NATIONAL AUDIT OFFICE

REPORT BY THE COMPTROLLER AND AUDITOR GENERAL

The Third Sale of Shares in British Telecommunications plc

ORDEREDBY THEHOUSEOFCOMMONS TOBEPRINTED 18OCTOBER1994

LONDON: HMSO 663 f7.40 NET

This report has been prepared under Section 6 of the National Audit Act 1983 for presentation to the House of Commons in accordance with Section 9 of the Act.

~John Bourn National Audit Office Comptroller and Auditor General 19 September 1994

The Comptroller and Auditor General is the head of the National Audit Office employing some 800 staff. He, and the NAO, are totally independent of Government. He certifies the accounts of all Government departments and a wide range of other public sector bodies; and he has statutory authority to report to Parliament on the economy, efficiency and effectiveness with which departments and other bodies have used their resources.

Contents

Introduction, summary and conclusions

Part 1: The International Offer

Part 2: The United Kingdom Public Offer

Pall 3: Costs of the sale

Glossary of terms 29

Appendices

1: Timetable of key events

2: Survey of institutional investors

3: Principal advisers and contractors appointed for the sale

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33

Page

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4

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Introduction, summary and conclusions

1 In July 1993 the Treasury offered for sale 1,311 million shares (about 21 per cent of the total issued shares) in British Telecommunications plc (BT). The proceeds, payable in three instalments (Figure l), will be some f5,202 million (f3,790 million in 1993-94). A timetable of key events in the sale is at

Appendix 1.

ThiS figure ShoWS the estimated gross pmceeds from the sale and

the timetable for payment

Objectives for the sale

2 This was the Government’s third Sale of BT shares and by far the largest privatisation sale in 1993-94. The Treasury had to raise about f3,800 million to contribute to the achievement of the Government’s target of f5,500 million

from privatisations during 1993-94.

3 The Treasury’s specific sale objectives were:

l to get a good deal for the taxpayer by maximising proceeds and minimising costs;

l to widen and deepen share ownership; and

l to create a perception of success.

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4 In considering how to maximise proceeds the Treasury had to take into account the fact that BT shares were already traded on the Stock Exchange.

This implied that the prevailing market price of BT shares would determine the pricing of shares in this sale and that the Treasury would also have to guard against ways in which the market price itself could be depressed artificially in anticipation of the sale.

Structure of the sale

5 The Treasury and their financial adviser, S.G. Warburg & Co Ltd, saw competitive tension as the key to maximising proceeds. To maximise competitive tension they decided to target the sale both at investors throughout the world and at individuals in the United Kingdom. Offering shares to individuals also enabled the Treasury to address the objective of widening and deepening share ownership. The Treasury decided therefore to repeat the basic structure of the second sale and to pursue two separate offers:

l an International Offer aimed at investors worldwide;

l a United Kingdom Public Offer (the Public Offer) aimed at individuals

The Treasury retained discretion to vary the size of the offers in the light of indications of demand.

Scope of the National .4ndit Office examination

6 The National Audit Office examined how far the Treasury met their objectives.

7 This report is based on an examination of the Treasury’s papers and discussion with the Treasury’s staff and other parties involved in the sale. The National Audit Office also conducted a survey of institutional investors in

the United Kingdom and overseas (Appendix 2). The National Audit Otfice obtained advice from Kleinworl Benson Limited. The National Audit Office are grateful for the assistance they have received in carrying out this study and producing their report.

6 Part 1 of this report examines the implementation of the international Offer. Part 2 deals with the Public Offer. Part 3 addresses the costs of the sale.

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Conclusions

9 The National Audit Office concluded that the Treasury successfully achieved their sale objectives, in particular:

Maximising proceeds and minimising costs

(a) following action by the Treasury to deter it, there was no evidence of any

significant market activity to depress the market price of BT shares artificially (paragraph 1.27 and Figure 3); (b) shares were sold to institutional investors at their market price plus the full value to investors of payment by’instalments. This was the first time such an outcome had been achieved in a Government secondary sale (paragraph 1.35 and Figure 6); (c) at the end of the first day of trading, the newly issued shares stood at a small premium of five per cent to the part-paid issue price, equivalent to two per cent on a fully paid basis (paragraph 1.42); (d) at just under 1.9 per cent of estimated gross proceeds, the overall costs of sale were lower than the 2.1 per cent of gross proceeds in the previous sale of shares by the Treasury in 1991 (paragraph 3.2).

Widening and deepening share ownership

(e) just under 1.6 million individuals received shares compared with 2.7 million in the previous sale. Nevertheless, the sale deepened share ownership among BT shareholders to a much greater extent than in the second sale (paragraph 2.9 and Figure 9); (9 the total value of discounts and bonus shares allowed to individual investors in the Public Offer is estimated at some f203 million. This was significantly lower than the previous sale in 1991, which is estimated at f348 million (paragraph 2.16 and Figure 10); (g) the Treasury judged demand in the Public Offer to be sufficiently strong to transfer 122 million shares to it from the International Offer. The expectation among institutional investors that there would be a transfer, confirmed by the Treasury just ahead of the close of the sale, increased competitive tension in the International Offer. It also increased individual share ownership. The gross cost of the transfer, in terms of proceeds foregone through additional discounts and bonus shares, is estimated at some f36 million (paragraphs 2.33 to 2.36);

Perception of success

(h) press commentary at the time and responses to the National Audit Office survey of institutional investors (paragraph 1.14) confirmed that the sale had been perceived as a notable success.

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The International Offer

1 .l The International Offer was designed to capture demand from investors around the world and to determine the price at which the shares could

be sold.

1.2 This part of the report examines how the Treasury implemented the International Offer and shows that they were successful both in pricing the

shares at the prevailing market price and in avoiding any significant distortion in the market price before the sale.

