WHY AIRLINE WENT DOWN

KQ ‘bullied’ to buy old KLM planes for Sh2 billion

Auditor says decision on purchase was a result of undue pressure by KQ management

In Summary

•KQ decided not to deal directly with the manufacturer, Boeing

•Transaction was never on the KQ fleet expansion plans

A Kenya Airways plane
STRATEGIC BLUNDER: A Kenya Airways plane
Image: FILE

Kenya Airways bought two second-hand planes at Sh2 billion from one of its major shareholders, KLM, and then sold them at just Sh200 million after five years.

The transaction that was never on the KQ plans, and which one of the KQ managers said was “rushed”, cost the national carrier Sh1.8 billion.

It has been classified as a strategic blunder. The wisdom of buying old, inefficient planes from a business partner, when the fleet expansion plan gave KQ an opportunity to deal directly with the manufacturer, Boeing, is what raised the red flag for the Deloitte auditors who carried out a forensic audit on the purchase.

 

The managers of KQ in 2010 went ahead to buy the old planes, even though the fleet planning committee had asked for the new generation model which “had longer range and increased fuel efficiency through a combination of advanced systems, as well as blended winglets”.

In fact, the Boeing B737-300 aircrafts had been manufactured in 1997 had flown for 13 years making money for KLM, and when they became old KLM sold the planes to KQ for Sh billion.

“Our review of the strategy indicates that the purchase of the two aircrafts from KLM may not have been in line with the fleet development strategy,” the auditors noted in their report.

“The decision to purchase the aircrafts in 2010 and dispose of them in 2015 was costly to the company”.

After going through the series of transactions, the conclusion the auditors made was: “It is possible that the decision made to purchase these aircraft was a result of undue pressure by the KQ management.”

That means KLM, as a major shareholder in KQ, bullied the management to buy the old aircrafts The ground operations director then, a Mr Francis, also informed the auditors that “the first aircraft was delivered prior to inspection by the Kenya Civil Aviation Authority”. In his opinion, the purchase process was a rushed decision,” reads the audit.

The Boeing B737 was succeeded by the new generation Boeing 737NG aircrafts which are more fuel-efficient and have lower maintenance costs.

 

“The fleet development business leadership team (BLT) presentation dated 20 February 2008 did not foresee the need for the Boeing B737-300 in the transition from 2008 to 2018. Our review of the minutes and correspondence of the BLT team revealed that the Boeing B737-300 model was in the process of being replaced with the Boeing B737-NG model,” reads the report of the auditors.

 
 

The interpretation is that the KQ management, which had trashed the Boeing B737-300 in 2008, had in 2010 made an about-turn and bought not just the same model of the inefficient plane which they had no plans of buying, but also bought the aircraft second hand.

The deal also exposed KQ managers as cons, who after inviting bidders to inspect aircraft, went ahead to “switch engines”, and the net effect of that decision was a Sh40 million drop in the price of the two aircraft.

“The presentation of Board Memorandum BM4/375/15 77 during the board meeting held on 25 September 2015 revealed that a decision had been made to switch engines after the vendor viewed the aircraft.

"This decision was made by management who thought it was in the best interest of the company to save money. We confirmed that the engines were switched,” reads the audit report.

The prospective buyer was Engage Aviation LLC. Though the two aircrafts with tail numbers 5Y-KYM and 5Y-KYN had been valued at Sh260 million and Sh340 million respectively, the deal with Engage was to have the two aircrafts sold for a total of Sh250 million.

The curious fact is that the KQ board, having seen the valuation, asked the management to sell to the “prospective purchasers for the highest price”.

It is unclear how the price for the two aircrafts came down from Sh600 million to Sh250 million when the board asked for the “highest price”.

“The board was concerned that the switching of the engines posed a reputational risk for the company given that Engage Aviation LLC, the prospective buyers, were not notified of the change. The board resolved that it was in the best interest of the company to sell the two aircrafts at a combined price of USD2.1 million” reads the audit.

While the auditors say they did not find anything irregular in the transaction -- they are not in the business of assigning fault-- there’s no explanation why the price moved from Sh600 million to Sh250 million to the final price of Sh210 million.