Cathay Pacific - Dragonair Merger

[hkskyline]

09 June 2006
Hong Kong strengthens its role as the premier Asia-Pacific regional aviation hub under shareholding realignment
CX Press Release





Introduction

Cathay Pacific, Swire Pacific, Air China, CNAC and CITIC Pacific have reached an agreement to change the shareholder structure of Cathay Pacific, Dragonair and Air China. The new structure will offer significant benefits for airline customers and for Hong Kong and Beijing as gateways to China.

Under the agreement, which is subject to shareholder approvals, Dragonair will be wholly owned by Cathay Pacific. Air China will acquire a 17.5% stake in Cathay Pacific, and Cathay Pacific will double its shareholding in Air China to 20%.

Swire will remain the principal, long-term shareholder in Cathay Pacific. Dragonair will continue to operate under its own brand, but under Cathay Pacific management.

Cathay Pacific and Air China will continue to develop closer cooperation on many fronts, including establishing an air cargo joint venture in Shanghai.

Benefits across the board

The agreement will produce far-reaching benefits across the board for customers, shareholders, employees and the Hong Kong economy. It will:

- Enable Cathay Pacific to connect its international network with Dragonair’s short-haul services to Mainland China and secondary regional destinations.
- Produce efficiencies and operational streamlining that will result in a wider network for the two airlines, more destinations, wider choice and greater convenience for customers.
- Reinforce Hong Kong’s position as the premier aviation hub in the Asia Pacific region and provide a platform for the growth and expansion for Hong Kong’s home carriers into the Mainland and the region.
- Further the development of Beijing Capital International Airport and Hong Kong International Airport as gateways to and hubs for Mainland China by enabling Air China and Cathay Pacific to increase business and operational cooperation, increase traffic and load factors and enhance flight connectivity between all three airlines.
- Deliver more jobs and career opportunities in the aviation sector and related industries in Hong Kong over a long-term period of growth.
- Give Cathay Pacific shareholders a stake in a larger, growth-driven company with a formidable international, regional and Mainland network.
- Create one of the world’s strongest airline groupings - Cathay Pacific, Dragonair and Air China.

Background

Cathay Pacific and Dragonair are natural partners. Cathay Pacific part-owned and managed Dragonair between 1990 and 1996 before its current ownership structure came into effect. Economic and aviation circumstances have since changed dramatically, particularly in Mainland China, and so too has the world in which Cathay Pacific and Dragonair and Hong Kong must now compete.

Hong Kong’s future prosperity hinges to a large extent on its development as a gateway to the Chinese Mainland and as a hub for the movement of people and goods around the globe. As Hong Kong’s home carrier, Cathay Pacific has a shared interest in and commitment to the welfare of Hong Kong and its people.

Yet neither Cathay Pacific nor Dragonair separately can serve all Hong Kong’s needs adequately. Dragonair lacks an international network. Cathay Pacific has a comprehensive international network hub is not yet able to offer the access consumers want to the Chinese Mainland, the world’s fastest growing economy and Hong Kong’s natural hinterland.

Given the urgency of competition Hong Kong faces from other regional hubs, there is not enough time for either carrier to evolve organically in order to fill these gaps. This agreement meets this pressing need.

Cathay Pacific and Dragonair are, in effect, like two separated halves of a whole: their networks and capabilities complement each other. Reunited, the whole will be greater than the sum of the parts. Hong Kong, the Hong Kong aviation hub, consumers, staff and shareholders will enjoy the benefits.

The agreement

1. Dragonair will become a wholly owned subsidiary of Cathay Pacific
2. Air China will become a substantial shareholder of Cathay Pacific and
3. Cathay Pacific will increase its shareholding in Air China to 20%

1. Dragonair will become the wholly owned subsidiary of Cathay Pacific
- Cathay Pacific has offered to acquire the remaining 82.21% shareholding in Dragonair that it does not already own for HK$8.22 billion, turning it into a wholly owned subsidiary.
- The consideration for the Dragonair shares will be a combination of the issue of new Cathay Pacific shares at HK$13.50 each and cash.