1.3 The Treasury set two targets against which the objective of maximising proceeds could, in part, be assessed:

To monitor whether adverse market activity took place

l BT shares should have performed no worse than the Financial Times Stock Exchange index of 100 leading companies (FTSE 100 Index) over the period from the announcement of the sale (18 November 1992) to the close of the offer (16 July 1993). This demanding target was narrowly missed;

To monitor the sale price relative to the market

l The shares should trade at a small (but unquantified) premium to the offer price in early dealings following the sale. This target was met.

1.4 To implement the International Offer the Treasury aimed to (i) set up a structure designed to elicit competitive bidding by all potential major investors (ii) prevent distortions in the market for BT shares before the sale (iii) set the best price for the shares in response to bids received (iv) allocate shares in accordance with stated policies, and (v) set up mechanisms to prevent distortions in the after-market.

Offer structure and demand

1.6 To retain flexibility in allocating shares between the offers, the Treasury provisionally set the International Offer at half the 1,220 million shares initially offered for sale. As in the second sale, the International Offer was open to investors anywhere in the world. To boost competitive demand, individual investors in the United Kingdom were again able to participate, provided they bid for at least 1,000 shares on the same terms as other investors in the International Offer.

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1.6 As in the second sale, the Treasury appointed a global coordinator, S.G. Warburg Securities Ltd, to co-ordinate marketing and book-building. The global co-ordinator led a global syndicate of 11 investment banks, established to generate competition for the shares among the world’s largest 450 or so institutional investors. The global syndicate was supported by three regional syndicates, consisting of a further 20 investment banks, established to generate additional demand from smaller investors in North America, Japan and the rest of the world.

1.7 Each syndicate member was appointed by the Treasury, in consultation with the global co-ordinator, on the basis of experience, trading record, distribution capability and research standing. Members of the global syndicate were able to compete with each other for investors’ orders anywhere in the world. This form of open, global competition was an innovation in international capital market practice. It aimed to increase demand and the price of bids for the shares and to provide the Treasury with a better flow of information on the progress of the International Offer. It was sharpened by the freedom allowed to the larger institutions to choose and change the global managers with whom they placed their orders. Members

of the three regional syndicates competed with the global syndicate and each other for orders within their geographical region.

1.8 In book-building immediately prior to the sale, syndicate members asked investors to indicate how much they would be prepared to invest at specific prices. Book-building, also a feature of the previous sale, allowed the Treasury to compile a comprehensive picture of the strength of institutional demand for the shares over a range of prices.

1.9 The Treasury set the price of shares in both offers in the light of book-building, at the end of the International Offer period. This price, known as the strike price, was to be payable in three instalments. As in the second sale, payment by instalments made the shares attractive and affordable for both institutional and individual investors. By stimulating demand in this way, the Treasury aimed to maximise the strike price.

1.10 The Treasury also sold the shares with the benefit of the final dividend for 1992-93, due in September 1993. This had marketing advantages for both offers and was considered by the Treasury to be an important element in maximising demand for the shares. The Treasury were advised that there was no advantage in selling the shares without entitlement to the September 1993 dividend, as this would simply cause institutions to reduce the prices of their bids by the amount of the dividend.

1.11 To encourage competitive bidding and give momentum to book-building, the Treasury announced that their allocation policy would favour bidders who indicated specific prices and volumes at an early stage. To reassure bidders that there would be an orderly after-market in the shares, the Treasury also announced that they would favour bidders who were likely holders rather than sellers of shares. To implement this policy, they required syndicate members to identify bidders.

Outcome

1.12 Syndicate members generated considerable demand forthe shares. Sufficient bids were received on the first day of book-building to make the International Offer fully subscribed at a premium of some 12 pence to the market price of existing BT shares. The Treasury considered that such early demand was unusual and very helpful to the sale. Over the following six days of book-building, total demand increased so that the shares provisionally available in the International Offer were 4.7 times subscribed at the strike price (Figure 2).

mis figure Shows that s”fficient bids were received.on the first day of book-building

CnxKxiay 8 July 1993) to n&e the lntemational offer MY SubSCribed at the

adju*fed market price lie the market

1.13 Demand from institutions exceeded the Treasury’s estimates of likely demand across all geographic regions and was greater than demand in the second sale. The global syndicate generated around 87 per cent of world-wide demand from institutions. Nine per cent was generated by the regional syndicates and four per cent by United Kingdom individuals.

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1.14 Over eight out of every ten respondents to a National Audit Office survey of institutional investors thought the syndicate structure was effective in maximising proceeds and two-thirds thought it had delivered an effective

service for potential investors. All but one of 78 respondents thought the sale had been perceived as a success.

Preventing market distortions before the sale

1.15 In handling the sale, the Treasury aimed to deter investors from engaging in adverse market activity which sought to reduce the market price of existing BT shares and distort the pricing of the new shares. The Treasury did not wish to depress normal market activity, since a live market would allow potential investors to make informed bids. To help maximise proceeds, they introduced measures to dissuade investors from engaging in adverse market activity.

Measures taken to deter adverse market activity

1.16 The sale of a significant volume of shares into the market ahead of the close of the offer would have depressed the BT market price. Sales of shares can either result from reductions in existing holdings, or institutions can sell shares they do not yet actually own but will be required to purchase

subsequently to settle the transaction.

1.17 The latter type of deal is commonly known as “short selling”. It involves a risk that a later purchase of shares will give rise to a loss if the share price rises. In the run up to a secondary sale a short seller speculates on driving down the market price of the shares, hoping to meet its commitments by buying

shares cheaply in the offer.

1.16 Although short selling is not illegal and it has been a feature of some major private sector share sales, it is in the interests of vendors to deter it. It is, however, difficult for vendors and market participants to detect either the volume of selling or the parties involved. This also applies to certain other types of activity, such as trading in options to buy or sell shares at a fixed price in the future, which may be linked to short-selling and have similarly adverse effects on the price of existing shares. The Treasury took three steps to deter short-selling and protect the price of BT’s shares in the run

up to the sale.

