Mon, Jun 19, 2006 page11

• Cathay Pacific gets ready to tap China

  CONTENDER The Hong Kong carrier's acquisition of Dragonair and increased stake in Air China puts it in a position to better rivals such as Singapore Airlines

  • AFP
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  A shake-up of the aviation industry is looming across Asia as airlines come to grips with Cathay Pacific's ownership overhaul, setting it up as a dominant world player with a box seat in China.

  Analysts believe the Hong Kong flag carrier's acquisition of Dragonair (港龍航空) and strategic alliance with Air China (中國航空) could put it in a position to eclipse rivals such as Singapore Airlines and Qantas.

  More importantly it realizes Cathay Pacific's long-held ambition to get into the key China market and creates breathing space for Air China, which suffers from close political oversight given its status as China's flag carrier.

  "These are positive steps, positive developments," said Jim Eckes, Hong-Kong based managing director at airline consultancy Indoswiss Aviation.

  He said the central government's role in the running of Beijing-based Air China, a contentious point with many in the industry, could be kept in check under the deal and by Cathay Pacific's new found influence.

  "Air China has always been the weakest of the Big Three in China," he said referring to China Southern Airlines (南方航空) and China Eastern Airlines (東方航空). "It doesn't make it any easier with people looking over your shoulder."

  Cathay Pacific is to acquire Dragonair and double its stake in state-controlled Air China to 20 percent, with the response to the US$1 billion deal seen as largely positive for the companies involved so far.

  Smaller local rivals, however, are expected to feel the initial brunt of the tie-up, with ownership now simplified and a rejuvenated Cathay Pacific acquiring full access to the booming Chinese market.

  Cathay Pacific previously flew to only two destinations in China -- Beijing and Xiamen -- but through Dragonair it has picked up 23 Chinese cities, including the lucrative Hong Kong-Shanghai route.

  US investment house Morgan Stanley noted that near record oil prices and higher airport taxes were expected to further undermine the operations of China Eastern and China Southern airlines.

  "We believe the combined Cathay-Air China-Dragonair franchise will represent a formidable threat to airlines operating in China and into the greater China markets, comprising China, Hong Kong, Taiwan and Macau," it said.

  As a result, "we think the two Chinese airlines -- China Eastern and China Southern -- would have a difficult time competing with the combined Cathay-AirChina-Dragonair franchise in the China market," it said.

  US-based research house Globalysis, which tracks the tourism industry said in a report that the deal would enable Cathay Pacific to become the largest airline group in the Asia-Pacific, ahead of Qantas and Singapore Airlines, and warned of troubled times ahead for the smaller players.

  "Consolidation will bring a little more security as bigger airlines may have deeper pockets to reach into should tough times hit while economies of scale could help reduce operating costs and increase profitability, as we may see happening with the new Cathay Pacific," Globalysis said.

  Crippling fuel prices resulted in Chinese airlines posting total losses of US$267 million in first quarter of this year, despite a booming market which is expected to double in size again from last year's levels by 2010.

  "Traffic in China and Hong Kong is growing at a nice rate every year and that growth rate is quite helpful ... it will stay that way in the lead-up to the [2008 Beijing] Olympics," Eckes said

  Last year the Chinese aviation industry carried 138 million passengers and 2.73 million tonnes of freight. To meet demand, Beijing plans to increase the national fleet to 1,580 aircraft by 2010 from 863 and plough US$17.4 billion into airport infrastructure.

  Globalysis said Cathay Pacific would likely outrank Singapore Airlines in terms of profitability once the tie-up with Dragonair and Air China goes through.

  "With the acquisition of Dragonair, Cathay may soon be in a good position to eclipse Singapore Airlines to possibly become the most profitable airline in the world," Globalysis said.

  It said Cathay Pacific's takeover of Dragonair may also trigger further industry consolidation in the coming years as the industry seeks to manage costs better, "especially with increasing risks from high and volatile oil prices, airborne diseases like SARS and bird flu, and terrorism."

  Analysts said consolidation was more likely at the lower end of the market among smaller airlines, particularly in the low cost segment.

  Eckes said the close association between flag carriers and national identity meant tie-ups among bigger airlines such as Malaysian Airlines or Thai Airways highly unlikely due to political opposition.

  That theory has spawned market talk that Air China, over the medium-term, could be in a position to mount a bid for Cathay Pacific, in which it will acquire a 17.5 percent stake under the deal.

  Most industry observers suggested this was fanciful at this stage while Eckes added: "I have heard the chatter."
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