Air China Wins Dogfight

In China’s fiercely competitive aviation market, projected to expand almost fivefold by 2026, state-owned Air China has been working hard to shed its second-class image. It has managed to become the country’s most profitable airline, booking a $300 million profit on $2 billion in revenues in the third quarter of 2007, and is now allied with one of the world’s most admired airlines, thanks to a June, 2006, injection of $530 million from Hong Kong’s Cathay Pacific Airways, which owns 20%. Beijing-based Air China, which raised $1.1 billion in a dual listing in Hong Kong and London in December, 2004, now has a market capitalization of $37.4 billion, higher than that of British Airways (BAB), Southwest Airlines (LUV), and Singapore Airlines combined.
There’s one big missing piece, though: Air China has just a minimal presence in Shanghai, the country’s busiest airport in terms of capacity and on track to overtake Hong Kong as the biggest aviation hub in Asia within the next decade. For Air China to expand in the more profitable international routes to and from China, it needs to be in Shanghai, which along with Beijing is China’s only hub for international flights. Without a strong Shanghai operation, Air China’s dream of becoming a major player in the global aviation market will remain just a dream.
So after Singapore Airlines and Singapore government-backed Temasek Holdings agreed in September to acquire 24% of Shanghai-based China Eastern Airlines (CEA) for $1.4 billion, rumors started flying that Air China would block the proposed deal (BusinessWeek, 9/25/07). Getting such a big piece of China Eastern would give the Singaporeans the right to prevent future shareholders from controlling the money-losing Shanghai carrier. That would wipe out any chance of Air China’s filling its Shanghai hole by acquiring China Eastern down the road.
Investors Cheer Market VictorySure enough, two days before China Eastern’s shareholders were scheduled to vote on Singapore Airlines and Temasek’s proposal to buy 24% of the airline, Air China made a preliminary counteroffer that was more than 30% higher than that of the Singaporeans. That did the trick, and on Jan. 8 China Eastern’s shareholders rebuffed the Singaporeans’ offer. Air China will now make a formal offer to buy up to 30% of China Eastern by Jan. 22, and analysts are cheering. %26quot;This is potentially such an important turning point for Chinese aviation overall,%26quot; says Peter Harbison, executive chairman of the Center for Asia Pacific Aviation, a Sydney-based consultancy. %26quot;Market forces have been allowed to determine the outcome.%26quot;
And there’s still plenty of deal-making ahead for an industry that is much in need of consolidation. China has 22 airlines and the industry suffers from too much competition. The carriers may fly 210 million passengers in 2008, compared with an expected 185 million last year, the General Administration of Civil Aviation said on its Web site on Jan. 14. However while the number of Chinese traveling by air has grown almost 9% annually over the past few years, the Big Three airlines%26mdash;Air China, China Eastern, and China Southern (ZNH)%26mdash;are filling less than three-quarters of their seats with paying passengers. Six privately owned budget airlines have popped up in China over the past five years. Consequently, there are too many airplanes going after not enough passengers.

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