Air China Ltd., the world’s second- most valuable airline, may face tougher domestic competition after failing to win a partner in Shanghai, the country’s commercial capital.
China Eastern Airlines Corp. and Shanghai Airlines Co., the dominant carriers in the city, plan to combine, said Shanghai Air Vice President Feng Xin. Together, they will control about 50 percent of the flights in and out of the city compared with 11 percent for Beijing-based Air China, according to Ally Ma, an analyst at Citigroup Inc.
“There’s no chance for Air China to reverse the decision that will cost it the market share it’s been longing for,” said Ma. “China Eastern and Shanghai Air will gain more power in setting prices and arranging routes after the merger.”
Without a partner in Shanghai, forecast to overtake Beijing as China’s biggest air travel market by 2015, Air China may have to focus on smaller cities. The government approved a deal after bailing out China Eastern and Shanghai Air, which had combined record losses of 16.5 billion yuan ($2.4 billion) last year.
“After this merger, Air China won’t be able to see much growth in the city,” said Li Lei, a Beijing-based analyst at China Securities Co. “It may be realistic to seek growth in other regional markets like central China.”
Air China’s Hong Kong-listed stock fell 2.1 percent to HK$3.72 at the close of trading. The shares have gained 55 percent so far this year, giving the company a market value of $10 billion, second only to Singapore Airlines Ltd.
The Chinese government is pushing for mergers across a range of industries to improve competitiveness. Carmakers and steelmakers are also being encouraged to combine as China’s economic growth crimps profits.
Air China’s head of investor relations, Rao Xinyu, declined to comment on the combination of the two airlines.
China Southern Airlines Co., the nation’s largest domestic airline, “would be happy to see it happen,” said Si Xianmin, the carrier’s chairman.
Terms of the Shanghai Air-China Eastern deal weren’t immediately available. The combined group of China Eastern and Shanghai Air would have 306 planes and more than 600 routes. China Eastern Board Secretary Luo Zhuping said yesterday that talks are open and terms have not been settled.
“To execute the merger will be harder than any other earlier cases in China’s aviation industry,” said Ma. “It will take them time to work out detailed shareholding structures.”
Both carriers halted their shares from trading yesterday, pending decisions on “important” issues on possible merger and acquisition. China Eastern is listed in Shanghai and Hong Kong. Shanghai Airlines is only listed in Shanghai.
Air China and affiliate Cathay Pacific Airways Ltd. sought a tie-up with Shanghai-based China Eastern last year to dominate the world’s second-largest aviation market.
China National Aviation Holding Co., state-run parent of Air China, bid for a stake of China Eastern in January, 2008, after it helped derail a proposed partnership between China Eastern and Singapore Airlines.
China National offered to pay at least HK$14.9 billion for as much as 30 percent of China Eastern’s shares. China Eastern rejected the offer. Air China’s President Cai Jianjiang has also said the airline wanted a stake in the smaller Shanghai Air.
Airlines worldwide may lose $9 billion this year as the recession and swine flu hurt travel demand, the International Air Transport Association forecast yesterday.
China Eastern has posted losses in three of the past four years, and forecast a loss for this year as it struggles with debt and China’s cooling economy stymies travel demand. The carrier has drawn up a list of 256 cost-cutting measures, delayed planes and agreed to sell a stake in a unit in a bid to return to profit.
The carrier’s state-controlled parent has gotten 9 billion yuan ($1.3 billion) in capital from the central government since December. Of this, 7 billion yuan will be used to buy new shares in China Eastern. The carrier hasn’t yet said what the other 2 billion yuan will be used for.
Shanghai Airlines, controlled by the city government, said in February it got 1 billion yuan in government capital.
“The government and both companies have realized the difficulties and importance,” said Ma. “The only thing is how to carry out the merger plan in the direction given by the government.”
The combination may also lead to the revival of the stymied deal between China Eastern and Singapore Airlines, said Kelvin Lau at Daiwa Institute of Research Ltd.
“China Eastern won’t give up its efforts to introduce an overseas partner, while Singapore Air won’t give up interest in China market,” said Lau. “That could be something to expect for the long term.”