In the runup to the 1 July handover of Hong Kong to the People's Republic of China, there were only a few clues to the many questions over Beijing's likely airline policies in the former UK colony. From
Cathay Pacific's managing director David Turnbull has a message for anyone concerned about the advent of Chinese rule in Hong Kong: when the Union Jack flutters off into the sunset on 30 June and Beijing's red banner unfurls, nothing will change for the territory's international flag carrier.
The handover of the former British colony has become a sideshow for Cathay. The challenges it faces, he insists, are the same as those confronting carriers everywhere: increased competition, the war on costs, and efforts to increase turnover and halt the decline in yields.
'In a business sense we will continue to operate as we have always operated. We are very confident of the future of Hong Kong, otherwise we wouldn't have poured a billion dollars into the new airport or spent billions of dollars on new aircraft and we wouldn't, as we probably will, spend billions more in future.
'From our point of view, Hong Kong still has good infrastructure, a good location, a good system of laws, good financial control, a stable currency, a strong police force. All the things are there to make it a very good place. Nothing has changed.'
Blind faith or optimism based on sound judgement? After all, even Turnbull concedes one political miscalculation by Beijing could damage business confidence, dent the economic stability of the territory, and wound the market in which the airline thrives.
But that is no different from countries where a change of government can bring significant shifts in aviation policy, he says. 'Airlines have to deal with that in the same way as they deal with commercial pressures, as and when they arise.'
His bullishness is probably justified, say industry sources. The Chinese, they agree, are acutely aware of the need to maintain stability in their new Special Administrative Region (SAR) and accept the critical role Cathay has to play in its economic growth.
Former Cathay MD Rod Eddington, now executive chairman of Australia's Ansett, spent years at the centre of Hong Kong and Chinese aviation. 'I think the Chinese leadership are aware of the dangers and I think that the Hong Kong community, business and otherwise, is pretty robust. So I'm an optimist about Hong Kong, Cathay Pacific and Dragonair's future beyond the first of July.'
No-one believes Cathay's future is in jeopardy, though there are plenty of threats to its ongoing success and many questions still unanswered:
1 Can Britain's Swire Group continue to hold big stakes in Cathay and Dragonair?
2 Will Hong Kong's aviation regulatory framework remain the same, preserving the 'one airline, one route' policy which protects Cathay Pacific from local competition, and will Cathay's close relationship with Dragonair, now controlled by Chinese government entity CNAC, survive?
3 What access will China's airlines get through Hong Kong and who will really make decisions on policy - the new SAR government and its civil aviation arm or Beijing?
5 How damaging will high charges at the new Chek Lap Kok airport be to Cathay's viability?
One of the most hotly debated issues in Hong Kong is the future of Swire's stake in Cathay and whether Beijing will ultimately allow a British company to retain such an influence in a Chinese airline.
While no-one will say it publicly, plenty make the point privately that the shareholder restructuring of 1996 - Swire's holding dropped from 52.6 per cent to 43.9 per cent and Citic's lifted from 10 per cent to 25 per cent - altered the balance of power. Cathay won't do anything without shareholder approval and Citic won't approve anything without clearance from Beijing.
Swire insists it is in for the long haul. The feeling among analysts is that, while this may be true at the moment, Swire's foothold in Cathay could be further diluted.
Nevertheless, a source very close to Beijing's aviation hierarchy says there is no evidence that last year's deals were the first step towards eliminating Swire. 'If they were seen to push Swire aside it would send all the wrong signals to everyone. In Beijing they are very keen to see a continuing involvement by Swire in Cathay, Hong Kong and China,' he says.
That doesn't rule out a dilution of the Swire stake and there is speculation that Cathay may have a role to play in the consolidation of China's airline industry. Beijing is bent on reducing the number of airlines - more than 30 at the last count - by forcing unprofitable operators out of business or into mergers. If Cathay invested in a Chinese airline, cash could be raised through a share issue, allowing increases in mainland interests and a further lowering of Swire's holding.
The China-isation of Cathay, whose management has for years been dominated by British and Australian expatriates, is well in hand. Former Dragonair chief Phillip Chen was moved last year into the key position of deputy managing director and it is generally accepted he is bound for the top slot.
Eddington says Cathay and Swire are sensible businesses which 'got their house in order' in the run-up to 1 July. The changes already made - bringing Citic into Cathay to a much greater degree, and the new relationship between Citic and CNAC's holdings in Dragonair - were 'fundamental changes to the structure of Hong Kong aviation which set the platform for a really positive future,' he says. Until last year Swire and Cathay held 43.16 per cent of Dragonair. Then Beijing-controlled China National Aviation Corporation (CNAC) took a 35.86 per cent stake, with Swire/Cathay reducing their holding to 25.5 per cent and China's Citic Pacific cutting its stake to 28.5 per cent.
Declan Magee, assistant director regional research for HG Asia, thinks the biggest potential for change is in the regulatory area, and a possible end to the 'one airline, one route' policy. Dragonair, now a successful regional operator flying four Airbus A330s and seven A320s to 15 destinations on mainland China and to Japan, Brunei, Malaysia, Thailand, Cambodia and Taiwan, could be the biggest beneficiary.
Dragonair has become something of a cash cow, dominating the Chinese market, and chief executive Stanley Hui says the handover will both lift constraints on its ability to add more Chinese destinations and lead to fleet growth.
