We're being privatised at last, Mr Bond

For years the MoD has seen the commercial sector snap up its inventions and make a killing. Now it wants a slice of the action too
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James Bond may have single-handedly saved the world from enemies as diverse as Russian terrorists, Colombian drug barons and a crazed media mogul. But he could never get anywhere without his gadgets. Whether it's a rocket launcher disguised as a camera or a bracelet that can fire cyanide darts, the film legend relies on the imaginative skills of the Secret Service's own Inspector Gadget – Q.

But the ingenious scientist isn't purely an invention of the silver screen. Real-life Qs reside in the Defence Evaluation and Research Agency (Dera), a division of the Ministry of Defence, and are just as important to national security. They are expert consultants and inventors for the ministry, working on top-secret projects as diverse as protecting its computer systems from hackers, designing parts of aircraft and testing missiles.

But now Q is moving from the world of secretive deals within Whitehall corridors to the cut-and-thrust of the international technology industry. Today three-quarters of Dera is being split from the MoD to form QinetiQ (pronounced kinetic) plc. The move leaves some sensitive divisions such as chemical and biological weapon research within the ministry and is the final stage before partial privatisation next year.

The new, government-owned company will allow the cutting-edge technologies developed through defence work to be more fully exploited commercially. It is easy to see why Labour is keen to take this route. For the past 50 years governments have watched countless technologies first seen within the MoD being developed in the private sector and generating millions, or billions, in sales. In the 1970s, for example, the ministry developed the liquid crystal displays used in digital watch faces and mobile phones. Before this, in 1952, it had developed the technology that turned out to be the precursor to the silicon chip.

"The father of the silicon chip was first discovered and proposed by Dera, but the MoD didn't have any use for it, so we put it on the backburner with all the other bits of technology the MoD couldn't use," says Andrew Middleton, who heads the IT research department within QinetiQ. "Six years later, Texas Instruments invented the chip again and took the benefit from its development. We don't want to let that happen again."

A commercial strategy has been developed during the past 10 years under chief executive Sir John Chisholm. He came from the private sector, as managing director of Sema Group, and has been slowly modernising Dera since arriving in 1991. He brought in thorough accounting procedures, marketing and commercial staff, as other support staff were laid off in a cost-cutting move.

"The nation invested for 50 years in its defence research establishments, but the end of the Cold War threw a big question mark over what they were all for. My aim was to take the jewel in what is the national technological crown and make it into a real business," says Sir John.

This process has born fruit. Non-MoD work accounted for about £145m of last year's £1bn turnover in Dera, an increase of 11 per cent on the year before. The transfer of top-secret technology into revenues has, so far, proved successful.

One example is Dera's speech recognition technology. This was developed for Government Communications Headquarters (GCHQ), the state agency that earwigs on communications throughout the UK and beyond. Although it is ridiculously secretive, legend has it that GCHQ works together with the US government on Echelon, the ubiquitous spying programme that can tap in on any phone conversation when certain key words such as "bomb", "IRA" and "Marx" are spoken over a phone line.

But now the speech experts have been hived off into a separate company, a joint venture between QinetiQ and NXT, the flat-panel speaker developer. The new company works on sensitive military projects such as the Eurofighter, but is also focusing on commercial applications of the technology. Talks are underway with car and computer game manufacturers to develop cars and games controlled by vocal commands.

Another top-secret division is the protection of computer networks. Within QinetiQ is a group of professional hackers who test government systems for vulnerability to malevolent computer nerds. This is going commercial, too. Banks of all kinds, pharmaceutical companies, and online retailers hire the specialised team to test their IT security. The work has led to the development of an anti-virus software package.

The list goes on. Missile-tracking technology is now used on Sky TV to track cricket balls during a match, and holograms are being developed in conjunction with Ford so that car design will work in three dimensions, with designers moulding the virtual image with electronic gloves to create the desired effect.

It is easy to be blinded by the vast amount of technological expertise and its commercial potential. Dera currently has 1,000 patents for a wide-ranging variety of inventions. But at the same time as commercial revenues have increased within Dera, work for the MoD has slightly decreased. And with increasing commercial freedom comes increased competition for the lucrative contracts.

Approval must be found for any work in the defence arena outside the MoD, so it is unlikely that the defence work can expand abroad. Sir John admits that it is more likely that the division will shrink. But he now wants to focus on exploiting the technology potential within the company. "The real value is in rapidly growing the commercial business," he says.

So when the organisation is floated, it is likely to be seen as a technology company, as this is where the growth lies. It is clear that this wouldn't be popular in the current market climate, although City sentiment may have changed by mid-2002, the planned date of the flotation.

Despite the high level of expertise contained within QinetiQ, the dismal history of privatisations in this country is also unlikely to inspire investors. AEA Technology, which was separated from the old Atomic Energy Authority (AEA) and joined the stock market in 1996, is still in investors' minds. The company was once a wonder stock. Shares soared from the float price of 260p to reach over 1000p in 1998. However, a reduced market in nuclear advisory services led to a number of profit warnings, and shares are now barely 30p above the original share price. The company is now selling off its nuclear activities.

Sir John says that QinetiQ will be a different proposition: "We have a broader technology base and more obvious commercial applications than AEA."

The MoD will retain a lot of influence over the company. In the planned flotation next year, the ministry will retain shares. The exact details have not been finalised, but it is likely to keep just under half of the company. It then intends to sell off tranches of shares as the company increases in value.

As with AEA, the Government will also retain a golden share, even if the rest of its holding is sold off. The MoD will be able to block a takeover of QinetiQ if it wants to and will be able to restrict foreign ownership of the company – two factors that may put off future investors. It can also block the appointment of directors, and it will get a cut on the revenues from certain corporate activities such as selling off property.

The downsides are typical of a privatised company, but there are few precedents for QinetiQ's flotation. "The comb- ination of safe, core defence income with real imbedded technological value will provide an exciting prospect for investors," says Simon Linnett, managing director of NM Rothschild, which is advising the company.

Texas Instruments is now a $55bn (£39bn) company. QinetiQ is likely to be valued at about £500m. If Q really can make it in the commercial world, it could be one of the few truly successful privatisations in the UK's history.