2. Air China will become a substantial shareholder of Cathay Pacific
- Air China will acquire Cathay Pacific shares from Swire Pacific and CITIC Pacific at HK$13.50 each. Air China will therefore become a shareholder of Cathay Pacific with a 10.16% equity interest for a total consideration of HK$5.39 billion. In aggregate, Air China and its subsidiary CNAC Limited will own an aggregate 17.5% of Cathay Pacific.
- Both Swire and CITIC have also undertaken to further reduce their respective shareholding in Cathay Pacific to 40% and 17.5% within 12 months of the completion of the agreement by selling Cathay Pacific shares in the open market.

3. Cathay Pacific will increase its shareholding in Air China
- Cathay Pacific has agreed to subscribe in cash for 1,179 million Air China H shares at HK$3.45 per each Air China H share, increasing its shareholding in Air China to 20% from 10% at a total cost of HK$4.1 billion.
- Reflecting its confidence in the benefits and synergies from acquiring Dragonair, Cathay Pacific has agreed to pay a special dividend of HK$0.32 per share upon completion of the transaction.

What it means for Hong Kong and the hub

The aviation industry is a major contributor to the Hong Kong economy, generating close to 10% of the SAR’s GDP in 2005, according to the Aviation Policy and Research Centre of the Chinese University of Hong Kong. The Cathay Pacific Group is one of Hong Kong’s largest employers, with a payroll of more than 23,000 people. This agreement means that the Hong Kong economy as a whole and the aviation industry in particular will benefit from the growth it represents.

Hub strength comes from flight frequency, connectivity and the ability of airlines to offer competitive fares. Cathay Pacific and Dragonair under single ownership and working towards a common management goal – to draw more traffic to and through Hong Kong from the Mainland and the rest of the world – would deliver on all three counts.

Close cooperation between Cathay Pacific and Dragonair has been difficult because Dragonair has not been able to offer competitive fares to our connecting passengers.

Customers flying from Sydney to Shanghai, say, have been offered more attractive prices on single-carrier services connecting in Bangkok and Singapore than Cathay Pacific has been able to offer in collaboration with Dragonair. Hong Kong is the loser as Mainland traffic flows through competing regional hubs.

Seamless operations between Cathay Pacific and Dragonair – which can only be achieved through common ownership – would lead to the coordination of services and schedules, create faster and more frequent connections and strengthen Hong Kong as a hub.

Cathay Pacific’s enhanced partnership with Air China will provide access to an even wider national network within China. The national carrier’s interest in the success of Cathay Pacific and Dragonair also signals a commitment to support the future growth of Hong Kong as a logistics centre.

A stronger hub creates a virtuous circle for consumers: increased traffic leads to more services, which leads to increased traffic and more choices and so on.

What it means for customers

Cathay Pacific and Dragonair’s combined networks and capabilities have the potential to deliver more destinations, greater travel choice, enhanced convenience and, therefore, better value for its customers.

The acquisition will be a boost for the consumer. Hong Kong will benefit from an aviation industry better able to compete in a global marketplace. Hong Kong people will share the benefits of such growth.

Greater international traffic flows through Hong Kong unlocked by the deal will enable Dragonair to operate with greater frequency to cities it now serves and to mount new services to destinations it does not – creating more competition and choice.

Hong Kong has a population of only 7 million people. With such a small domestic market, many of the flights now available to Hong Kong people would not exist were it not for the international traffic funneled through the Hong Kong hub. About half of Cathay Pacific’s passengers transit Hong Kong.

Cathay Pacific would not, for example, be able to operate daily to Bali and Colombo without the support of passenger and cargo traffic drawn from across its network. The fare on a less frequent service sustained only by Hong Kong travelers would be higher as well.

With great volumes of traffic fed from the Cathay Pacific network, infrequent and even daily services operated by Dragonair would be improved and new routes opened. Similarly, Cathay Pacific would be able to mount more services and offer greater customer value with support from Dragonair’s Mainland network.

The two airlines’ fleet structures will help such growth. With a fleet comprised entirely of large aircraft, Cathay Pacific cannot operate economically to smaller Mainland and regional cities. Dragonair with its fleet of small, short-range aircraft can. Yet it needs the support of international traffic from Cathay Pacific to profitably do so.

