Skewed revenue sharing formula dims KQ’s fortunes

Commercial law experts have blamed Kenya Airways loss making trend to skewed revenue sharing formula entered into with KLM.

Part four of the execution copy of the joint venture agreement, a copy The Standard on Sunday obtained, stipulates the procedures and formula of sharing revenue between KQ and KLM within the understanding of the Joint Venture (JV) agreement.

Economist Aly-Khan Satchu is now warning that unless significant steps are taken, KQ will sink irredeemably.

“The documents as seen by myself indicate an egregious agreement. We need to move at speed because Addis is stealing a march, Rwanda Air is now lifting passengers from Mombasa and the Gulf carriers have an outstanding product. Deeper pocketed Middle Eastern airlines look a far better prospect than KLM at this moment,” he said.

In the agreement between KQ and KLM, the income payable to each party (KLM and KQ) from the proceeds of transactions within the deal has been defined as settlement.

KLM and KQ are required to contribute to the JV (the common basket of the investment), the profit made during the settlement period. This profit is referred to as party result. It is the total income (party revenue) minus expenses (party costs) which gives you the profit both KLM and KQ would have made individually (party result). The sum of KLM and KQ party results is equal to the joint venture result (or the sum of the profits made by both KLM and KQ within the understanding of the JV).

It is this joint venture result that KLM and KQ agreed to share equally regardless of whether the bottom line is positive or negative. The income each party ultimately gains from the joint venture result is referred to as joint venture share. However, this joint venture share does not automatically end up into KQ’s or KLM’s account as profit. According to the agreement, there are other conditions that need to be met.

Settlement amount (money owed to each party) is to be obtained by subtracting party result (individual profit contributed to the JV) from joint venture share (proceeds obtained after equal sharing of the profits made from the JV). That is to say, Joint Venture share - party result = settlement amount (income payable to each party).

However, it is the capping of this settlement amount that experts say has seen Kenya Airways continuously make losses from this agreement.

The settlement amount is capped at 1.5 perc ent of the sum of party revenues (The sum of all income contributed to the JV by both KLM and KQ including costs). That is to say, if KLM’s contribution to the JV was Sh20 million inclusive of costs, and KQ contributed Sh5 million, the money payable to KQ by KLM shall not exceed 1.5 per cent of Sh25 million (Sh375,000)

“Ask yourself, why was a cap on profits introduced yet none on losses was included. It’s the same as saying, look here, I am here to make money and you only take a drop of it. In case of losses, you are alone, carry your burden. That is what happened to Kenya Airways,” said Mbugua Ng’ang’a, a commercial law expert.

Sources say the agreement hardly earns KQ profit because KLM’s revenue is higher.

KQ is currently flying 787-800 to Amsterdam. This is an approximately 234 passenger aircraft. KLM is flying 777-300ER, a 440 passenger aircraft on the same route.

“Kenya Airways can never make any money from this arrangement. It will sink even deeper because we are operating very small aircraft compared to KLM. As a result, KLM’s income is a lot times higher than ours. KLM is also flying the same aircraft to London, Entebbe, Kilimanjaro, Rwanda, Dar es salaam and even Lusaka,” said Mr Mbugua.

Other sources at KQ also told The Standard on Sunday, that there had been agreement to the effect that KQ would cede passenger and sales handling in Europe to KLM while KLM would allow KQ to take over the same in Africa.

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