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1. Creating uncertainty

1.19 The timing of the sale was not announced until 24 May 1993 and the Treasury reserved the right to sell all or only a proportion of the Government’s holding. This created uncertainty. An expectation by investors that selling shares ahead of the close of the offer might not be matched by subsequent purchases of the newly issued shares at a lower price was seen by the Treasury as a strong incentive to potential investors to refrain from selling ST’s shares.

2. Deterring “short-sellers”

1.20 The Treasury announced that anyone suspected of manipulating the market might receive a reduced or nil allocation of shares. The global co-ordinator, with assistance from other syndicate members, monitored trading in the markets and changes in holdings recorded in BT’s share register throughout the offer period. Nothing untoward was revealed by this monitoring, but the Treasury were aware that the information provided by such monitoring might not identify short-selling and the investors involved.

1.21 The Treasury therefore considered whether to seek the assistance of the self-regulatory bodies established under the Financial Services Act 1986. These bodies had access to the full range of information necessary to identify all parties to transactions in BTsecurities. but only under strict confidentiality agreements. Following consultation with their legal advisers, the Treasury considered they would be in breach of the provisions of the 1986Act if information provided by the regulators was used to assist with the sale rather than as part of the Treasury’s overall responsibilityforfinancial regulation and proceeded no further.

3. Giving preference in allocation to net buyers of BT shares

1.22 To protect the share price directly, the Treasury indicated that investors who bought or increased their holdings of ST shares before the close of the offer would be treated favourably in allocation. This was a new policy which the

Treasury and their advisers considered fully complied with the provisions of

the Financial Services Act 1986. To implement it effectively, however, the Treasury needed an up to date register of holdings of ST shares at the end of the offer. This was not possible given the standard delay of up to three weeks between a share transaction and its settlement. To speed up the settlement process the global co-ordinator requested the London Stock Exchange to move to a cash settlement system for trades in BT shares in the six weeks before the close of the offer.

1.23 The Stock Exchange did not adopt the global co-ordinator’s request but instead agreed to monitor closely transactions entered into between 21 June and 16 July 1993. This information was confidential to the Stock Exchange.

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1.24 As the Treasuty could not rely on BT’s share register to provide up to date information on changes in share holdings, they exercised preference in allocation partly on the basis of statements provided by bidders who had bought BT’s shares or increased their holdings. These statements set out the size of their holdings at 21 May and 16 July 1993. To reassure bidders about the use of the statements, the Treasuty said that they would not be used to penalise those who had sold shares or had not provided a statement.

1.25 Bids at or above the strike price were submitted by some 2,300 institutions around the world and individuals overseas. Statements of changes in share holdings were provided by 206 bidders. Of these, 100 bidders claimed to have bought shares or increased their holdings, 97 bidders reported no change in their positions and nine stated that they had sold shares. The total net increase in holdings amounted to 35 million shares, a small proportion of the 5,000 million or so BT shares in existence prior to the sale.

Price relative to the market

1.26 To measure the effectiveness of their actions, the Treasury set themselves the demanding target that BT shares should perform no worse than the FTSE 100 Index from the announcement of the sale (18 November 1992) to the close of the offer (16 July 1993). Movements between the two dates show that BT’s shares under-performed the index by 2.6 per cent, equivalent to some f125 million in the pricing of the offer (Figure 3).

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1.27 The relative movements between the BT share price and the FTSE 100 Index (Figure 3) do not suggest unusual market behaviour. Over the final seven days of the International Offer (8-16 July), during the book-building period, the ST price fell by 3.8 per cent, from 42.6 pence to 408.5 pence a share, against a reduction in the index of less than 0.5 per cent. This relatively small drop, at a time when adverse market activity might be expected, is insufficiently pronounced to suggest such activity was widespread, and could equally reflect normal fluctuations in trading.

1.28 In the first week of trading after the close of the offer, BT’s share price rallied by some two per cent to end the week at 416.5 pence a share. The FTSE 100 Index fell by around 0.2 per cent over the same period.

Views of institutional investors and syndicate members

1.29 In response to a survey by the National Audit Office, nearly three-quarters of respondents thought that the actions taken by the Treasury had been successful in minimising adverse market activity prior to the close of the offer. Discussions with syndicate members suggested that the Treasury’s aim to price the shares at full market value, including the full time value of payment by instalments (paragraphs 1.30 to 1.32 and 1.35) may in itself have been an effective deterrent to short-selling.

Pricing the shares

1.30 On 16 July 1993, at the end of the International Offer, the market price of BT shares closed at 408.5 pence. The Treasury wished to set the strike price higher than this to take account of the full value to the investor of paying for the shares by instalments (the time value). On 22 June 1993, the global co-ordinator estimated this time value at 12 pence a share. Potential

investors were made aware of the estimate during marketing.

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Value of payment by instalments

1.31 The critical component of the estimate of the time value was the rate of interest used to calculate the present value of future instalment payments. The second and third instalments on the newly issued part-paid shares were discounted to their present value at 5.7 per cent and 5.9 per cent respectively. These rates were equivalent to yields available on comparable short-term gilt edged securities issued by the Government of the United Kingdom. Such “risk-free” rates of interest are an appropriate measure of the cost to the Government of deferring payment for the shares. They equate to the cost of issuing short-term gilt edged securities to fund the Government’s borrowing requirement until the balance of proceeds is received.

1.32 The National Audit Office examined changes in the value of the newly issued shares to determine how the market had priced the time value of payment by

instalments. Although the newly issued shares traded at a small premium to their expected price of two pence (one per cent) to eight pence (five per cent)

during the four months following the offer, this premium gradually disappeared in subsequent trading to the end of 1993 (see Figure 4). There is thus a correspondence between the market and expected prices (based on a risk-free interest rate) of the part-paid shares, This suggests that the estimate of 12 pence as the value of payment by instalments was broadly correct.

