June 30, 2008

Soros-Backed Chinese Airline Hangs Tough

These are certainly not the best times for an upstart Chinese airline to be spreading its wings worldwide. With the price of oil pushing $140 a barrel, carriers around the globe are cutting back on the frequency of some flights, cutting others altogether, and imposing new fees on passengers [BusinessWeek, 5/29/08].

Until recently, Chinese carriers enjoyed some protection from oil's dizzying rise, thanks to government subsidies for fuel oil. But on June 19, Beijing's National Development & Reform Commission announced it was curtailing support, resulting in a sudden 8% increase in fuel costs for airlines.

It's not just oil that's causing headaches for Chinese airlines. While many carriers have been hoping this would be a boom year because of the Beijing Olympics in August, so far 2008 has been one to forget. The bad news started with some of the worst winter weather in decades, followed by the unrest in Tibet in March. The May 12 Sichuan earthquake killed tens of thousands and sent the whole country into mourning. More recently, floods have hit southern China. These catastrophes have led to depressed air travel.

Continental Drift And with the global economy weakening, traffic numbers for China's airlines are declining. The number of domestic air travelers shrank 3.3% last month, the first such drop since the SARS epidemic in 2003, according to the Sydney-based Center for Asia-Pacific Aviation. While airlines hope for a lift thanks to the opening of direct charter flights [BusinessWeek, 6/23/08] between the mainland and Taiwan for the whole year, traffic is likely to grow just 10%, compared with a 16% increase in 2007.

Still, Hainan Airlines is pushing ahead with expansion plans. The fourth-largest carrier in China, Hainan is named after the island province in the South China Sea near Vietnam that is China's answer to Hawaii. Outside the country, Hainan Airlines is best known as George Soros' favorite carrier. The billionaire investor paid $25 million for a 15% stake in the airline in 1995 and invested another $25 million in 2005. But the airline stuck largely to China, with just a few international flights in Asia.

Now Hainan is branching out. Last month it launched its first route to the U.S., a nonstop service from Beijing to Seattle. The company has also expanded to Europe, flying to Brussels, St. Petersburg, and Budapest; a Berlin flight will begin in September. A Hainan executive says the airline isn't going to be deterred by the inauspicious moment. "We have a long-term strategy," says Joel Chusid, general manager for North America. "It's like a train going on the tracks."

The Cathay Pacific Challenge Hainan is making moves closer to home as well. The company owns 45% of Hong Kong Express Airways [HKE], a six-aircraft airline controlled by Macao casino tycoon Stanley Ho's family. [They also control a sister carrier, Hong Kong Airlines.]

The Hong Kong market is dominated by Cathay Pacific and its affiliate, Hong Kong Dragon Airlines, but through HKE, the Ho family and Hainan are hoping to win passengers looking for an alternative way of flying to China's commercial hubs of Beijing and Shanghai. HKE has recently started flying the Hong Kong-Beijing route and on June 11 launched service between Hong Kong and Shanghai.

Higher fuel prices won't get in the way of HKE's plans to launch a second flight schedule on the Hong Kong-Shanghai route soon, says airline President Ronnie Choi. "Shanghai is a prime city that every airline would like to fly to," says Choi, a former Dragon Air and Cathay executive who joined HKE last November. "We will not give up this opportunity." Hainan Airlines' network within the mainland, he adds, will give HKE an advantage over its larger Hong Kong rival.

Investor Wariness Still, the climate is not friendly for an airline trying to break into the big time. "There is a very distinct impact on our bottom line" from rising oil prices, says Choi. "There's a limit to how much cost we can take." The airline has cut back on flights to Chengdu, capital of Sichuan province, for instance.

Investors have been wary about Hainan's overall plans. The airline earned $129 million on sales of $1.9 billion last year, but its Shanghai-listed stock price has plunged 64% this year. One investor concern is that while China's three largest carriers -- Air China, China Southern (ZHN), and China Eastern (CEA) -- all have permission to begin flying to Taiwan next month, Hainan doesn't. Hainan Chairman Chen Feng was not available for an interview. A Soros spokesman had no comment.

Meanwhile, plans to consolidate Hainan and related holdings into one Beijing-centered carrier, to be called Grand China, seem to be on hold. "They were meant to be restructuring under the Grand China brand to shed the provincial [Hainan] background and focus on Beijing as their core hub; that hasn't happened," says Derek Sabudin, the Center for Pacific Aviation's chief operating officer. Why not? "It's a very unwieldy organization, with cross-shareholding," he says. "It's very convoluted."

Looking for a Seattle Pickup Nonetheless, Hainan is confident that the winds are favorable. The change to Grand China will be "gradual," says Chusid. "The name will be changed ultimately." And, he adds, traffic is bound to grow as Seattle-based companies like Microsoft (MSFT) and Starbucks (SBUX) take advantage of the new service and send more people back and forth to China.

Chinese tourists, too, will be increasingly able to travel to the U.S. "The Chinese middle class is growing and there is demand for air travel," says Chusid. "The entire industry is going through challenges. We are not making any short-term changes."