What it means for shareholders

Cathay Pacific shareholders will be owners of a much larger and stronger company, better placed to compete and maintain profitable future growth by capturing the complementary brands, network and operational attributes of Hong Kong’s two largest airlines.

Cathay Pacific’s ownership of Dragonair will create a company able to fully exploit the dual strengths of both airlines: Cathay Pacific as a full-service global network carrier and Dragonair as regional airline with predominantly mid-size short-haul fleet and established network focused on the Chinese Mainland and some secondary regional destinations.

The seamless integration of both airlines’ operations will generate hitherto unobtainable opportunities for Cathay Pacific to increase efficiency, create new and stronger streams of revenue, expand both its network and market share and further strengthen Hong Kong’s strategic position as a global aviation hub and gateway to the Chinese Mainland.

What it means for staff

Cathay Pacific, over many years, has developed an impressive and profitable passenger and cargo network throughout Asia and to Europe, North America, Australasia, the Middle East and South Africa. However, the glaring gap in this network is the company’s very hinterland, Mainland China. It was intended some years ago that Dragonair would fill this gap, but for several reasons this plan has not worked in practice. The agreement now changes all this.

Common ownership will create opportunities for growth and expansion, thus creating more job and career opportunities over the longer term. The enlarged company will, of course, maintain the rigorous standards of productivity, cost management and efficiencies that have underpinned Cathay Pacific’s remarkable success in the past.

[hkskyline]

BROKER CALL- Cathay Pacific to outrank SingAir after Dragonair deal - Globalysis
12 June 2006

HONG KONG (XFN-ASIA) - US-based research group Globalysis Ltd said Cathay Pacific Airways Ltd s likely to outrank Singapore Airlines in terms of profitability when the Hong Kong carrier has taken over the operations of Dragon Airlines Ltd (Dragonair) as planned.

'With the acquisition of Dragonair, Cathay may soon be in a good position to eclipse Singapore Airlines to possibly become the most profitable airline in the world,' Globalysis said.

Globalysis said Cathay's acquisition of Dragonair will enable the airline to become the largest airline group in the Asia-Pacific, surpassing Qantas and Singapore Airlines.

It said Cathay's takeover of Dragonair may trigger 'more mergers and acquisitions (M&A)' in the coming years.

The spate of M&A activity will come 'as the regional airline industry could head for consolidation in order to manage costs better, especially with increasing risks from high and volatile oil prices, airborne disease like SARS and bird flu, and terrorism which could severely affect the airline industry.'

'Consolidation will bring a little more security as bigger airlines may have deeper pockets to reach into should tough times hit, and economies of scale could help reduce operating costs, increase profitability as we may see happening with the new Cathay Pacific,' Globalysis said.

The US house said an expanded Cathay penetration of the China's aviation market will open vast opportunities for the Hong Kong carrier.

It noted that China, by passenger volume carried is the second largest aviation market in the world, and by far the largest in Asia.

Globalysis believes that China passenger volume growth looks set to continue its surge with near 20 pct annual growth over the next five years.

'By 2019 there will be 100 mln outbound Chinese passengers,' it said.

Dragonair already has access to 23 destinations in China including access to key markets such as the lucrative Hong Kong-Shanghai route.

Cathay's access to these markets now puts the Cathay Pacific group in very strong competitive standing in the years to come, Globalysis added.

[hkskyline]

Cathay takes China box seat in aviation overhaul

HONG KONG, June 18, 2006 (AFP) - A shake-up of the aviation industry is looming across Asia as airlines come to grips with Cathay Pacific's ownership overhaul, setting it up as a dominant world player with a box seat in China.

Analysts believe the Hong Kong flag carrier's acquisition of Dragonair and strategic alliance with Air China could put it in a position to eclipse rivals such as Singapore Airlines and Qantas.

More importantly it realises Cathay Pacific's long-held ambition to get into the key China market and creates breathing space for Air China, which suffers from close political oversight given its status as the mainland flag carrier.

