China airline mergers finally on the cards

The increasing pace of Chinese restructuring has sent the shares of mainland airlines through the roof.

For over a year now the Civil Aviation Administration of China (CAAC) has talked about consolidating the 10 airlines under its control into three groups. Investors are finally paying attention and its latest reiteration of this policy has proven a significant factor behind a surge in the prices of listed H-shares China Southern Airlines (CSA) and China Eastern Airlines (CEA), both of which have more than doubled since late May.

The reason investors are sitting up and taking notice is, in part, due to last week's Rmb5.77 billion ($670 million) takeover of Shandong Huaneng Power Development Cmpany by Huaneng Power International. The deal has fuelled hopes that the Chinese government is serious about restructuring state-owned entities into viable units ahead of the country's entry into the World Trade Organization (WTO). "I think the power deal gave investors the impression consolidation among H-shares may be accelerating ... Ever since that deal H-shares have been rising across the board," says Elvic Ng, research chief at Vickers Ballas in Hong Kong.

For CSA and CEA, the Shandong Huaneng deal has heightened expectations the two airlines will start picking off smaller state-owned rivals in the near future รป something that so far has been held up by vested interests at the local government level. CSA and CEA, along with Air China, have been picked to head up the three groups of CAAC airlines. The airlines earmarked to join the three carriers are China Southwest Airlines, China Northwest Airlines, China Northern Airlines, China Xinjiang Airlines, China Yunnan Airlines, Great Wall Airlines and China Zhejiang Airlines. Together, CAAC's 10 carriers have assets worth Rmb150 billion and 73,000 employees.

In talks

CEA, which last year bought China General Aviation Co, has confirmed it is in talks to acquire Great Wall Airlines, a small carrier with just three aircraft, and reports earlier this year suggested it is planning to merge with China Northern Airlines, China Southwest Airlines, ChinaNorthwest Airlines and China Zhejiang Airlines as well.

Separately, CEA said it is also in talks to sell a stake in its cargo subsidiary to China Airlines of Taiwan.

In addition to a domestic restructuring, there are signs foreign investors will be allowed a greater role in mainland China's aviation market. The Chinese government recently said it may raise the foreign shareholding ceiling for listed carriers to 49% from 35% at present.

CEA is currently in talks to sell a stake to cash-rich Cathay Pacific Airways, which is keen to hedge against the potential loss of business that would arise if direct flights resume between mainland China and Taiwan. These talks could prove premature as CAAC is thought keen to complete the restructuring of its carriers before freeing up its three airline groups to seek foreign partners.

CEA ended Monday up HK$0.27 at HK$1.62, while CSA was HK$0.40 higher at HK$2.925.