Magee believes it may be tempted in other directions. 'The statistics show a lot of Hong Kong routes to other parts of Asia are the largest routes in the region - Hong Kong to Taipei, Singapore, Bangkok, Tokyo. As Dragonair grows and expands it's just like a little child growing up. It's now in its teenage years and at some stage it's going to want to break off. I imagine, given how hard they (CNAC) fought to get that stake, obviously they would like to grow that business.'
Growth could come from key Asian trunk routes outside China. 'If I was Dragonair I would be thinking, "Taipei is a very big route. If the regulatory environment is to change why can't we serve Taipei or Tokyo or Bangkok?" Dragonair [should go] to the regulator and say, "What is the economic justification for this policy? A one airline, one route policy is not the optimum for competitors in the industry and consumers." '
There may also be changes in the shareholding, he suggests. 'CNAC is now the largest shareholder in the company. Obviously, the links between Swire/Cathay and Dragonair are still strong but they are not as strong as they were. Who knows, something might happen at a later stage where those ties are weakened even further.'
In contrast, Salomon Brothers Hong Kong vice president and senior research analyst Peter Negline is convinced that current policy will remain and Cathay and Dragonair will continue to work closely together. 'It makes no sense for those guys not to want to work together, when they have got common aircraft, they are both in Hong Kong, and they both rely heavily on Haeco (for engineering).' But whether Cathay and Swire remain shareholders in Dragonair is a different story, he adds.
Another question is how much access China's airlines will get to Hong Kong and what competitive threat they pose. Earlier this year a deal was struck allowing four Chinese carriers beyond rights through Hong Kong for the first time.
Air China can now fly to London via Hong Kong and it is expected that Shanghai-based China Eastern, Guangzhou-based China Southern and one other operator will be permitted to operate one fifth freedom service each to Singapore, Manila and Bangkok.
Turnbull is unfazed, describing the arrangement as a typical aviation deal involving reciprocal benefits for both sides. Chinese carriers get rights through Hong Kong and in exchange Cathay can overfly China to Europe, which cuts up to 90 minutes off flight times and brings huge savings in fuel.
The truth is that Chinese carriers' service standards have a long way to go before they can attract customers away from western airlines. 'Of the three major Chinese airlines and Cathay, Cathay has a substantially higher cost base but substantially higher yields on a lot of its international routes,' says Negline. 'Cathay can consistently secure high levels of premium class traffic. It is a very different business.'
Other analysts say air travellers will turn to Chinese operators only if they can't get a seat elsewhere. With only a few weekly flights through Hong Kong, and no service reputation, they are hardly a threat to Cathay.
No-one has any doubts that the Beijing aviation authorities will influence decision-making in Hong Kong. But most analysts don't regard it as an issue because the territory's aviation interests are now inextricably tied to those of China. Beijing influence remains a highly sensitive issue but industry insiders point out privately that 'there have definitely been times in the past when the Civil Aviation Department worked under instructions from London and not for the benefit of Hong Kong.'
From that point of view they have little to fear from China, which is likely to be more closely aligned with the needs of the SAR. Furthermore, the intellectual property of Cathay and Dragonair - their management and operational expertise and quality reputation - can be used to foster improvement among mainland airlines.
Cathay is no threat because it has no intention of entering the Chinese market itself. 'Dragonair does that,' says Turnbull, who points out that Cathay is looking to expand in other directions.
Meanwhile Cathay's biggest task is coping with existing business challenges and preparing for rapid growth after CLK opens. The carrier is in good shape financially as it pushes through a restructuring and a $9 billion fleet modernisation. During calendar 1996 it reported net profits of US$488 million, 27.9 per cent up on 1995. Turnover climbed 6.3 per cent to $4.2 billion. The company's profit margin was 11.8 per cent, compared with 9.8 per cent the year before.Turnbull says the airline expects 'reasonable performance' this year in terms of profit growth.
But stock market nervousness has seen Cathay's shares, peaking at $1.89 in June 1996, dip to around $1.53 in more recent times and chairman Peter Sutch points to factors such as fuel prices, overcapacity and congestion that could dent short-term income.
'Congestion at Kai Tak International Airport will reach its worst levels in 1997, placing severe constraints on Cathay Pacific's ability to expand,' he warns.
Chek Lap Kok airport opens in April 1998, initially with only one runway. 'The bottom line is that anything of any seriousness in the aviation market won't happen until the second runway is available around November 1998,' says Negline.
Turnbull says that when the second runway does open 'there are going to be plenty of slots for everyone and we will probably grow quite rapidly for a couple of years, to catch up as it were'.
But the runway will also bring more competition and high user charges. Landing a B747 will cost around $8,570 against about $4,030 at Kai Tak. Cathay, which operates nearly 30 per cent of all flights, will be hit hard.
It's a trade-off between the benefits the new airport will bring to a business in terms of efficiency and the extra costs involved, says David Nash, an auditor with KPMG in Hong Kong. 'One of the big extra costs will be the depreciation of facilities.'
Magee points to economies of scale and efficiencies. 'They are being given the ability to expand. The price they will have to pay is probably not going to knock the stuffing out of profitability.'
Eventually, direct flights between Taiwan and China will impact Cathay's biggest market, Hong Kong-Taiwan, much of which consists of high yield Taiwanese traffic heading for the mainland via the territory. However there is strong growth in non-China related traffic.
Despite this, analysts agree that Cathay has a rosy future. 'Cathay's fundamental risk is in the economy itself and the broader view in Hong Kong at the moment is that Hong Kong's growth if anything will possibly accelerate after the handover,' says Negline. 'Everyone in the markets who has a vested interest believes it will be a success,' he adds.
Source: Airline Business