"These are positive steps, positive developments," said Jim Eckes, Hong-Kong based managing director at airline consultancy Indoswiss Aviation.

He said the central government's role in the running of Beijing-based Air China, a contentious point with many in the industry, could be kept in check under the deal and by Cathay Pacific's new found influence.

"Air China has always been the weakest of the Big Three in China," he said referring to China Southern and China Eastern airlines. "It doesn't make it any easier with people looking over your shoulder."

Cathay Pacific is to acquire Dragonair and double its stake in state-controlled Air China to 20 percent, with the response to the one billion dollar deal seen as largely positive for the companies involved so far.

Smaller local rivals, however, are expected to feel the initial brunt of the tie-up, with ownership now simplified and a rejuvenated Cathay Pacific acquiring full access to the booming Chinese market.

Cathay Pacific previously flew to only two destinations in China -- Beijing and Xiamen -- but through Dragonair it has picked-up 23 Chinese cities, including the lucrative Hong Kong-Shanghai route.

US investment house Morgan Stanley noted near record oil prices and higher airport taxes were expected to further undermine the operations of China Eastern and China Southern airlines.

"We believe the combined Cathay-Air China-Dragonair franchise will represent a formidable threat to airlines operating in China and into the greater China markets, comprising China, Hong Kong, Taiwan and Macau," it said.

As a result, "we think the two Chinese airlines -- China Eastern and China Southern -- would have a difficult time competing with the combined Cathay-AirChina-Dragonair franchise in the China market."

US-based research house Globalysis, which tracks the tourism industry said in a report the deal would enable Cathay Pacific to become the largest airline group in the Asia-Pacific, ahead of Qantas and Singapore Airlines, and warned of troubled times ahead for the smaller players.

"Consolidation will bring a little more security as bigger airlines may have deeper pockets to reach into should tough times hit while economies of scale could help reduce operating costs and increase profitability, as we may see happening with the new Cathay Pacific," Globalysis said.

Crippling fuel prices resulted in Chinese airlines posting total losses of 267 million dollars in first quarter 2006, despite a booming market which is expected to double in size again from 2005 levels by 2010.

"Traffic in China and Hong Kong is growing at a nice rate every year and that growth rate is quite helpful ... it will stay that way in the lead-up to the (2008 Beijing) Olympics," Eckes said

In 2005 the Chinese aviation industry carried 138 million passengers and 3.035 million tons of freight. To meet demand, Beijing plans to increase the national fleet to 1,580 aircraft by 2010 from 863 and plough 17.4 billion dollars into airport infrastructure.

Globalysis said Cathay Pacific would likely outrank Singapore Airlines in terms of profitability once the tie-up with Dragonair and Air China goes through.

"With the acquisition of Dragonair, Cathay may soon be in a good position to eclipse Singapore Airlines to possibly become the most profitable airline in the world," Globalysis said.

It said Cathay Pacific's takeover of Dragonair may also trigger further industry consolidation in the coming years as the industry seeks to manage costs better, "especially with increasing risks from high and volatile oil prices, airborne diseases like SARS and bird flu, and terrorism."

Analysts said consolidation was more likely at the lower end of the market among smaller airlines, particularly in the low cost segment.

Eckes said the close association between flag carriers and national identity meant tie-ups among bigger airlines such as Malaysian Airlines or Thai Airways highly unlikely due to political opposition.

That theory has spawned market talk that Air China, over the medium-term, could be in a position to mount a bid for Cathay Pacific, in which it will acquire a 17.5 percent stake under the deal.

Most industry observers suggested this was fanciful at this stage while Eckes added: "I have heard the chatter."

[classhopper]

Pros - Best connection to China
Cons - No more cheap ticket to HK?

[sfgadv02]

Originally Posted by classhopper

Pros - Best connection to China
Cons - No more cheap ticket to HK?

Well, there are other carriers that fly to HK...

[trueapprentice]

Swire to lift China portfolio

Conglomerate Swire Pacific may use the windfall from the sale of its interest in Dragonair to further expand into the mainland property market.

