• The big three take shape

Airlines in China are seeing sweeping changes as the Civil Aviation Administration of China cuts equity ties and the first round of consolidation gets under way, writes Richard Burgess.

Under plans which have been two years in the making, the Chinese government has now agreed that Air China will take control of China Southwest, Zhejiang Airlines and the China National Aviation Corporation (which holds shares in both Air Macau and Dragonair). China Southern will take control over China Xinjiang Airlines, Yunnan Airlines and China Northern, and finally China Eastern will take control over China Northwest and Great Wall Airlines. Each of the three groups will boast assets of over US$6 billion and fleets in excess of 150 aircraft.

The Chinese government anticipates that second and third tier regional airlines will also seek partners as part of a second wave of consolidation in a bid to survive. In May last year, China Postal Airlines, Shandong Airlines, Wuhan Airlines, Sichuan Airlines and Shenzhen Airlines created China Sky Aviation Enterprises with a view to improving their competitiveness through an alliance. Hainan Airlines, in which the finance guru George Soros has an interest, is also seeking to expand through acquisitions and has recently acquired China Xinhua Airlines and Changan Airlines.

The current consolidation highlights the Chinese government's desire for a handful of airline groups to provide the majority of the country's flights, as was the case until the early 1980s. At that time the former regional divisions of the Civil Aviation Administration of China, were re-branded as Air China, China Eastern, China Northern, China Northwest, China Southwest and China Southern. Provincial governmental departments were also allowed to set up regional airlines to support the economic growth of the regions, and in the following years the number of airlines in China leapt from just a handful to more than 30.

The economic downturn in Asia however brought a halt to years of phenomenal growth within the Chinese aviation sector. It was during the late 1990s that the Civil Aviation Administration of China (CAAC) started to call for major consolidation among China's 30 airlines, an announcement which prompted several of the major airlines to seek out potential partners. In 1999, the government asked Air China and China Southern to study the potential for a merger. However, talks broke down, primarily due to opposition from the airlines themselves.

After two years of regulatory upheaval, the widespread consolidation of China's aviation industry is now starting to happen. The consolidation of the sector is intended to halt the period of unprofitability following the Asian economic downturn of the late 1990s, as well as heavy discounting, which has only been temporarily abated through several government measures including fare pooling on key routes.

CAAC role changes
In addition to consolidation amongst the airlines, the CAAC will lose all equity ties with the airlines and will adopt a more regulatory role. The CAAC will also reduce bureaucracy through the closure of 24 regional offices and will split China into seven key aviation areas. Ancillary aviation service providers will be restructured to provide greater autonomy, and airport management will be placed in the hands of local government. The country's route network will be reworked, with many in the industry favouring a US-style hub and spoke framework aimed at improving regional connections. Airlines will be encouraged to establish more routes between smaller cities. As part of these network changes, China saw its first regional jets delivered last year to Hainan Airlines and more 50-100 seater aircraft are expected to be required as more regional areas are opened up to airline services.

The consolidation and subsequent overnight growth in China's main three airline groups has also increased interest from global airline alliances. The multinational grouping Star Alliance is understood to hold a strong interest in Air China, which already has code-share and joint venture agreements with both Lufthansa and SAS, both Star Alliance members.

Return to profitability
The benefits of consolidation and rationalisation will take some time to have an impact. However, the industry already appears to be returning to the growth and profitability levels enjoyed before the Asian economic slowdown. Several of the airlines, including Air China, returned to profit last year, with the industry as a whole recording a profit of Yn690 million. The CAAC expects the industry to be profitable again in 2002, with passenger figures expected to rise to 83 million from 75 million last year. Air China will shortly seek a stock exchange listing in both Hong Kong and New York. China Eastern and China Southern are already listed on foreign stock exchanges and the Chinese government is now considering increasing the maximum permitted equity stake in Chinese airlines from 35% to 49%. This is expected to encourage foreign ownership and to bring in foreign funds to help airlines deal with the anticipated growth in competition following China's entry into the World Trade Organisation.

Aircraft orders have now also resumed, and in October last year the government confirmed a deal for a further 25 Boeing aircraft, which increased Boeing aircraft sales to China last year to 40. Another large order for Airbus aircraft is also understood to be close to agreement.

Richard Burgess is sales and marketing manager, UK and Ireland, Air China.