China Airlines Ties With Australia’s Quantas

Posted: December 28, 2014 in Econ 101, Free Trade, Technology and Energy

SOURCE: http://www.smh.com.au/business/chinese-aviation-tiger-wants-more-of-australian-market-20141228-12d0ku.html

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Chinese aviation tiger wants more of Australian market

December 29, 2014

By Matt O’Sullivan Business Reporter

“We are like tigers,” China Eastern regional boss Kathy Zhang laughs. “We see a rabbit come out, and we catch it.”

Her analogy highlights China Eastern’s aspirations to expand its international network. China Eastern is one of China’s big three airlines, long regarded as the sleeping giants in the aviation world’s new order. That is changing quickly.

At one end of an office in China Eastern’s Sydney building sits a photograph of Qantas chief executive Alan Joyce and China Eastern chairman Liu Saoyong signing a deeper alliance. Overlooking the pair are Prime Minister Tony Abbott and Chinese Premier Xi Jinping, one of the most powerful men in the world.

While helping to focus attention on Australia’s free-trade agreement with China, the alliance signed in late November raises questions about China Eastern’s long-term plans for Australia – and importantly, Qantas. 

Two months earlier, Joyce unveiled plans to set up a new holding company for Qantas’s loss-making international operations as a way to open the door to a foreign investor eventually buying a stake of up to 49 per cent.

In the wake of their deeper alliance, China Eastern has been fingered as the airline most likely to be interested in investing in a business that has clocked up massive losses in recent years. Emirates, Qantas’s main alliance partner on routes to Europe, has repeatedly ruled out buying a large holding. 

“If Qantas is looking for a foreign carrier as a cornerstone investor, China is the obvious place to look. Other carriers have gone down this road,” Rod Eddington, a former boss of Cathay Pacific and British Airways, said.

Indeed, Cathay Pacific and Beijing-based Air China have cross shareholdings.

“The three major Chinese carriers – Air China, China Eastern and China Southern – have all come a long way in the last two decades,” Eddington said. “They all have substantial ambitions for Australia. Qantas will decide which of those three carriers it wishes to have a closer relationship with.”

It will have to decide carefully. The big three Chinese airlines are in stiff competition with one another for worldwide traffic flow as they build their networks beyond their home borders.

China Eastern did not discuss the possibility of buying a stake in Qantas during negotiations in Shanghai and Sydney for their deeper code-share alliance.

“But who knows the future,” Zhang said. “The world is changing so fast – who could expect what happens for the next step.”

In the space of a few years, Qantas has hitched itself to China Eastern. Qantas executives have invested considerable time building relationships with their counterparts in Shanghai. After cementing a code-share deal in 2008, the two airlines strengthened their alliance on short- and long-haul routes.

In 2012, the pair also became cornerstone shareholders in Jetstar Hong Kong, the budget airline that is still waiting approval from regulators more than a year after it planned to begin flying.

Now, the question is whether committing a large slab of capital to buy a stake in Qantas’s international operations would give China Eastern any more than it gains from a deeper code-share alliance. This has long been the explanation for Emirates showing no inclination to invest in Australia’s largest airline.

A former Qantas executive with extensive experience in China doubts the state-backed China Eastern will buy a stake because it will get what it needs out of a closer alliance, without having to deploy capital.

“If the Chinese government wanted to take a serious stake it would have made more sense for China Southern to be the instrument,” he said. “It has a more extensive service into Australia. China Southern is probably a pain in the backside for Qantas at the moment in terms of competitiveness.”

In recent years, the Guangzhou-based China Southern has been the most aggressive of China’s big three in expanding into Australia, and in late 2013 formed a code-share deal with Qantas.

China Southern showed interest in buying a strategic stake in Qantas in 2012, as it searched for ways to boost passengers from one of its most important international markets. However, its interest waned as roadblocks emerged. At the time, the Qantas Sales Act limited a single investor to 25 per cent. A purchase would also have required approval from the Foreign Investment Review Board, while the Australian Competition and Consumer Commission would need to consider competition concerns.

Importantly, China Southern also needed approval from authorities in Beijing.

Since then, foreign-ownership restrictions on Qantas have been relaxed. While a 49 per cent cap on total foreign ownership remains, the 25 per cent limit on a single investor and 35 per cent on foreign airlines have gone.

However, hurdles remain, as much in gaining approval from political masters in Beijing as satisfying regulators and politicians in Australia. “From a regulatory point of view, there is no real reason why it couldn’t happen. But politically Qantas is such a touchstone company,” the former Qantas executive said.

Even so, he conceded that the recent free-trade agreement with China could change the ball game.

But regardless of whether it is a potential buyer, China Eastern’s deeper alliance with Qantas sends a signal that it intends to expand its reach into Australia.

“The cake is getting bigger than before,” Zhang said. “But how to adjust our capacity in getting into the market and getting people on to China Eastern but not the others is a focus for us all the time.”

Over the next five years the airline will take delivery of 20 new Boeing 777-300s and 50 Airbus A330-200 aircraft, for long-haul flying to destinations such as Australia. “The long-haul fleet has the biggest growth rate in the total fleet, which is why we need to fly to more destinations long haul or more frequencies,” she said.

In early December, China Eastern launched a new route from Shanghai to Auckland, which was expedited by a free-trade agreement between China and New Zealand.

The extent to which the free-trade agreement between Australia and China will benefit Qantas and China Eastern is unclear. “The news is big but what is the result? We have to wait for a while to see the feedback from the market,” Zhang said.

“With the [free-trade agreement] signage between China and other countries, we have seen that more people are travelling for business. But how to turn potential into reality is a very good project in front of us.”

Traffic on routes between Australia and China has grown at an average annual rate of 11 per cent over the past four years. Qantas, including Jetstar, has a 10 per cent share of the market between Australia and China, while Cathay Pacific has 17 per cent, China Eastern 19 per cent and China Southern 27 per cent.

In an effort to gain regulatory approval for its deal with China Eastern, Qantas has highlighted a fall in its share of traffic on Australia-China routes, despite the market experiencing rapid and significant growth.

It has emphasised that its share of the market fell from 21 per cent to 15 per cent in the four years to April, while China Southern’s doubled to 22 per cent.

“Without the proposed [deal], Qantas is likely to become increasingly marginalised in respect of the Australia-China market,” Qantas and China Eastern told the competition regulator in a joint filing. “Alone, Qantas will not be able to keep pace with the capacity growth being driven by carriers such as China Southern.”

While the immediate focus is on winning approval for the alliance, Qantas has made clear that its long-term plan is to attract a foreign investor to its international business.

Qantas chief financial officer Gareth Evans has emphasised that he and his fellow executives support consolidation over the longer term. But he has made clear that first Qantas needs to put its international operations in a position where it is attractive to a large strategic investor.

“We said that was a longer-term initiative and in the short to medium term we are focused on the transformation [of Qantas]. But right now we haven’t made any more steps in terms of dialogue with carriers,”  Evans said in early December.

Since then, he has been handed the toughest gig at Qantas. He will take the reins as boss of Qantas’s international operations by February.

His first task will be to return the business to break-even. The bigger longer-term challenge will be to secure a cornerstone shareholder. And a pouncing tiger seems to be the most obvious dance partner.

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