CATHAY PLUS DRAGONAIR EQUALS ASIA'S LARGEST AIRLINE

C O N F I D E N T I A L SECTION 01 OF 02 HONG KONG 002335 SIPDIS NOFORN SIPDIS STATE FOR EAP/CM AND EB/TRA STATE PASS USTR USDOC FOR 4420 E.O. 12958: DECL: 06/06/2031 TAGS: ECON EAIR PREL PGOV CH HK SUBJECT: CATHAY PLUS DRAGONAIR EQUALS ASIA'S LARGEST AIRLINE Classified By: EP Chief Simon Schuchat; Reasons: 1.4 (b/d) SUMMARY -------------- ¶1. (C) A JP Morgan transportation analyst told us that he is confident that media reports are accurate regarding plans for Cathay Pacific to take over Dragonair. He anticipates the deal will be announced tomorrow (June 7). If true, Cathay Pacific would become the Asia-Pacific region's top carrier by revenue, ahead of Qantas and Singapore Air, according to a Morgan Stanley estimate quoted by media. Cathay is presently a long-haul carrier with a Hong Kong-centered route structure but with very limited access to mainland China. The motivation for the takeover appears to be acquisition of rights to serve the 23 mainland cities now covered by Dragonair. END SUMMARY BUYOUT OF MAINLAND STAKES; BUY-IN FROM AIR CHINA -------------- --- ¶2. (C) JP Morgan Transportation Analyst Peter Negline told us that he is confident that media reports are accurate regarding plans for Cathay Pacific to take over Dragonair. He anticipates the deal will be announced tomorrow (June 7). Press reports suggest that Cathay will pay USD 1 to 1.3 billion in cash and stock for the 72 percent of Dragonair now owned by China National Aviation Corporation (CNAC) and Citic Pacific, both of which are Hong Kong red chips, i.e., locally listed companies that have significant ownership ties to PRC government entities. If true, Cathay Pacific would become the Asia-Pacific region's top carrier by revenue, ahead of Qantas and Singapore Air, according to a Morgan Stanley estimate quoted by media. Although Cathay had a controlling stake in Dragonair from 1991 to 1996, it divested ahead of the Hong Kong handover and now holds only 18 percent. As a result, the two airlines are competitors, especially on Hong Kong-Taiwan flights. ¶3. (SBU) The media reports suggest that direct mainland holdings in Dragonair may disappear, but the contemplated deal is not that simple. Along with Cathay's takeover of Dragonair would come changes to Cathay's own holding structure. Presently, the largest shareholder in Cathay is Swire Pacific, linked to the UK's Swire Group, with second place going to Citic Pacific, one of the red chips whose stake in Dragonair Cathay is buying. Current speculation is that Air China would now take up some of the holdings of Swire and Citic Pacific. What remains to be seen is whether the two (mainland) entities would have a combined shareholding greater than (British) Swire's. A COMPLICATED WEB OF INVESTORS -------------- ¶4. (U) The anticipated deal actually involves five listed Hong Kong companies, all of which have a complicated web of cross-holdings in each other, and all of which have suspended trading since June 5 as a result of reports of the deal: o Cathay Pacific, the Hong Kong-based airline, which owns 17.8 percent of Dragonair and 10 percent of mainland carrier Air China. o Swire Pacific, a Hong Kong-listed entity of the British conglomerate Swire Holdings. The firm holds the largest single stake in Cathay, 46.33 percent, as well as 7.71 percent of Dragonair. o Citic Pacific, a Hong Kong-listed red chip of the mainland financial conglomerate Citic. The firm owns 25.42 percent of Cathay and 28.5 percent of Dragonair. o China National Aviation Company Ltd, the Hong Kong-listed red chip, which owns 43.29 percent of Dragonair, and is 66.36 percent held by Air China. o Dragonair, which is 97.39 percent owned by the four noted entities. The five entities had issued a statement on April 10 confirming that "discussions are taking place about operational cooperation between Cathay Pacific and Air China and about the realignment of shareholdings in Cathay Pacific, Air China, and Dragonair." HONG KONG 00002335 002 OF 002 CENTRAL ISSUE: ACCESS TO MAINLAND CITIES -------------- ¶4. (U) Cathay is primarily a long-haul carrier with a global network centered on Hong Kong, but its mainland routes are limited. It presently flies passengers only to Beijing and Xiamen and has just one mainland cargo route, to Shanghai. Dragonair, by contrast, flies to 23 mainland cities. With many international carriers seeking to expand service to China, Cathay is under competitive pressure to do the same, and the Dragonair deal is seen as a good fit. ¶5. (C) Negline told us that he believes all of Dragonair's rights would transfer to Cathay. He anticipates that with several PRC-connected entities involved in the deal, China would have a "very pragmatic attitude" about Cathay expanding service to Dragonair's network. OTHER IMPLICATIONS -------------- ¶6. (U) Media speculates that a Cathay-Dragonair tie-up would create back-office and fleet management efficiencies. Cathay is also already providing management support to Air China for cabin crew, engineers, and other staff. Expanded ownership of Cathay by that mainland carrier could expand the basis for existing business collaboration. ¶7. (C) While there is some discussion in Hong Kong of "monopoly" issues arising from a Cathay-Dragonair deal, Negline was dismissive. He said there are enough airports and airlines within and serving the Pearl River Delta region that it would be hard to make a case to Hong Kong or mainland authorities that consumer choice had been restricted significantly. Cunningham