Kenya: Let's Not Mess Up KQ Turnaround Efforts the Way We Did Rift Valley Railways

A standard gauge railway cargo train departs from Mombasa port on May 30, 2019.
analysis

For a transport business, logistics are straight forward: The sole responsibility of an operator is to move goods and passengers from one point to another. However, the operator's success is determined by efficiency and pricing -- factors influenced by the environment.

In 2005, the Kenya Railways Corporation (KRC) and Uganda Railways Corporation (URC) entered into an agreement to concession out the operation of the Kenya-Uganda railway in an effort to turn around the business. A concessionaire was to be granted a 25-year agreement in a deal that would see them profitably operate the railway from which both governments would earn revenues in form of concession fees paid out every quarter.

Due to the capital-intensive nature of the undertaking, the concessionaire approached the opportunity in consortia. The first concessionaire, Sheltam Investment, was awarded the mandate in 2006. It managed the operation for three years until 2009 when the agreement was cancelled and a new consortium awarded the railway operation mandate.

Sheltam managed to secure a long-term debt financing of Ksh4.6 billion ($45.5 million). But due to circumstances that the lenders were unhappy with, the concessionaire was unable to draw down on the financing to advance its capital expenditure (capex) programme. Nonetheless, Sheltam progressed, surviving on a shoe-string budget to save the century-old rail operation that had been neglected and starved of business direction and investment for more than 25 years.

When Sheltam took over Rift Valley Railways (RVR), it inherited a bloated work-force of 3,300 staff that was not only idle owing to years of mismanagement and diminishing rail business, but the vocally unionised workers were also entitled. The government somehow ensured that all workers received their pay and benefits, however irregular. Kenya Railways and Uganda Railways were both haemorrhaging public revenue.

INVESTMENT

In contrast to their cash position, the parastatals that were running the railway were enviably asset rich. Some of the assets they included on lease to the concessionaire were the stations, the Victorian railways headquarters and more important, the 100-year old dilapidated and vandalised track, which came with broken culverts and sections where the track had literally disappeared due to encroachment and human activity.

The Sheltam-led consortium capitalised the business by a total of Ksh1.3 billion ($12.8 million) as it worked on drawing down the Ksh.4.6 billion debt it had secured to finance their capex. Of the Ksh1.3 billion, only Ksh258 million ($2.55 million) went into acquiring new assets, a total of Ksh946 million ($9.35 million) was gobbled up by concession fees. The rest of the fee were split between consultants and a re-branding exercise.

In 2009, three years into the agreement, the Kenyan and Ugandan governments concluded that Sheltam Investment did not have the muscle to turn the operation around. The agreement was terminated. Still in 2009, new shareholders bought out the old shareholders and took over the concession agreement. The new consortium was led by Egyptian-based private equity fund, Citadel Capital, which later changed its name to Qalaa Holdings.

According to Citadel Capital officials at the time, RVR required a minimum of Ksh25 billion ($247 million) to finance a five-year capex programme. This was a far cry from the Ksh4.6 billion that Kenya Railways and Uganda Railways had required of the Sheltam consortium.

In 2010, the Citadel Capital-led consortium closed on the financing of the five-year Capex Programme, securing the Ksh28.5 billion ($282 million) that they required to overhaul the operation. Part of the capex money would come from internally generated profits over the period. This meant that the management had to make some investments in long-term efficiency initiatives that would cut operating costs. Staff would be targeted. Unions would push back.

TURNAROUND

The turnaround narrative began at the start of 2011. In order to retain the concession rights, RVR was required to meet four main conditions including payment of concession fees on time, due every quarter; haulage of a specified amount of cargo between Mombasa and Uganda and increase of cargo freight by 75 per cent within five years; and reduction of travel time between Mombasa and Uganda. RVR embarked on a track and rolling stock rehabilitation programme that would see it meet these targets.

As a private entity however, RVR had no control of the efficiencies at the port. This was the mandate of Kenya Ports Authority. All loading of cargo on trains would be done by KPA, at their availability and convenience. This greatly impacted on the first two conditions of the revised concession agreement. RVR had streamlined its internal operations but was not able to control the external factors. The delays can be said to have been deliberate since the railway business was rebounding and taking business away from truck owners.

In addition to the inefficiencies at the port, RVR was required to pay a fuel levy each time it fuelled its locomotives. The state allocates all funds in the fuel levy kitty to road repairs, a direct competitor of RVR. The operator also paid a Railway Development Levy of 1.5 per cent of the Customs value of all the rolling stock they imported. This money went into the railway development fund, which would fund the SGR, another direct competitor of the operations.

The RVR turnaround narrative started to die with the launch of the standard gauge railway construction. The concession was for the second time cancelled, this time because the countries were looking East for a faster, more modern option. Officially, the concessionaire was dismissed for not having met the turnaround conditions.

BUSINESS ENVIRONMENT

Recent developments where Kenya was unable to secure the additional $3.6 billion required to continue the SGR construction from Naivasha to Malaba effectively means that the cargo would then be put on the old metre-gauge line to complete its journey to Western Kenya and landlocked Uganda. This is expected to be costly in terms of logistics at the inland container depot in Naivasha.

In retrospect, it would have benefited the country if the government had provided a more conducive business environment for the concessionaires and a budget to rehabilitate and upgrade the metre gauge track, which remains a national asset.

I can draw a lot of parallels between the handling of the Kenya Airways concession proposal and the mismanagement of the RVR concession. In principle, KQ proposed to have a deciding voice in how the Kenya Airports Authority is run in an effort to increase its efficiency while at the same time making KAA fees from the concession agreement. The assets will remain the property of KAA, therefore the argument that KQ is looking to use KAA to prop up its balance sheet from KAA's assets is a misrepresentation of facts.

KQ has no preferential treatment in its own hub of operation, even though it is responsible for around 50-60 per cent of overall traffic at Jomo Kenyatta International Airport.

Considering this absence of synergy between KQ and JKIA, the national carrier will never be as competitive as other airlines and will continue to lose market share and generate losses. One of the rationales for the public-private partnership is the fact that KQ is the only airline interested in the further development of JKIA.

Currently, of all the airlines operating from JKIA, KQ contributes 83 per cent of KAA's revenues collected from the international airport. Should KQ collapse or limit its operations, JKIA, which is a more strategic asset to Kenya, is likely to be downgraded to the status of a regional airport.

FINDING SOLUTIONS

Like in the case of the railways business, Kenya Airways currently has no influence over the ports and this greatly impacts on the airline's efficiency as well as pricing for its services.

And while the proposed KAA-KQ concession does not seem immediately viable to policy makers and economic pundits, in the long run, it is the only option that responds to three key aspects of the aviation industry: Improved efficiency at JKIA, better pricing and growth for KQ and revenue for KAA. This is a long-term solution that can be achieved without additional bailouts from taxpayers.

As for the railway business, we have a second chance to do it right. With $400 million ($3.95 million) now secured for the rehabilitation of the old metre gauge railway, we still need to provide a conducive business environment for the operators particularly efficiencies at the port in Mombasa and ICD in Naivasha.

There are a number of contributing factors that led KQ to sink to a loss of Ksh25 billion ($247 million), in just four years. The haemorrhage has been stemmed and the loss has narrowed to Ksh7.5 billion ($74 million) and while that is not the best outcome, let us not throw out baby KQ with the bathwater as in the case of RVR.

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