Air China unveils plans to take control of a smaller carrier

HONG KONG – Air China Ltd. unveiled plans to take control of Shenzhen Airlines Co. by injecting funds into the smaller carrier, in a move that will further strengthen the Chinese flag carrier’s foothold in southern China, which for years has been dominated by rival China Southern Airlines Co.

The deal is in line with the Civil Aviation Administration of China’s intention to further consolidate the country’s aviation market to improve efficiency amid growing competition on both domestic and international routes. In January, Shanghai-based China Eastern Airlines Corp. completed its merger with Shanghai Airlines Co.

Analysts are generally upbeat on the latest deal’s long-term impact on Beijing-based Air China, the world’s largest airline by market capitalization. Its market share in Shenzhen will likely rise to 40% and its share in Guangzhou will likely reach around 20%. Air China currently has an overall share of about 10% in southern China.

However, analysts said the premium that Air China plans to pay to boost its stake in unprofitable Shenzhen Airlines will have a slightly negative earnings impact in the near term.

Air China said in a statement the airline and Total Logistics (Shenzhen) Co., a unit of Shenzhen International Holdings, will inject a total of 1.03 billion yuan ($150.9 million) into Shenzhen Airlines, with around 66% of the funds coming from Air China. Air China’s stake in the private carrier will rise to 51% from 25%, while Shenzhen International’s stake will rise to 25% from 10%.

Air China said the capital injection will help alleviate Shenzhen Airlines’ cash flow pressure and will support cooperation between the two carriers by consolidating domestic and international routes, boosting their competitive strengths in the Pearl River Delta, south China’s industrial hub.

Shenzhen Huirun Investment Co., which is Shenzhen Airlines’ controlling shareholder with a 65% stake, will see its stake fall to 24% after the capital injection. The investment company is in the process of being liquidated by its creditors, which comes after news broke in December that its controlling shareholder, Li Zeyuan, was arrested for suspected economic crimes.

Mr. Li couldn’t be reached for comment.

Mr. Li, who held the post of senior consultant at Shenzhen Airlines, had de-facto control of the airline through Huirun, according to analysts.

After Mr. Li’s arrest in December, Shenzhen Airlines’ board named Air China Vice President Fan Cheng as acting president of the airline.

Analysts said Huirun’s bankruptcy provides Air China with the opportunity to further raise its stake in Shenzhen Airlines, though the airline’s company secretary, Huang Bin, said Monday that it has no plans to further boost its stake at present.

The secretary said Air China’s board will evaluate the possibility when the opportunity arises.

Air China lost its bid for a controlling stake in Shenzhen Airlines in 2005, when the Guangdong provincial government’s investment company, Guangdong Holding Group, sold its 65% stake in the carrier in a public auction.

“We view the deal strategically positive but financially negative as it takes time for Air China to turn around Shenzhen Airlines,” said Jim Wong, head of Asia transport and infrastructure research at Nomura Securities. He said the deal values Shenzhen Airlines at close to three times its book value.

Shenzhen Airlines had a net loss of 863.7 million yuan in 2009, widening from a net loss of 31.3 million yuan a year earlier.

Morgan Stanley analyst Edward Xu said in a report Monday that the move is expected to negatively impact China Southern Airlines as Air China boosts its foothold in southern China. China Southern is the nation’s biggest airline in terms of fleet size.

Air China, which announced a bigger-than-expected fund raising plan of 6.5 billion yuan this month, said it plans to fund the capital injection through internal resources.