Tuesday, June 06, 2006

Cathay Breathes Dragon Fire In SIA's Face

Shares of five companies, including Cathay Pacific Airways and Air China, were suspended from trading Monday amid a pending takeover of Dragonair by Hong Kong's flag carrier, Cathay Pacific. Share trading was also halted Monday for China National Aviation Co, the largest single shareholder of Hong Kong-based Dragon Airlines, as well as Dragonair's other stakeholders, Swire Pacific and CITIC Pacific. Such suspensions are commonplace once rumors of an acquisition or merger begin to affect trading in relevant shares. Cathay, which holds a 17.79% stake in Dragonair, sees the acquisition as a vehicle to grab a bigger share of the fast-growing mainland aviation market. Dragonair at present flies to 23 Chinese destinations from Hong Kong, operating more than 300 flights a week, while Cathay - which especially covets the lucrative Hong Kong-to- Shanghai route - is limited to directly servicing Beijing and Xiamen. Simple logic is Cathay needs a network into China; Dragonair's got one. Its a wonder it took Cathay Pacific that long to buyout Dragonair. Dragonair's other Asian destinations include Bangkok, Taipei and Tokyo, while it also offers freighter services to Europe and the Middle East, as well as to New York and Shanghai.

Cathay will be able to operate mainland and Hong Kong routes, while Air China will be able to expand its international market through holding Cathay's shares. Air China, which holds a 66.36% controlling interest in CNAC - Dragonair's parent company - would likely acquire shares in Cathay Pacific as part of the deal, therefore becoming Cathay's third-largest shareholder after Swire Pacific and CITIC Pacific. Conversely, Cathay holds a 10% stake in Air China, and the cross-shareholding is expected to strengthen ties between the two carriers, helping the Beijing-based airline to gain valuable management expertise needed to compete more effectively internationally. Cathay's long-contemplated takeover of Dragonair will likely involve revamping the shareholding structures of several major players in the regional aviation sector, including Cathay, Air China, CNAC and CITIC Pacific.

To gain sole ownership of Dragonair, Cathay would need to purchase CNAC's 43.29% stake, along with CITIC's 28.5% and Swire Pacific's 7.71%, as well as the 2.71% held by other minor shareholders. Dragonair is estimated to be worth about HK$12.2 billion. Air China is looking at privatizing Hong Kong-listed CNAC after Cathay's takeover of Dragonair. The airline operation from Dragonair and Air Macau will lower the CNAC group's earnings due to high oil prices. However, the problems will be solved if Cathay buys out Dragonair.

Meanwhile, the Hong Kong government would have to rearrange traffic rights owned by two separate airlines if Cathay takes full control of Dragonair. Dragonair's traffic rights would have to be transferred to Cathay Pacific if the operation and management of Dragonair is under Cathay. It is the first matter that the Economic Development and Labour Bureau will need to cope with.
Dragonair might also cancel some money- losing routes after Cathay's takeover. In 2003, Dragonair said only five of its mainland destinations were profitable. Cathay estimates that Dragonair had a 30% profit margin on the Hong Kong-Shanghai run, and 15% on the service to Beijing.

The takeover has the effect of propelling Cathay Pacific as the premier Asian airline at the expense of SIA. Even though SIA would have loved to buy Dragonair, there is no possible way for that to happen with the inter-related China interest affecting China skies. It could only happen if Cathay made its move, and the entire deal would not have happened without the presence and initiative by Larry Yung from Citic Pacific.

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