I g ‘C :i

E 7 E

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1

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The pricing decision

1.33 Book-building indicated that shares in the International Offer would be subscribed about 4.9 times at prices up to 420 pence, 1.7 times at 421 pence and 1.2 times at 422 pence. At prices above 422 pence demand fell short of the total number of shares available to the International Offer. See Figure 5.

mis figure Shows ma, demand for snares in the lntemafional offer at various prices

1.34 To secure a small premium to the issue price in early trading and hence a healthy and stable after-market, the Treasury aimed to set a strike price which lefl demand from institutions unsatisfied. The Treasury anticipated that a strike price of 420 pence would lead to an initial premium of four to five pence a share in early trading. In the light of demand there was no case for pricing the shares at less than 420 pence and the Treasury considered that bidding by investors above this level was tactical to ensure some allocation of shares.

1.35 Treasury Ministers decided, on the basis of this information and advice from

the global co-ordinator, to set the strike price at 420 pence. This was equivalent to the market price on 16 July 1993 plus a premium of 11.5 pence for the time value of instalments. This was the first secondary sale by HM Government to obtain for the taxpayer the full value to investors of payment by instalments in addition to the market price of the shares (see Figure 6).

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This figure Shows that, in all but one Of the secondary S&S prior to the third

BT sale, the issue price was set below the price Of Shares already trading in

the market PIUS the time “al”e Of payment for the new ~hare.s by instalments.

Allocations to investors

1.36 The Treasury allocated shares to investors in accordance with announcements made to the market in the offer period. They allocated shares in proportion to the volume of shares bid for at the strike price, and gave preference to investors who bid early in the book-building process and maintained or increased their bid prices. The Treasury also had regard to whether a bidder had bought or increased their BT shareholding ahead of the sale and the likelihood of the bidder holding rather than selling their part paid shares.

1.37 Institutions which bid early at or above the strike price received on average about 20 per cent of the shares they applied for. In response to a National Audit Office survey of institutional investors, just under eight out of ten respondents stated that their allocation of shares fairly reflected their

bidding behaviour.

1.36 United Kingdom institutions received some 47 per cent of the shares available, North American institutions were allocated 20 per cent and the rest of the world 19 per cent. United Kingdom individuals who took part in the International Offer were allocated 14 per cent of the shares available.

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This fig

nlen me

1.39 The global syndicate of investment banks accounted for 95 per cent of the shares allocated to institutional investors and the regional syndicates accounted for the remaining five per cent. Figure 7 summarises the outcome and shows the shares of selling commission earned by members of the global syndicate. The high proportion of al1ocationsforS.G. Warburg Securities Ltd reflects the many orders for shares placed by investors through the global co-ordinatorfor processing purposes but then designated, for the payment of sales commission, across a spread of investment banks in the global syndicate (paragraph 3.5).

l’rnmtinp distortions in the after-market

1.40 The Treasury’s objective to create a perception of success for the sale was closely linked to the stability of the price of the newly issued shares in the after-market. The Treasury were concerned that a sale of over 1,200 million shares into an existing market could create instability and affect investor confidence. The Treasury were also aware that bidding in the International Offer would be keener if they were to demonstrate their intention to secure an orderly after-market

1.41 The Treasury regarded an orderly after-market as one in which the value of shares would not be adversely affected by temporay imbalances in supply and demand. In addition to their target to secure a small premium to the issue price in early trading (paragraphs 1.3 and 1.34) they announced that the global co-ordinator would, if necessay, stabilise the price following

the sale.

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Price of the newly issued shares following the sale

1.42 At the close of the first day of trading (19 July 1993), the newly issued shares stood at a premium of eight pence, or five per cent to the part paid issue price (160 pence). This was equivalent to two per cent on a fully paid basis (420 pence). Over the two week stabilisation period, the price increased to a

maximum of 174 pence (a nine per cent premium to the part paid issue price), before falling back to 171 pence (seven per cent), at the end of the stabilisation period (Figure 8).

Price stabilisation

1.43 The Treasury announced, in advance of the sale, that the global co-ordinator could allocate 91.5 million shares (which the Treasury initially retained) in addition to the 610 million shares provisionally available in the International Offer. The global co-ordinator was also required, if necessary, to buy shares in the after-market to stabilise the market price at or just below the issue price. Any part-paid shares bought in this way could be used by the global co-ordinator to satisfy the allocation of the additional 91.5 million shares.

1.44 The stabilisation period ran from 19 July 1993, when dealing started, until 30 July 1993. In the event, no stabilisation was necessary. During this period, the global co-ordinator did not buy shares in the market because

their value did not fall below the issue price.

1.45 As no shares had been bought to stabilise the share price, all 91.5 million shares retained by the Treasury were purchased by the global co-ordinator to settle the over-allocation of shares to institutions. This increased the number of shares sold. Additional proceeds amounted to f384 million at a cost of some fl.5 million in management and selling commission.

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The United Kingdom Public Offer

2.1 This part of the report examines the Public Offer. The Public Offer allowed the Treasury to advance both the objective of maximising proceeds and that of widening and deepening share ownership. It also provided a further opportunity for the Treasury to test the effectiveness of their offer methods for use in future sales.

2.2 The Treasury saw retail demand for shares in the Public Offer as an important source of competitive tension in the sale as a whole. They therefore took steps:

. to maximise retail demand: and

. to ensure that the prospect of such demand created in the minds of institutional investors a sense of scarcity.

2.3 To meet the objective of widening share ownership (that is, selling to individuals not already owning shares) and deepening share ownership (that is, selling more shares to existing owners of shares), the Treasury tailored the Public Offer to appeal to both classes of investor. They recognised, however, that to maximise demand in such a large sale they would need to

attract interest from both classes of investor, so they did not always need to consider which of the two objectives was the target of any specific step they took.

2.4 The Treasury set themselves the specific target that the number of individuals who applied for shares in the Public Offer should have been no less than the number who applied in the second sale and the proportion of

applicants securing a reasonable allocation of shares should at least have matched the previous sale. The Treasury sought to avoid making small allocations to individuals, as they thought this would merely encourage early selling.