Alman Loong

Monday, July 03, 2006


Conglomerate Swire Pacific may use the windfall from the sale of its interest in Dragonair to further expand into the mainland property market.
"Swire is very keen on China," chairman Christopher Pratt, told Sing Tao Daily, a sister publication of The Standard.

Pratt was speaking nearly 20 days after five listed companies, including Swire, Cathay Pacific, CITIC Pacific, Air China and China National Aviation Corporation, outlined a plan to realign their aviation interests.

Swire stands to gain a net HK$1.2 billion from the sale of its 8 percent interest in Dragonair to Cathay, the sale of Cathay shares to Air China and other related transactions - all part of the restructuring plan - a recent Goldman Sachs report said.

The inflow is expected to reduce Swire's gearing to 2.8 percent from 4 percent, thereby giving the company more room to raise its borrowings.

"We are looking at a couple of things [in China]," Pratt said.

Swire expects to seal some property deals by the end of this year, he said without elaborating.

At present, Swire owns commercial and residential projects in China including the four billion yuan (HK$3.89 billion) Taikoo Hui Guangzhou Cultural Plaza project in Guangdong.

It also holds a 10 percent interest in CITIC Square, which consists of 1.1 million square feet of retail and office space on Nanjing Road West, Shanghai.

Real estate generated 81 percent of Swire's earnings last year, down from 99 percent in 1996.

Pratt, however, insisted property will remain the principal source of revenue for the forseeable future, unaffected by the recent aviation agreement.

"We have signed a big aviation deal but we have no intention not to invest in property," Pratt said.

Referring to the Hong Kong property market, Pratt characterized the outlook for local real estate as "comfortable."

Swire recently boosted its residential sector portfolio in Hong Kong by acquiring two luxury properties on The Peak.

In January, the company purchased a 50 percent stake in Festival Walk from its partner CITIC Pacific for HK$6.18 billion, making it the largest investment property deal so far this year.

Swire, which holds interests in beverages and trading businesses in the mainland, is expected to generate strong growth in these operations.

It holds the license to distribute Coca-Cola in the mainland.

"We do have other business in China and growing very well. All of them are the leaders in their sector," Pratt added.

Asked about the dividend policy of Swire, Pratt said: "We have no plans to have a special dividend in 2006."

He also noted that after the acquisition of the interest in Festival Walk, Swire had placed orders for 16 vessels at a cost of about HK$2.5 billion, with the investment stretching well into next year.

[trueapprentice]

Interest shown in Kai Tak project

Swire Pacific chairman Christopher Pratt said the company is "interested" in the former airport site, which the government said last month will be redeveloped into a multi-purpose leisure and tourist hub with sports fields, residential projects, hotels and offices, as well as a cruise liner terminal.

Staff reporter

Monday, July 03, 2006



Swire Pacific chairman Christopher Pratt said the company is "interested" in the former airport site, which the government said last month will be redeveloped into a multi-purpose leisure and tourist hub with sports fields, residential projects, hotels and offices, as well as a cruise liner terminal.
He did not provide further details about which specific projects in the 328-hectare site are of most interest to Swire.

The government is currently conducting public consultations on Kai Tak redevelopment plans, but Pratt said Swire has not yet made a written submission.

"Swire is likely to be most interested in the potential of the Kai Tak site for office and commercial developments," said an investment bank analyst.

The Kai Tak site contains the potential for up to 700,000 square meters of Grade-A office space, the analyst said.

Pratt said Swire is very confident about prospects of the office and commercial property market in Hong Kong.

"From a strategic point of view, Swire is aiming to achieve more long- term returns from its property assets, which means it will favor commercial properties over residential properties," the analyst said.

The private residential portion of the government's blueprint for Kai Tak will contain space for the development of up to 18,000 apartments.

The site will also spawn up to 17 new hotels to provide up to 6,800 rooms, or about half the total room inventory in the Tsim Sha Tsui area.

"Swire already has substantial stakes in several five-star hotels on Hong Kong island, and is also considering plans to invest in new hotel projects in Britain," the analyst said.

"The group is therefore likely to be interested in the hotel projects in Kai Tak."

