadvantage, those best able to turn round the business may be those least likely to get the job.  It is analogous to a market failure, and may be a rare circumstance that allows a rationale for Government intervention.  In the case of Phoenix, intervention might usefully have improved the governance set up.

A fault line in MG Rover's governance

Had the Phoenix four turned MG Rover round, we would have congratulated them.  But they didn't and the reasons they didn't are clear in the report.  The strategy might have worked and they nearly pulled off a strategic partnership with SAIC, a state-owned Chinese automotive company.  But they didn't have the skills or experience to run a major motor manufacturer.  Importantly, they didn't have to account to anyone else for what they did.  

The report catalogues many examples of weak governance, including a habit of the Phoenix four to hold board meetings without inviting other board members.

As the inspectors concluded, there was "probably a feeling on the part of the members of the Phoenix Consortium that they were the owners of the Group and should be able to do as they wished".  Furthermore, the report quotes one of the professional advisors: "they had a big cash-credit balance, courtesy of BMW, and did not have lenders to chivvy them in terms of their financial information in the same way as one would get with . . . a different company of equivalent size."

In retrospect, the Phoenix four had been given a big toy to play with and a way of becoming very rich without necessarily making it a success and free of any serious monitoring or supervision.  Incentives and governance were distorted.

It mattered

It wouldn't have mattered so much if the toy hadn't been a strategically important business for the West Midlands economy, one on which a large number of employees and supplier businesses depended.  

But it did matter.  And policy makers may have been well placed to make a difference - right at the start.

The report traces the origins of the Phoenix bid back to meetings on 17 March 2000 between one of the Phoenix four, John Towers, and the then Secretary of State for Trade and Industry, Stephen Byers, and the Labour MP for Birmingham Northfield, Richard Burden.  They met to discuss the proposed sale of MG Rover to the venture capital house (Alchemy), presumably because they considered there were public interest issues at stake.  Perhaps it might have been better if politicians hadn't got involved at this stage, but . . .

John Towers agreed to consider alternatives to the sale to Alchemy and the resulting paper, ‘Project Phoenix', outlined a "Timely Sale of Rover to a Good Home" to "Minimise job losses at Rover and at associated/dependant firms" and to "Avoid further dilution of UK/Midlands manufacturing base."

So a minister was involved at the conception of the Phoenix project and political connections at least facilitated the rapid development of the bid and the public support it gained.  If they weren't before, public interest issues were certainly now at stake, and policy makers might have spotted the potential risk in the distorted incentive and governance set up.

It is easy to say that with hindsight, but politicians got mixed up in a transaction that involved no public money and that needed to complete in an extremely short timescale.  Arguably, that political support exacerbated the public interest problem.  Superficially, politically, the Phoenix bid was attractive, but should it have received so much political support without sensible conditions?  Something small, like a 10% special employee share (costing perhaps £1) with the right to be consulted on the appointment of an independent non-executive director could have transformed the group's governance.

But it is not about blame; it is about learning the lessons.  The MG Rover episode tells us that the incentive and governance set up for the owners of an important business can have significant public interest implications and that political involvement can heighten those implications.  Hopefully, the experience will help the Government in the future avoid giving unqualified euphoric support and instead have a more constructive influence on apparent ‘white knight' rescuers.

Ian Rowson
6 October 2009

[1] £472 million was by way of a 49 year interest-free loan

[2] These amounts exclude benefits for Mr Kevin Howe who became Chief Executive after the acquisition and was not one of the original four.