Temporarily grounded

The mood at Singapore Airlines (SIA) was somber on December 8, following the rejection of its bid for a 24% stake in China Eastern Airlines (CEA) by the Chinese firm’s shareholders. In a brief statement, the Singapore carrier said it was “disappointed” the proposal had failed but that it would respect the outcome of the meeting.

CEA, which backed the deal, was more defiant. “China Eastern will never give up no matter how big the obstacle it faces,” said its chairman, Li Fenghua. He added that the airline “will never consider Air China as a strategic investor.”  

Li’s harsh words for China’s flag carrier came after its parent, China National Aviation Holding Co (CNAHC), ruined the Singapore deal by suggesting a higher counter-bid. In leading CEA shareholders to reject SIA’s offer, CNAHC also renewed uncertainty over the future direction of China’s domestic airline industry.

“Decisions will be politically driven, the outcome is uncertain and there may be no resolution before the end of 2008,” Mark Webb, an analyst at HSBC Securities, wrote in a recent report.

If successful, SIA’s bid, which was supported by Temasek, Singapore’s sovereign wealth fund, would have given the carrier a firm toehold in China. CEA’s management, in turn, hoped that an injection of cash and foreign expertise would revive the fortunes of what has been the weakest financially of China’s big three airlines.

However, reports that SIA rival Cathay Pacific might back a higher CNAHC offer erased many of the perceived advantages of an SIA partnership.

“In the minds of investors and shareholders, [Cathay Pacific] is an effective replacement for Singapore Airlines,” said Derek Sadubin, chief operating officer of the Center for Asia Pacific Aviation.

If CEA’s management continues to oppose a deal with Air China, what might result is an unprecedented hostile takeover of one Chinese state-owned enterprise by another. The shift in Beijing’s position, from backing the SIA-Temasek bid to allowing CNAHC to derail it, is evidence of a fierce debate that now appears to tilt in favor of consolidation.

Takeover or partnership?

In the short term, consolidation would not necessarily mean a flurry of mergers. Air China has said it wants a partnership, perhaps amounting to a share swap, with CEA, rather than a full takeover.

The Shanghai-based carrier’s long-term fate is less certain. The promotion of former Air China President Li Jiaxiang, a known proponent of consolidation, to the head of China’s civil aviation administration (CAAC) casts doubt on CEA’s ability to continue as an independent operator.

However, Sadubin noted that Li, “will need to balance the needs of all airlines in China … We do not expect any significant change to China’s policy of progressively liberalizing aviation access.”

Furthermore, the final decision on any merger would ultimately rest with the State-owned Assets Supervision and Administration Commission, the State Council body that controls the major shareholdings in each airline.

That has not deterred Air China, which has made public its goal of becoming a Chinese “super-carrier.” A merger with China Eastern would give it a 36.3% share of the market on domestic and international routes. Air China has also expressed interest in joining forces with China Southern Airlines, though the Guangzhou-based carrier has not reciprocated.

It is still too early to paint a clear picture of the future of China’s airlines. Any counter-offer for CEA by CNAHC is subject to shareholder approval; there is a chance SIA may seek to resubmit its previous bid, despite having ruled out a higher offer; and, all the while, Beijing continues to give out mixed signals.

In the CEA case as in the market overall, “what Air China wants may not be what the outcome is,” said a senior equity analyst following the negotiations. “This is definitely not over.”