Planning for the land, largely unused since the opening of Hong Kong International Airport in 1998, began in June 2002 after then chief executive Tung Chee-hwa approved the initial Outline Zoning Plan.

When the Planning Department unveiled its blueprint for Kai Tak last month, it estimated the project will generate up to 85,000 new jobs.

[hkskyline]

Officials fail to address fears over airline merger
21 July 2006
South China Morning Post

"The fact there will be a cross-shareholding [between Cathay and Dragonair] doesn't mean there won't be any competition. I don't believe we should draw such a conclusion. It is too early to say."

Eva Cheng Yu-wah, permanent secretary for Economic Development, to Legco, July 18, 2006

"With regard to our major markets, the merger will not reduce competition. The response from the aviation industry is positive. A cross-holding of shares does not eliminate competition."

Michael Wong Wai-lun, deputy secretary for Economic Development and Labour, at the same Legco meeting

You don't have to have an MBA to figure out that when one company buys another, the likelihood of them continuing to engage in price competition against each other to capture or sustain market share evaporates before the ink dries on the new contract.

What is particularly unsettling about the above statements is that Ms Cheng is leading the consultation process which may result in Hong Kong catching up with all other major economies in Asia by introducing a competition law.

Moreover, only seven legislators bothered to show up to hear the government's position on the merger on Tuesday. Ms Cheng and her mob always may have been unlikely to answer any concerns raised but one would have thought the topic of interest to just about every constituent the legislator represents.

Perhaps aware Mr Wong et al had failed miserably to answer concerns about the merger's impact on the travel sector, they ducked out the back door of Legco to avoid an inquisitive media throng.

As senior government officials, Below Deck will assume that Ms Cheng and Mr Wong are aware that a dominant market position - such as that which cross-shareholders Cathay, Dragonair and Air China will enjoy between Hong Kong and Beijing, where they will offer 90 per cent of flights - is bad for consumers. This leads us to ask why they would make such statements.

But just in case their knowledge of how supply and demand affects market prices is a bit rusty, here are a few examples of how a lack of competition is putting a dent in the travel consumers' pocketbooks.

If you want to buy the cheapest return airfare to London that Cathay Pacific offers next month, you'll be paying $5,970 before taxes for travelling 9,740km as the crow flies.

This means you fly about 3.26km for every $1 you spend, round trip. Four airlines offer direct flights to Heathrow every day.

Fly the same airline to Los Angeles next month, when they will be the only carrier to offer a direct service, and you'll pay a buck for every 2.49km you fly before taxes.

To be fair, Below Deck doesn't have total visibility into the factors that make up Cathay's ticket prices, so let's look at some other routes that compare similar distances.

Hong Kong-Bangkok is one of the most competitive routes in Asia, with 13 airlines directly connecting the cities, although some not daily. If you buy Cathay's cheapest seat next month, you'll pay a buck for every 1.53km you fly.

Fly to Hanoi, a market which only Cathay and Vietnam Airlines serve - often sharing one aircraft - and your dollar buys you 0.43 of a kilometre.

To Singapore, another route with many airlines fighting for the travel spend, each dollar will move you 3.67km. To New Delhi, which is served only by Cathay and Air India, your buck buys you 1.54km of flight before taxes.

Our government may still be unclear about whether Cathay, Dragonair and Air China will compete on the half-dozen mainland routes they will dominate but Cathay doesn't appear to. Nowhere in its five-page discourse rationalising why the merger was good for Hong Kong - which the government used to explain its position to legislators on Tuesday - does it mention lower ticket prices for consumers. It knows better.

On the whole, the merger is likely to benefit the greater economy. But you cannot deny the fact it will open the door for the new partners to abuse their dominance of some of the busiest routes connecting Hong Kong to the mainland.

No one is suggesting they will but the possibility will be created by the merger come August when the deal is expected to be approved by shareholders.

And governments that answer to their constituents through the ballot box put mechanisms in place to either prevent a monopolistic environment from being created or they legislate ways to hold the players to account if and when they abuse their position.

[samsonyuen]

I wonder if Dragonair will eventually be folded into Cathay Pacific's brand?