Rolls Royce will face costs of over 300 million $ to fix the Trent 900 problems

Rolls Royce now faces direct costs for replacement of 40 Trent 900 engines, compensation claims from Airbus and from the airlines involved and lost opportunity costs as the Trent 900 inevitably loses market share to the General Electric / Pratt & Whitney Alliance GP 7200 engine. These could add up to around 300 million $ for fixing the Trent 900 problems and that is a best case scenario which assumes that they have not been negligent in knowingly supplying unfit engines. The cost of the consequent loss of market share cannot be easily quantified.

Airbus has already signalled that it is preparing its compensation claims for the additional costs incurred by diverting new engines from the Airbus production line to the replacement of faulty engines for Qantas, Singapore Airlines and Lufthansa. Any consequent delays to the aircraft under production at Airbus will no doubt lead to further penalties for Rolls Royce. The airlines are also, I am sure, preparing their compensation claims. Qantas is said to be losing one million dollars for every day without its A380’s. The fleet has been grounded for 15 days so far and it seems likely that this may last another 2 or 3 weeks and maybe for the rest of the 2010 calendar year. Qantas has already prepared its summer schedules based on no A380’s being available. Singapore Airlines has restarted its A380 flights.

In most supply contracts the consequential business losses at the airlines would not normally accrue to Rolls Royce but if it can be shown that the faulty engines delivered by Rolls Royce were “not fit for service” or – even more damagingly – that Rolls Royce were aware of the faults when the engines were delivered then Rolls Royce could be liable for massive damages and even for criminal negligence. In fact it would be comparable to issuing a cheque with no money in a bank account which could be construed as criminal negligence and fraud. Certainly it seems that Rolls Royce has known for some time that some of the engines delivered were “not fit for service” and it is highly unlikely that they could completely escape paying some compensation to the airlines. If the method of operation or maintenance by Qantas could be shown to be a contributory factor then Rolls Royce would have had some possibility of resisting the claim and of mitigating the penalties. But if the engines were “unfit for service” to begin with, then it even becomes possible for Airbus and the airlines to make claims for “loss of reputation” in addition to claims for loss of business. There is no viable defence at all if Rolls Royce knowingly supplied unfit engines.

A Trent 900 engine has a price of about 30 million $ and a complete A380 sells for about 320 million $. The direct cost for the engine rectifications for 40 engines is likely to be around 100 million dollars and this could easily increase to 300 or 400 million dollars with the compensation claims mainly from Airbus and Qantas. The Singapore Airlines and Lufthansa claims for compensation will not be small but will be significantly lower than the claims from Qantas. But if Rolls Royce has been negligent- whether criminally or not – then all bets are off and I think costs could escalate to be of the order of one billion dollars.

While the direct costs and compensation – once settled – can be quantified, the effects of loss of market share is potentially even more damaging but much more difficult to quantify. Since there are only 2 engine suppliers I would estimate that Rolls Royce will lose at least 5% market share to its rival as a consequence of this incident.

From my previous knowledge of the costs of fixing problems with land based gas turbines (more than 1 billion $ each for General Electric with their F-class Frame 7 and Frame 9 machines and for Alstom  and Siemens with their versions of F-class machines), I would be looking for Rolls Royce to provide – as a matter of prudence – for at least 200 million £ (300 million $) during this quarter. Rolls Royce will need to sell around 100 new engines just to recover this cost.

From an investor perspective I find the lack of communication from Rolls Royce inexplicable and suggestive that there has in fact been some negligence.

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6 Responses to “Rolls Royce will face costs of over 300 million $ to fix the Trent 900 problems”

  1. Rolls Royce shares – Trent 900 hit will last at least 18 months -time to sell? « The k2p blog Says:

    […] Trent 900 debacle will probably eat up at least £200 million – and perhaps more – over the next 12 -18 months. The immediate effect will also be the […]

  2. Qantas prepares for legal action against Rolls Royce « The k2p blog Says:

    […] Qantas prepares for legal action against Rolls Royce By ktwop The Trent 900 fix is not going to be cheap for Rolls Royce. I am still maintaining my estimate that the total cost for the engine manufacturer will be in excess of $300 M. […]

  3. Qantas A380 flights to LA to restart on 17th January « The k2p blog Says:

    […] For Rolls Royce, getting Qantas back to full operation is critical to bringing this chapter to a close and to limiting at least one part of the inevitable claims that will come. They will also face claims from Airbus who announced a few days ago that they would only deliver 18 A380′s during 2010 and would not reach their already revised target of 20 planes. This delay is put down to the extra inspections caused by the fault in Rolls Royce engines. No doubt Singapore Airlines and Lufthansa will also have claims on Rolls Royce. I still estimate that the total costs to Rolls Royce will reach $300 million. […]

  4. Rolls Royce profits down 76% as Trent 900 costs start to kick in « The k2p blog Says:

    […] if Rolls Royce have made any provision for further costs which is a little worrying and I stay with my estimate of around $300 million as the total hit that Rolls will have to swallow for the Trent 900 for the A380 in addition to any […]

  5. Rolls Royce engine failure will eat up $80 million of Qantas profits « The k2p blog Says:

    […] With compensation claims due also from Airbus (EADS), Singapore Airlines and Lufthansa and with the additional costs spilling over into 2011, the total cost of the engine mishap will likely exceed my estimate of  $300 million. […]

  6. Rolls Royce settles with Qantas for over $100 million « The k2p blog Says:

    […] My estimate made in November 2010 that Rolls Royce would face a hit of around $300 million for direct costs and in settlement costs seems to be not far off the mark. The cost to Rolls Royce of loss of future sales remains intangible and perhaps only temporary. […]

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