Dutch disconnect in Kenya Airways

NAIROBI: Executives at Kenya Airways (KQ) have said the airline’s cooperation with its Dutch equivalent is dysfunctional at best, and is responsible for its plunge.

Chief Executive Mbuvi Ngunze and Finance Director Alex Mbugua made the startling revelations during an on-going probe being conducted by a Senate committee.

They said the operating pact was costing Kenya Airways, and was specifically responsible for the losses reported in the last three financial years.

But it was not entirely unexpected, especially after combing through the articles of association the national carrier entered into with KLM, the Dutch government-owned airline, which was picked to steer KQ’s revival from similar insolvency two decades ago.

FINANCIAL HOLE

However, the problem then was much simpler because the financial hole to be plugged was smaller, and the airline’s operations not as complex, as its fleet was smaller.

Now, investor confidence in the airline is low, going by events of 2012 when a rights issue floated to raise Sh20.6 billion just hit the minimum acceptable success rate of 70 per cent.

The International Finance Corporation, and the Dutch and Kenyan governments had to be called in to take up shares.

The additional shares issued in the rights issue were priced at a 32 per cent discount to sweeten the deal, but it appears retail investors remained sceptical.

Three years after that cash call that could be described as a flop when gauged against similar fundraisers by other listed firms, came the bombshell of a record Sh25.7 billion loss.

Chris Kirubi, one of the largest individual investors in the airline, captured the feelings of shareholders on the day the firm announced the losses.

“This is b******t,” he said, before trying to tone down his bitter sentiment. In a subsequent interview, he talked about “losing a lot of money” after investing in the airline’s stock.

Things had been good in the early years of the airline’s privatisation. Its stock hit a high of Sh126 in 2006, after listing at Sh11.25 a share in 1996. The Kenyan government offloaded 77 per cent of the airline to the Dutch airline and the general public in an initial public offer that was oversubscribed.

The airline made thousands of millionaires when its profits were flying high and the stock price following closely.

Aloise Chami is one of the once-happy shareholders, now disappointed in the latest financial results that were posted. “I feel like there is a deliberate push to sink this airline,” Mr Chami told Business Beat last week, having gone through the roller-coaster that is the airline’s valuation at the stock market. It closed Friday at Sh5.25.

KQ was once the best-performing stocks in his portfolio, which includes nearly all listed firms.

“Obviously, I am not happy when the company’s jets are parked,” he said in response to an announcement by the management that KQ’s fleet was nowhere near the global average of 15 flying hours a day.

STRATEGIC INVESTOR

When KLM was tapped as a strategic investor, it bargained for control of all aspects of operations, including the rapid expansion of the fleet, which management said has now sunk KQ.

The firm beat out other bidders, like fellow European airline British Airways and Africa’s most established carrier, South African Airlines, to the deal.

Documents of the co-operation partnership, which were first reported by The Standard last Friday, show the conditions that KQ and the Government had to live with throughout the term of the pact, which is still in force.

KLM would be directly responsible for the acquisition and disposal of idle fleet, to the point that objections by a single director representing the Dutch firm would be enough to overrun a resolution carried by the 11 co-directors.

There has not been any indication that the Dutch carrier has loosened its grip on the management and operations of KQ, even though it is no longer the biggest shareholder.

KLM came in with tight conditions, including having the final word on the composition of the board and its sub-committees, appointment of the chief executive and finance director, issuance of any new shares, acquisition and disposal of aircraft, and most critically, the routes that the Kenyan airline would ply.

From that alone, Kenya had ceded control of the airline to the Dutch, and could not walk out of the deal by selling its remaining stake without KLM’s approval.

While Mr Ngunze and Mr Mbugua have acknowledged that the deal has been more costly than beneficial, that admission did not come easy, especially considering that they were KLM’s appointees on the board and management.

Ngunze told the Senate committee that the Government now had a bigger say, thanks to its being the single-largest shareholder at 29.3 per cent, but that is unlikely to stand in the face of the articles of association entered into in 1995 before the airline was privatised.

OVERLY OPTIMISTIC

The two directors took the committee through the various aspects that had undermined the airline, including the overly optimistic fleet expansion, dubbed Project Mawingu, which involved fleet modernisation through the delivery of six Boeing 787 jumbos, before the order was revised up to nine.

“We do not feel it was overambitious, but only we had not foreseen that competition would eat into our projected routes,” Mbugua said, in part admitting to a failure in strategy to the select committee.

Currently, 10 of KQ’s aircraft have been grounded due to low business, the executives said. Worse still, the firm is paying Sh100 million a month to service loans that financed their acquisition.

That cost alone is about Sh1.2 billion a year, on top of the Sh25 billion the airline spent on fleet acquisition expenses in the last financial year.

Therefore, no income is being generated from the assets that are yet to be fully paid for. Further, the ones in operation are not being fully utilised either.

And as regards fuel hedging, the executives revealed their strategy closely mirrored the approach taken by KLM in its own operations.

Mbugua revealed that KQ was buying its fuel at a price pegged at $80 (Sh8,100) per barrel. The bet was hoped to cushion the airline from much higher pricing in the international markets, but it fell flat. Oil prices have tumbled globally.

As a result, KQ booked a loss of Sh1.6 billion in the last financial year, with a further Sh5.6 billion yet to be realised. Only a sharp rise in oil prices could reverse the loss.

While the hedging arrangements were entered into in KQ’s best interests, Mbugua said, they have ended up being a costly measure. Again, the articles of co-operation granted KLM control over KQ’s material contracts.

Fuel costs make up to 60 per cent of all operating expenses of airlines, effectively making hedging a very material agreement.

The Senate further blasted the executives for out-pricing the market on its services, a definite way to lose customers. In a specific example, the Senate was told that KQ was 10 per cent more expensive than another airline operating the same route.

Other illustrations have shown an even bigger variance in pricing, with the national airline almost always charging premium prices.

Finally, KQ was restricted from entering any other co-operation agreement with another airline that could be deemed to be a direct competitor of KLM throughout the term of the engagement. What that means is limited options for a way out in case the agreement was not felt to be beneficial to Kenya.

The senators have called for a review of the agreement before the State injects any fresh funds into the airline.

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