2.5 To learn lessons which might be applicable to future sales, the Treasury conducted post-sale research.

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Maximising retail demand

2.6 The Public Offer closed on 14 July 1993. It led to 1.67 million applicants for 1,057 million shares, equivalent to some 1.7 times the 610 million shares provisionally on offer. This compares with 2.78 million applicants for 2.6 times the number of shares provisionally available in the second sale.

The Treasury therefore missed their specific target that the number of individuals who applied for shares in the Public Offer should have been no

less than the number who applied in the second sale.

2.7 The target was set in December 1992, at the start of planning for the Public Offer. Mark&research, carried out from February 1993, indicated, however, that individuals were likely to be cautious about their investment decisions. Subsequent decisions by the Treasury to reduce the value of incentives in this sale, compared with the second sale, were also expected to have an impact on the total number of applicants in the Public Offer. Post-sale

research by the Treasury suggested that the main reason there were fewer applicants than in the second sale was shortage of funds. At 51 per cent of those interviewed, this was a more significant factor than in the previous sale

(36 per cent).

2.8 Shares were allocated in full to just under 57 per cent of all applicants and 96 per cent received all or some of the shares they wanted. This exceeded the 43 per cent of applicants who received fully allocations in the previous sale, but fell slightly short of the 98 per cent of applicants in the previous sale who had received all or some of the shares they had applied for. The slightly higher proportion of applicants who received no shares, reflected the preference in allocation for individuals who had registered for the sale and those who had applied through a share shop (paragraph 2.21).

2.9 Just under 1.6 million individuals received shares compared with 2.7 million in the previous sale. Figure 9 compares the numbers of existing BT

shareholders, who added to their holdings, and new shareholders, with the previous outcome. The sale deepened share ownership among existing ST shareholders to a much greater extent than in the second sale.

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2.10 As a group, BT employees, including existing employee shareholders, received 95 per cent of the shares they applied for (83 per cent in the second sale). Excluding employees, existing BT shareholders received 79 per cent (80 per cent previously). Other applicants received 56 per cent (53 per cent).

2.11 To maximise the demand for shares from retail investors, the Treasury aimed to:

l devise a cost-effective package of incentives;

l establish a system of registration and application with a share information office and an extended share shop scheme;

l develop a marketing campaign.

Incentives

2.12 As in previous offers, the Government saw incentives as a key element in widening and deepening share ownership by encouraging individuals to purchase and retain shares. To inform a decision on the type and value of incentives to be offered in this sale, the Treasury commissioned a survey of investor attitudes. This indicated: that 40 per cent of those interviewed considered the generosity of the incentives package to be crucial or very important; and that 43 per cent and 45 per cent regarded a discount on the first instalment and the availability of bonus shares respectively as crucial or very important.

2.13 Further research pointed to a significant drop in the overall attractiveness of a Public Offer without bonus shares. It also indicated that the alternative of two discounts on the second and third instalments of 15 pence a share were favoured by 45 per cent of respondents; discounts of 10 pence and 15 pence were favoured by 44 per cent; while two discounts of only 10 pence lowered acceptability to 38 per cent.

2.14 The Treasury also took account of the attractive short-term yield on the part-paid shares, based on selling the shares with an entitlement to the September 1993 dividend (paragraph 1 .lO) and to BT’s February 1994 dividend before payment of the second instalment due on 1 March 1994 This presented an opportunity to reduce the value of discounts on instalments and bonus shares.

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2.15 Having regard to these factors, the Treasury decided to offer a less costly package of incentives to investors in the Public Offer than in the second sale of BT shares. Details were announced at the beginning of the offer period (29 June 1993). As in the previous sale, payment was to be in three instalments, subject to the following:

l a discount of 10 pence a share from the first instalment payable by investors in the International Offer to encourage individuals to apply for shares (15 pence in the second sale):

l for investors who pre-registered an interest in the Public Offer, a bonus of one share for every 15 held until 31 July 1996, subject to a maximum of 100 bonus shares (one for every 10 to a maximum of 150 in the second sale); or alternatively

l a discount of 10 pence a share on each of the second and third instalments on the first 1,000 shares provided the shares were held by the original purchaser until the relevant instalment was paid (15 pence on each instalment in the second sale).

2.16 The final cost of the incentives package will not be known until after July 1996 when the bonus shares are due to be issued. However, the Treasury currently estimate the cost of discounts and bonus shares at some f203 million (equivalent to 17 pence a share in the combined offers). The total cost of discounts and bonus shares in the second sale is estimated at f348 million (26 pence a share). See Figure 10.

This figure Shows that the overall cost Of the initial diSCO”nt and

incentiveS was reduced in cOmpanSOnwiththe

Second Sal-3

2.17

Registration and application system

Some 5.2 million individuals registered an interest in the offer, almost exactly the same number as in the previous sale. Within this total, 2.4 million BT employees and existing shareholders were automatically registered with the Governments share information office, a centralised registration and application service for the public, set up specifically for the sale (1 .l million existing shareholders were automatically registered in the previous sale). The remaining 2.8 million individuals were active registrants (4.15 million in the previous sale). The Treasury set no target for numbers of registrants.

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Share shops: second sate of BT shares

2.18 In most Public Offers prior to the second sale of BT shares, individuals were encouraged to register interest and apply for shares through specially constituted share information offices. These arrangements successfully generated demand in specific sales but did little to familiarise the public with share dealing in general.

2.19 In the second sale of BT shares, the Government sought to promote wider public knowledge and understanding of private sector share dealing services by appointing eight share shops, mainly high street banks, to provide cheap and accessible buying and selling services for BT and other shares. Individuals had the opportunity to nominate a share shop when registering with the share information office in the Public Offer. Those doing so received preference in allocation. The share shops were allowed to market their share dealing services, but not to market the offer or process applications for BT shares.

