In July 2001, PricewaterhouseCoopers, the accounting group put a £862 million price tag on the defence research group. A little over a year later, Carlyle agreed to buy 37 per cent of the business for just £42 million cash, giving the company a value of £319 million.

The perceived value of QinetiQ fell by 63 per cent during the sale process to Carlyle, the US private equity group, according to a report by the National Audit Office report released yesterday.

The sale of QinetiQ has attracted controversy on several fronts but the NAO reserved some of its harshest criticism for the manner in which Carlyle was appointed preferred bidder. The MoD's first mistake, according to the NAO, was to kick the only trade bidder, Serco, out of the competition immediately.

The department went on to receive seven initial bids, valuing the company between £450 million and £600 million. A shortlist of six bidders was intended to be drawn up, but this was later reduced to just four — Carlyle, Permira, Goldman Sachs and Candover — a decision approved by the then Chancellor, Gordon Brown.

It took just three months to reduce the bidders to one. That haste was a mistake, the NAO said, because it reduced the competitive tension in the sale. The rapid appointment of a preferred bidder looked particularly illjudged, since it was done before the potential value of a long term contract held by QinetiQ to look after MoD firing ranges was determined.

The department received proceeds of £155 million from the 2003 sale of a 37.5 per cent stake to Carlyle Group, the US based private equity business. However, this was £32 million less than Carlyle originally bid for just 35 per cent of the company.

“We were puzzled as to why they MoD sold an extra 2.5 per cent of the business for less,” Patricia Leahy, director of the NAO study, said.

Carlyle's initial bid valued the company at £374 million, but the well-connected private equity group later revised its bid down after looking at pension liabilities and the risks of the long-term agreement. It finally put a valuation of the company, which today is worth £1.3 billion, of just £319 million.

Asked whether the NAO was placing a health warning over Carlyle, Ms Leahy said: “If there is a warning, it is that as a vendor you have to be aware of how private equity firms work. You need experienced professional people to deal with them.”

Carlyle achieved an internal rate of return of 112 per cent, the NAO said. Private equity businesses usually aim for an internal rate of return of 33 per cent.

It finally sold its entire stake in the business in February this year, having made about £370 million from the four year investment. “If all our deals were like this, we would be very happy,” one director of Carlyle Group said.

The NAO was also very critical of the way the incentive scheme, which resulted in QinetiQ executives achieving 19,900 per cent returns on their investment, was divised.

The QinetiQ executives who stood to benefit most worked closely with Carlyle to draw up the scheme. Ms Leahy said this was an unusual arrangement, but not against the rules.

"The returns achieved were much higher than were typical and exceeded what was needed to incentivise the management," Ms Leahy, the director of the NAO study, said.

The MoD was remiss in not seeking professional advice from specialist consultants on the incentive scheme, the NAO said.

Apparently the MoD rubberstamped the incentive scheme on the basis that Sir John Chisholm would make £10 million of profit, in fact he made more than £25 million.

For every £1 that the chairman Sir John Chisholm and Graham Love, chief executive, put into the business they made £200. Mr Love turned an investment of £110,000 in Qinetiq shares into a £21.35 million stake in the business, while Sir John Chisholm invested £130,000, which was worth £26 million when the company was floated in 2006.

Ms Leahy suggested that in future departments should make sure they have sufficient advice from specialists but the MOD was advised by 13 companies, including leading investment banks, corporate lawyers and consultancies.

UBS was the investment bank which provided financial advice and managed the sale to Carlyle. It was paid £2.5 million for the work. PWC, which provided consultancy services and accounting advice was paid £3.7 million, while the highest billing adviser was Simmons &Simmons, which was paid £10.7 million.

Total costs to advisers came to £28 million.

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