17 December 2015
The Ticking of the Clock
by J R Thomas
Fifty or so years ago, the advertising for Rolls Royce cars used to proudly claim that at 60 miles per hour the loudest noise was the “ticking of the clock”. Now, a very different Rolls Royce business also has its eye on the clock.
Rolls built beautiful and reliable motor cars that became the epitome of wealth and a certain style around the world. But the car business was highly specialist, with its cars appealing only to a small niche of customers and its costs inflated by the craftsman-intensive nature of the build. What it became known for, and what made the money, was the quality of Rolls engineering, and especially its ability to build large and specialised engines. The smaller versions were sold for use in various industrial applications (trucks, cranes, generators, railway locomotives), and the bigger engines became world leaders in aircraft propulsion.
After the Second World War, Rolls concentrated on aircraft jet engine technology and in the 1950’s and 1960s was encouraged by the Conservative governments of the time (who saw it as of strategic importance) to consolidate its position by both vertical and horizontal integration of its rivals. In the late 1960’s the company began the development of a new generation of jet engines, the cost of which became too much for it, leading to the remarkable spectacle of Ted Heath’s (then) free market orientated Tory government having to nationalise the entire business (the cars division was later sold off) to save it from bankruptcy.
Now events might be leading up to a repeat of that unlikely act. Mrs Thatcher privatised the reorganised and once again profitable group in 1987, since when it has traded successfully as one of the two main jet engine suppliers in the world, powering a large proportion of jet aircraft flying today. Most of the industrial engine business has been sold off but Rolls Royce plc, as it now is, has pushed into other specialist engineering applications such as nuclear engines for the Royal Navy’s fleet of nuclear submarines, maintaining the present set and developing a new generation. Another area in which it is growing is its involvement in the next generation of gas turbine engines, which are key to “greener” large scale power generation.
There is one common theme to all this – it involves very large amounts of money. Just to turn up the financial heat, all these projects require not just large amounts of cash – they need it for many years before they produce any returns (though once they do, the returns are potentially enormous).
The problem, as the synopsis of the business set out above might suggest, is that Rolls have two massive projects in the investment stage. In addition the jet engine programme is also swallowing much investment to develop more efficient (and quieter) engines in the domestic sector where demand remains low and in the defence sector where orders remain hard to come by. Rolls geared up its cost base for all this, and has been slow to scale back to meet slower demand and government hesitation to commit in an era of spending restraint.
Earlier this year the company took on a new chief executive, Warren East, a man with considerable experience in complex engineering businesses. The board already had concerns as to the welfare of RR, with profits and turnover both falling in the 2014 published results. East began a close examination of the business and the word is that he is not terribly happy with what he is finding – not least by having to give a profit warning on his first day behind his new desk, and another one since.
Also causing red faces is his discovery that Rolls is unlikely to make the originally agreed timetable for delivery of the new generation submarine nuclear engines. Six months ago the government might have been secretly relieved by this, with less short term pressure on defence spending and the possibilities of price cuts through penalty clauses in the contracts. But with tensions ramping up in the Middle East and Mr Putin busy testing everybody’s nerves and military awareness by sending his planes and warships where they should not be, suddenly defence spending is more favourably viewed.
Much of Britain’s ultimate defence strategy is based not on fighter planes, as you might think, but on submarines. They are the perfect weapon. Once they have slipped away from their home ports into deep water, nuclear power means that they do not need to surface for months. They are virtually undetectable whilst in the sea, and unlike planes, they can carry large stocks of warheads, both conventional and nuclear, and fire them from anywhere in the ocean. But our existing Trident fleet is ageing – in terms of the competition out there, it is virtually life-expired – and is due to be replaced, at a cost of £31 billion. The renewal programme – imaginatively called Successor (let’s hope nobody won a cash prize for coming up with that codeword) needs to get going now to have four new submarines operating in the early 2030’s, as the delivery schedule is about twenty years.
But that the programme is very dependent on Rolls Royce delivering those new nuclear engines (and BAE, also not in great financial shape, is responsible for much of the rest of the technology). Recently, with the sudden new enthusiasm for defence spending, the Defence Board, which is the highest level procurement committee in the Ministry of Defence, has interviewed the leadership of both Rolls Royce and BAE and is understood to have (stand-by for Whitehall-speak) “expressed concerns” over both businesses’ financial shape and ability to deliver the Successor programme. Both companies remain profitable and properly funded, so it is far from clear what those concerns actually are.
When the Thatcher government privatised Rolls nearly thirty years ago, it kept a couple of safeguards – a golden share which means that no foreign party can take over more than twenty five per cent of the business (or any of the nuclear business) without British government consent; and an overall ceiling on foreign ownership of fifteen percent. Philip Dunne, the minister responsible for defence procurement, allowed himself to be interviewed by the Financial Times and referred to a need for partnership and harmony to get the programme working properly. Dunne also pointed out that RR maintains and supplies parts and services to the existing military nuclear power capability, so its economic welfare is paramount.
A chief executive of a company whose cash flow is looking more like a cash ebb, and wishing to get things on a more even keel, might well consider such things as a rights issue, or a sale of parts to raise some cash, or a partnership with a larger business. Because of the government golden share, those are not straightforward options for Mr East. But in yet further leakage (on a scale which we trust will not be allowed in those submarines) “officials” from the MoD have suggested that a solution to Rolls problems might be bring to in foreign investors, or possibly to bring about a merger with BAE to make a super defence based engineering company. (Those readers with very long memories may remember that this latter was also the Whitehall solution to the problems of the British car industry which led to the creation of British Leyland. It didn’t work that time…)
How much concern about Rolls’s financial position the MoD really has is not very clear, but by the beginning of this week Conservative MP’s were talking about the need to nationalise at least the nuclear division either (take your pick): to bring about an assisted reconstruction of the Roll Royce Group; or to save the bit that matters to British national interests and allow the rest of the group to wither or be dismembered by its competitors.
All this muttering does seem a little odd. Rolls Royce plc is a major UK public company. Accounting matters and company news is subject to strict rules regarding disclosure to shareholders and to the stock market generally. The business, whilst finding conditions more difficult, remains profitable (so far as is known) and is tackling cost and delivery issues under its new chief executive. Yet here is a government minister and various civil servants busy expressing concerns and doubts; hinting at part nationalisation or forced mergers. The effect on shareholders, on staff, on the company’s bankers, on competitors, suppliers, advisors could be very damaging indeed. Either things in the business are much worse than analysts and investors have been led to believe, which for a public company with fierce regulatory and disclosure requirements would be alarming indeed, or there is some political agenda. Whatever it is, some clarity is needed urgently. Or Mr Putin will be bidding for the company at a bargain price.