2.20 In addition to share shops, approved managers and private client brokers were authorised to submit applications on behalf of their own clients, who received the same preference in allocation and rights to incentives as those who applied through share shops.

Share shops: this sate

2.21 The Treasury decided to develop the share shops initiative. Following consultation with the financial services industry and the invitation of applications from specific firms, they replaced the previous share shop scheme, and the use of approved managers and private client brokers, by some 150 share shops, which were permitted to market the offer and process applications. The key elements of the new arrangements were:

l individuals could register and apply for shares through a share shop or, as before, through a share information office;

l all share shops were required to be members of a self-regulatory organisation and authorised to carry on investment business (enabling them to market the offer);

l share shop applicants would again receive preference in the allocation of shares.

20

Share shops: performance

2.22 Share shops attracted some two million registrations of interest, which included some 600,000 BT employees and existing shareholders automatically registered with the share information office but subsequently registered with a share shop. Applications were received from nearly one million individuals, nearly 59 per cent of all applicants in the Public Offer

(Figure 11).

ThiS figure shows tile ““InbeE 0‘ regi*tration* and applications

through the share information oike and share shops. the co”“ersion

rates of registrations into applications and the average Size of applications

2.23

2.24

Share shops were more successful in converting registrations into applications (49 par cent) than the share information office (18 per cent). This was not unexpected, since share shop applicants received preference in allocation and, having taken the trouble to choose between a wide range of share shops, were more likely to apply.

Share shops also attracted larger individual applications from the public than the share information office. Share shop applications averaged 696 shares (548 shares through the share information office). In total the scheme generated 64 per cent of total demand in the Public Offer.

21

As individuals had a choice between applying through a share shop or the share information office the Treasury did not set targets for share shop registrations and applications, but regarded the overall outcome as a success.

2.25 Following the sale, the Treasury contacted each share shop to assess how far public awareness of share dealing services had been increased and to gauge how participants were planning to take the scheme forward outside the context of a Government share sale. Sixty share shops responded. These accounted for around 80 per cent of all shares sold through share shops. The responses were broadly supportive of the innovative nature and achievements of the scheme but less forthcoming about the long-term future of share shops. Key points included:

l one third of respondents, mainly big banks and major share-dealing firms, marketed the shares widely (and were responsible for generating 54 per cent i

of successful applicants); I

l the remaining two thirds of respondents acted principally for existing clients

or new clients, who asked about their services, but had not marketed their I

services to a wider audience; /

l the reasons given by respondents for not marketing their services widely included strategies to acquire only high net worth clients, or to maintain quality of service to existing clients and a perception that the sale was too complicated to market in a cost effective manner;

l two respondents reported an increase in share dealing after the offer although one firm said it was not possible to discern whether this resulted from the sale itself or from market conditions generally. !

Marketing campaign

2.26 To encourage registration and application, the Treasury conducted a

marketing campaign through television, press and poster advertising across the United Kingdom. The campaign cost some f12.5 million, of which f9 million was spent on television advertising. Post-sale research on its effectiveness in encouraging applications indicated that it made 16 per cent of interviewees more likely to apply, six per cent less likely, while 78 per cent maintained it had no effect.

2.27 Separate research, commissioned by the Central Office of Information, suggested that the market for shares among individuals who already owned shares had become more clearly defined and important. As a result, they suggested that future publicity campaigns might be more focused, perhaps particularly in secondary sales, on deepening rather than widening

22

share ownership. The Treasury, however, remain cautious about the scope to fine tune campaigns in this way. They remain committed to the principle of carrying out pre-sale market research before deciding on specific campaign strategies.

Creating a sense of scarcity in the International Offer

2.28 The Treasury’s flexibility to transfer shares from the International Offer to the Public Offer provided a clear mechanism by which institutional investors could see that strong retail demand could reduce the shares available for institutional investors.

2.29 To create a sense of scarcity in the International Offer, the Treasury considered that they should, if possible:

l ensure that they were seen to be conducting a high-profile Public Offer:

. make announcements during the course of the two offers about the extent

of retail demand;

. create and fufil the expectation that allocations to the International Offer would be reduced.

Profile of Public Offer

2.30 Given the size of the sale, the Treasury considered that a Public Offer was essential to bring competition to bear on United Kingdom and overseas institutional demand and maximise price tension. Having included a Public Offer in the sale, the Treasury had to ensure its success.

2.31 Discussions with syndicate members indicated that institutions perceived the Public Offer to be a success at an early stage in the offer period. This view was echoed in responses to the National Audit Office survey of institutional investors. Some 38 per cent of respondents to the survey stated that the likelihood of the Public Offer being over-subscribed was a major factor in their decision to bid for shares in the International Offer.

Announcements

2.32 Book-building took place following the announcement, on 6 July 1993, of some 5.2 million registrations in the Public Offer. This was a firm marker to institutions that the final level of demand was likely to exceed the number of shares provisionally allocated to the public and indicated that the Treasury would be likely to increase the size of the Public Offer.

23

2.33 The International Offer was fully subscribed by the close of the first day of book-building (8 July 1993) and bidding strengthened considerably throughout the book-building period (paragraph 1 .I2 and Figure 2). On 15 July 1993, the Treasury informed the market that is was likely there would be an increase in the number of shares allocated to the Public Offer, although final decisions on the size had not yet been taken. Demand remained buoyant in the last two days of book-building (15 and 16 July 1993).

2.34 Having created an expectation among institutional investors that shares would be transferred from the International Offer to the Public Offer, the Treasury had to fulfil the expectation. If the allocation of shares between the offers remained unchanged, the Treasury judged that institutions would be less likely to react to competitive tensions in a future sale, with a consequent and adverse impact on proceeds.

