Cathay, Air China Deal Enables Dragonair Purchase

A major shareholding realignment among three Asian carriers—Cathay Pacific, Air China and Dragonair—has set the foundation for a powerful airline group in Asia. It also has given Cathay Pacific a much-needed boost in the competitive Chinese air market by enabling it to purchase Dragonair, a regional carrier based in Hong Kong, for US$1.06 billion.

The agreement reached among the boards of Air China, Cathay Pacific, China National Aviation Company, CITIC Pacific and Swire Pacific also gave Air China a 17.5 percent stake in Cathay Pacific and doubled Cathay Pacific's holdings in Air China to 20 percent. Hong Kong-based Swire Pacific remains the principal shareholder in Cathay Pacific.

With its new ownership of Dragonair, which currently operates 400 flights a week between Hong Kong and 23 cities in China, Cathay Pacific gains far greater access to cities in mainland China. The two airlines have few overlapping routes, with Cathay's passenger service to China limited to just two cities, Beijing and the southeastern city of Xiamen.

Under terms of the agreement, Dragonair will continue to operate under its own brand for at least six years, but as a wholly owned and managed subsidiary of Cathay Pacific. Although competitors for new routes in recent years, Cathay Pacific held a 17.8 percent stake in Dragonair between 1990 and 1996.

According to a statement issued by Cathay Pacific, the agreement enables the airline to "connect its international network with Dragonair's short-haul service to mainland China and regional destinations." It also will "result in a wider network for the two airlines, more destinations, wider choice and greater convenience for customers."

Airline industry analysts also view the acquisition of Dragonair by Cathay Pacific as a union of two airlines with complementary attributes. While Dragonair offers deep penetration into China, Cathay Pacific offers an extensive global network in key business centers in Europe, North America, Asia and the Middle East.

"This gives Cathay new strength beyond their long-haul network, which has been their strength in the past," said airline analyst Robert Mann, president of R.W. Mann & Associates in Port Washington, N.Y. "They get a more powerful hub network and reach into China."

Mann also sees the acquisition as turning the tables for Cathay Pacific, which had faced increasing competition in penetrating the Chinese market not only from Dragonair, but also from the emergence of carriers such as China Southern Airlines and China Eastern Airlines. "This will now mean more competition for other airlines, particular those who don't have the worldwide long-haul capacity that Cathay Pacific does," he said.

At the same time, China remains a highly competitive and desirable market for airlines in general, observed analyst Michael Boyd, president of The Boyd Group in Denver. "These days, if you're not Sino-centric, you're out," he said. "Airlines such as United and Northwest understand the importance of the Chinese market. Cathay Pacific still faces formidable competition."

Boyd said the shareholding agreement was "something that Cathay Pacific had to do. They were being squeezed out of the market otherwise. This at least guarantees they will stay around."

Both Boyd and Mann believe that another result of the agreement—closer ties between Cathay Pacific and Air China—also is an important benefit for Cathay Pacific. "It means that Chinese air authorities have given them an endorsement, that Cathay has their tacit approval," said Mann. "It's a very good sign for their relationship with the Chinese air authorities."

No changes are expected in the alliance programs of the two airlines. While Air China recently joined Star Alliance, Cathay Pacific is a founding member of Oneworld, which includes codeshare partner American Airlines. The two carriers are teaming up to form a Shanghai-based cargo airline.

Cathay Pacific executives are banking on the new relationship among the three airlines to boost Hong Kong's importance as an Asian gateway. "Cathay Pacific taking full control of Dragonair and strengthening its partnership with Air China will reinforce Hong Kong's role as the premier aviation hub in the Asia/Pacific region," said Cathay Pacific chief executive Philip Chen, adding that Hong Kong's future prosperity hinges to a large extent on its development as a gateway to the Chinese mainland.

Hong Kong, which has been eclipsed somewhat in recent years by the roaring business economy of mainland China, could use the potential boost, according to Boyd. "Both Hong Kong and Tokyo are yesterday's gateways to China," he said. "Hong Kong was important because you couldn't get to China and that is where we did our trade. Now all that has changed. We can get to Shanghai and Beijing."

In the meantime, Cathay Pacific is hoping that a recent expansion of air service agreements between mainland China and Hong Kong will enable it to resume passenger service between Hong Kong and Shanghai after an absence of 16 years. The airline has applied to the Hong Kong special administrative region government requesting an allocation of rights to re-launch Shanghai service as well as to provide additional service to Beijing tentatively in the fourth quarter of this year.