China Eastern minorities reject SIA deal

The vote clears the way for a counter bid from Air China.
Minority shareholders in China Eastern Airlines yesterday voted down a deal to sell a 24% stake in ChinaÆs third largest carrier to Singapore Airlines (SIA) for $923 million.

In what has become a contested bid between two state-owned enterprises û virtually unheard of previously in China - the deal appeared doomed after rival carrier Air China announced over the weekend that it would offer a higher price for a stake in China Eastern.

The rejection is a blow for SIA which last year looked well set to secure a deal that would have given it a foothold in Shanghai, the second most lucrative hub in the worldÆs fastest growing aviation market.

The deal required support from two-thirds of China EasternÆs minority H and A shareholders. Air ChinaÆs parent, China National Aviation Holding Company, and four other institutional investors in Air China hold 31% of China EasternÆs H-share minority shareholdings and 25% of the A-share minorities. More than 90% of the A-share holders and 77% of the minority H-share holders voted against the sale.

YesterdayÆs vote sets the stage for a counter bid from Air China together with Hong KongÆs Cathay Pacific which had issued a statement on Monday saying it may join Air ChinaÆs bid. Air China and Cathay each hold 17.5% of each othersÆ shares. Air China said in a statement last weekend that if the minorities rejected a deal with SIA it would make a rival bid within two weeks, offering to pay at least HK$5.00 a share for the stake.

There is some possibility that SIA may also counter with a higher bid, although the Singapore flagship has already said it will not increase the HK$3.80 per share that it has offered.

Following the vote, SIA said in a statement that it was disappointed by the outcome but it "will continue to support the building of a relationship with China Eastern,ö noting that the airlines are still mutually willing to develop the relationship.

Despite yesterdayÆs vote, China Eastern chairman Li Fenghua, appeared adamant that working with Air China was out of the question. ôWhen it comes to introducing a strategic investor, we will not consider Air China. We still think Singapore Airlines is the best cooperation partner," Li said in Shanghai. "It is not simply the price. If you don't like her, no matter how big the dowry is, it wonÆt work," he added, likening the deal to choosing a wife.

His comments will further fuel the intense political tensions surrounding the deal.

"If China Eastern and Air China were to combine into one group you can only have one chairman," says Adrian Lowe, aviation analyst at CLSA.

Trading in SIA shares was suspended Tuesday afternoon at the airline's request pending the outcome of the vote. SIA shares last traded at S$16.70 per share before the halt, up 18 cents or 1.1% from its close of S$16.52 on Monday. China Eastern was also suspended on Tuesday, trading at HK$3.76 before the suspension, down considerably from HK$8.05 in the previous week before Air China announced that it would make a counter bid. Air China closed at Rmb28.26 down 2.2%, while Cathay Pacific closed at HK$20.25 up 1.25%.

The outcome of this highly political and increasingly intense contest will determine the shape of the latest round of aviation consolidation in China. Following the last major restructuring of ChinaÆs aviation industry in 2002, nine airlines were reduced to three, Air China, China Eastern Airlines and China Southern Airlines.

ChinaÆs airline industry is under strong pressure to improve its performance so as to compete with international carriers when the country accelerates the opening of its skies after 2009. The performance of these companies, up until the beginning of the 2006, had been mixed due in part to the nature of the reorganisation. Some airlines inherited old aircraft, airports that were expensive to run and incompatible airline networks. But much has been due to poor management.

The decision to introduce foreign carriers such as Cathay and Singapore Airlines appeared to be recognition by the authorities that foreign capital and expertise is needed to get the mainland carriers into shape.

The deal signed with China Eastern Airlines in mid-November gave 15.3% of the company to SIA and 8.3% to Temasek Holdings, the Singapore investment company. It was the culmination of negotiations that lasted two years.

But the deal began to appear less secure when, although it had already been approved by the China Eastern board and the state council, Air China together with Cathay Pacific launched their first attempt to derail the deal in mid-September.

This triggered a speculative frenzy in ChinaÆs airline shares, which up to that point had been relatively subdued compared with other China stocks.

China Eastern surged from HK$3.80 to HK$10, while Air China rose 35%, and China Southern Airlines 26%. China EasternÆs price fell back to around $8.00 when Air China and Cathay Pacific agreed to back-off for three months. But the damage to SIAÆs deal had been done as minority shareholders began to complain that SIA was getting a cheap deal. In addition, analysts say that there were greater synergies to be had from a strategic partnership between Air China and China Eastern rather than between China Eastern and SIA.

ôIt makes a lot of sense for Air China and China Eastern to consolidate their international legs to compete with foreign carriers, and to build a size-equivalent rival to China Southern in the domestic market,ö says Citi aviation analyst Ally Ma in a recent report.

According to some analysts, the tensions over the deal reflect indecision within the Chinese leadership over whether to kept the existing big three carriers or whether to consolidate further.

ChinaÆs former chief civil aviation regulator, the highly respected Civil Aviation Administration of China (CACC), director-general Yang Yuanyuan said last year that he personally felt it was too early to reshuffle the top three carriers as this would stifle competition. He further added that none of the three had the capability of managing the resultant huge airline.

However Yang was replaced as director-general of the CACC at the end of 2007 by Air China chairman Li Jiaxing. Li has long been pushing for a more aggressive and nationalistic approach and for industry restructuring to turn Air China into a "super carrier" to better compete with foreign rivals for larger market shares. His promotion increased uncertainties over the prospects for the SIA deal.

Both SIA and China Eastern claim the HK$3.80 offer - to buy into an airline that has made losses for three of the past five years - was fair at about six times the airline's end-2006 book value.

However, ChinaÆs airlines witnessed a huge improvement in performance in 2007. The booming economy and robust consumer demand has tripled the countryÆs aviation earnings in the first three quarters of 2007 with profits of Rmb13.72 billion ($1.89 billion) compared with Rmb4.38 billion in the comparable period in 2006. "The operating performance of all Chinese airlines has improved over the past six months. While China Eastern made losses in 2006 it is expected to make a profit in 2007," says CLSAÆs Lowe.

But despite the longer term benefits that might have accrued from SIAÆs expertise and proposed capital expenditure spending, with yesterdayÆs vote, the pendulum appears for the moment to have swung in favour of further consolidation. ôThe situation is panning out favourably for Air China and Cathay," says Lowe.
¬ Haymarket Media Limited. All rights reserved.
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