Allocations

2.35 The Treasury judged the strength of demand to be sufficiently strong to transfer 122 million shares from the International Offer to the Public Offer. This increased the scarcity of shares and competitive tension in the International Offer, helping the Treasury maximise proceeds. It was also helpful towards the widening and deepening objective. The transfer brought the total allocation in the Public Offer to 732 million shares or 60 per cent of the combined offers. This was a smaller percentage of the shares available than the 67 per cent allocated to the Public Offer in the previous sale.

2.36 The transfer increased individual share ownership at a gross cost in proceeds foregone of f12 million due to the 10 pence discount on the first instalment. The gross cost is expected to be increased further by an estimated f24 million for additional discounts on the second and third instalments and bonus shares available to investors who purchased the shares transferred. The Treasury judged that these costs would be off-set by the impact on the International Offer of the announcement of a transfer, but could not quantify this. A smaller transfer of shares would have reduced the

gross cost (in terms of proceeds foregone) at the expense of the widening

and deepening objective. For example, allocating 671 million shares to the Public Offer, or 55 per cent of the combined offers, would have saved around f 18 million.

2.37 The allocation of shares between the offers was made in the light of much higher demand from institutions and a lower level of interest in the Public Offer than in the previous sale. Figure 12 summarises the outcome. It shows that sufficient shares were transferred to the Public Offer to satisfy 67 per cent of demand (59 per cent in the second sale). The Treasury satisfied 20 per cent of demand in the International Offer (33 per cent).

24

This iigure shows that a higher proportion Of demand in the Public 5

Offer was *atisfied in this sale 2 COrnDared With the Second sale. 5

2.38 In view of the lower level of demand in the Public Offer, the Treasury felt that they could fully satisfy the share ownership objective without expanding its size to the maximum permitted 67 per cent, as in the second sale. They wanted to allocate to retail investors at more generous levels than in the second sale, particularly to reward existing shareholders and share shop applicants. They also judged that institutions had bid in the expectation that there was a real prospect of allocations amounting to only one-third of the available shares and would welcome a 40 per cent share of the combined offers.

25

3

Costs of the sale

3.1 This pan of the report examines the methods used by the Treasury to minimise the management and operational costs of the sale. The National Audit Office examined whether the Treasury had:

l appointed advisers and contractors by competition;

l secured competitive rates of management fees and selling commission; and

l considered whether the sale needed to be underwritten.

3.2 The Treasury estimate the net cost of carrying out the sale, excluding their own staff costs, value added tax, stamp duty, discounts and incentives, at just over f96 million. This represented just under 1.9 per cent of the estimated gross proceeds. The cost of carrying out the previous sale is currently estimated by the Treasury at fl17 million or 2.1 per cent of gross proceeds. Details of the estimated proceeds and administrative costs of both sales are shown in Figure 13.

This ngure Stmw the estimated ‘oceeds, costs and net proceeds, “ding value added tax and &mp

duty from the Second and ftwd S&S Of BT shares

26

Appointments of advisers and contractors

3.3 The Treasury appointed a number of advisers and contractors with responsibility for the management and operation of the sale. These are listed in Appendix 3. With one exception, all key appointments were made following competitions in which the Treasury assessed the quality of service offered, having regard to price. Linklaters and Paines, the Treasury’s legal advisers in the United Kingdom, were appointed on the basis of experience gained in the previous sale. In the Treasury’s view, extra costs would have been incurred if a new firm had been appointed. The firm’s charges for work on this sale were some 70 per cent of their charges for the previous sale.

Selling commission and management fees

3.4 Payments totalling f23.5 million were made to banks and brokers involved in the International Offer. Management fees (0.2 per cent of the value of shares sold) were shared equally between members of the global syndicate (0.16 per cent) and the managers of the regional syndicates (0.04 per cent). Syndicate members earned selling commission of 0.6 per cent on the value of shares sold. These arrangements rewarded selling more than in the second sale, in which the more usual market practice of splitting commission 40:60 between management and selling was followed.

3.5 The distribution of selling commission within the global syndicate was dependent on a syndicate member’s ability to win designations from investors who were free to reward those members who, in their view, provided the best quality of service in the offer. The share of commission earned by members of the global syndicate is shown at Figure 7. This system of investor designations was also new. In the previous sale, the distribution of selling commission among syndicate members varied according to local custom. The Treasury regarded a change as desirable to

promote competition within and between the global and regional syndicates. The level of demand in the International Offer (paragraphs 1 .12 to 1.14 and Figure 2) suggests that this approach was successful.

3.6 The global co-ordinator earned an additional commission of 0.09 per cent on all shares sold in the combined offers, At f4.5 million, this was nearly twice the amount paid in the second sale of BT shares. The Treasury increased this element of the global co-ordinator’s remuneration for two reasons: first, the global co-ordinator’s share of management fees would be lower than in the second sale as a result of the new management fee arrangements; and secondly, the Treasury judged that the global co-ordinator would be faced with greater competition for orders than in the previous sale, because of open competition within the global syndicate.

27

3.7 The global co-ordinator earned 36 per cent of the available selling commission in the International Offer (see Figure 7). This, as expected, was less than the 41 per cent earned in the previous sale.

3.8 Share shops received commission of 1 .l per cent of the discounted Public Offer price of shares (410 pence) allocated to their applicants, with a minimum payment of f12.50 for each successful applicant. These rates applied to allocations of up to f8,OOO; the commission rate was reduced to 0.5 per cent for higher allocations.

3.9 In total, share shops earned commission of f21.3 million. Total commission paid on shares sold in the Public Offer in the previous sale was some f7 million (on a lower price of 335 pence par share). The Treasury estimated that there might be cost savings in operating a reduced share information office in this sale which would offset some of the additional commission paid. They considered that the additional costs of the expanded share shops scheme would help the development of a retail network capable of handling future share issues and encourage strong relations between individuals and stockbroking services.

3.10 The rates paid by the Treasury for the management and syndication of the sale, at around one per cent of the value of shares sold in the International Offer, compare well with recent secondary sales in the United Kingdom and other European countries, where rates have ranged from three per cent to 3.5 per cent.

Underwriting

3.11 The Treasury decided not to underwrite the sale. They took the view that underwriting would be inconsistent with a demand-driven sale and that the risk of shares remaining unsold was a small one. The Treasury expected the book-building exercise to provide a clear indication of demand and retained discretion to vary the relative size of the International and Public Offers as

well as the overall size of the sale. The global and regional managers carried any small, residual risk: once they had accepted allocations at the strike price in the International Offer, they were obliged to purchase the shares even if bidders subsequently failed to honour them

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Glossarv of terms J

After-market The period following the start of dealing in the part paid shares on the London Stock Exchange

Book-building Indications from institutional investors in terms of the number of shares at different prices an investor would be willing to purchase

Deepening Share Ownership Persuading individuals who already own shares to add to their portfolios by purchasing and retaining further shares

Discount A reduction in the price of shares to encourage individual investors to apply for shares and retain their allocations

Financial Times Stock Exchange 100 Share Index

International Offer

An index of the share prices of the 100 largest companies quoted on the London Stock Exchange

Shares offered for sale by tender to United Kingdom and overseas investors

Strike Price The price at which shares in the International Offer were offered for sale

Underwriting An agreement under which, in return for a fee, financial institutions agree in advance to buy unsold shares from the vendor

United Kingdom Public Offer

Widening Share Ownership

Shares offered for sale to individual investors resident in the United Kingdom

Persuading individuals who had not previously owned shares, or if they no longer did so, to purchase and retain shares

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Appendix 1

Timetable of kev events

18 November 1992

24 May 1993

29 June 1993

2 July 1993

8 July 1993

14 July 1993

15 July 1993

16 July 1993

17-18 July 1993

19 July 1993

30 July 1993

Announcement of sale during 1993-94.

Announcement of sale structure; start of marketing campaign and registration period for Public Offer.

Prospectus published (including offer timetables, number of sham; to be sold and provisional allocations of shares between each offer’. Discounts and incentives for individuals announced. Start of aprtlication period for Public Offer.

Close of Public Offer registration period.

Start of book-building for International Offer.

Close of application period for Public Offer.

Allocation of shares between offers determined and announcement made that Public Offer would be allocated a higher, but unspecified, percentage of shares provisionally available.

Close of book-building for International Offer and final level of demand in Public Offer announced.

Strike price determined: decisions made on allocations of shares to individual and institutional investors.

Trading begins in part-paid shares; commencement of stabilisation period.

End of stabilisation period.

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Appendix 2

Survev of institutional J .

investors

Background

1 The National Audit Office undertook a survey of institutional investors in the United Kingdom and overseas. The purpose of the survey was to: a) assess how successfully the International Offer was managed by the Treasury and their advisors: b) identify and assess the factors responsible for decisions by institutions to

bid in the International Offer; c) assess the extent to which measures taken by the Treasury to prevent distortion of the market price of BT shares in the run up to the offer were

effective in ensuring that the taxpayer obtained a fair price for the shares: d) obtain overall perceptions of the sale.

Methodology

2 Following consultations with Kleinworl Benson Limited, questionnaires were sent to a sample of 200 institutions in the United Kingdom and 90 institutions overseas, The overall response rate was 28 per cent (36 per cent from

United Kingdom institutions, 10 per cent from overseas institutions). The key results from the survey are included in Parts 2 and 3 of this report. The responses to all the main questions are summarised below:

Questions Percentage of respondents who answered:

Yes No

Al Do you think the syndicate structumwas effective in maximising proceeds? 83 17

AZ Do you think the syndicate structure delivered an effective service? 66 34

A3 Were you confident that your order for shares would be fairly treated? 56 44

A4 Did market monitoring during the sale influence your activity? 34 66

A5 Do you think the Treasury minimised adverse market activity in BT shares? 74 26

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To what degree were the following responsible for your decision to bid in the International Offer?:

81 Timing of the sale 82 Payment by instalments 83 Likelihood that the Public Offer would be

over-subscribed 64 Market price of the shares ahead of the

close of the offer 65 Eligibility for the 1993 final dividend from BT 66 Prospective yield on the part-paid shares

ahead of the second instalment 87 Prospective increase in the market price

of the shares

To what extent were the following factors effective in ensuring that the Treasury obtained a fair price for the shares?:

Cl Preference in allocation for bidders who gave price leadership early on

CZ Preference in allocation for specific price bids over strike price bids

C3 Preference in allocation for net buyers of BT shares ahead of the sale

C4 Preference in allocation for likely buyers of part-paid shares after the sale

C5 Reduced or nil allocation for bidders suspected of adverse market activity

C6 Announcement of level of applications in the Public Offer

C7 To what extent did all of the above factors influence your bidding behaviour?

C8 Do you believe your allocation fairly reflected your bidding behaviour7

Dl Do you think that the sale was perceived as a success?

D2 Would you bid in a future sale structured in the same way?

Major Minor None

12 45 43 41 35 24

38 45 17

61 30 9 52 34 14

63 26 11

67 21 12

High Medium Low None

35

48

19

12

22

9

26

45

43

40

37

30

53

44

17 3

8 1

28 13

43

40

31

17

Yes

79

8

8

7

13

No

99

21

1

86 14

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Appendix 3

Principal advisers and contractors appointed for the sale

Financial Adviser

Global co-ordinator

Legal Advisers UK us

Retail advisers

PR adviser

Advertising agents

Market research

Lead printers

Systems audit

Fraud audit

Lead receiving bank Receiving bank 1 Receiving bank 2

S.G. Warburg & Co Ltd

S.G. Warburg Securities Ltd

Linklaters & Paines Davis Polk & Wardwell

Solid Solutions Associates

Brunswick Public Relations Ltd

WCRS Ltd

Market and Opinion Research International

Burrups

Coopers & Lybrand

Price Waterhouse

National Westminster Bank plc Lloyds Bank plc Royal Bank of Scotland plc

33