Consumer

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

How do you get a foot in the world's soon-to-be-biggest aviation market in the face of official intransigence from its government? American Airlines Group Inc. thinks it's found a way. 

The world's biggest airline  is in talks to take a stake of about $200 million in China Southern Airlines Co. via a private placement, people familiar with the matter told Bloomberg News.

To a carrier with more than $40 billion of revenue over the past 12 months, the sum is a bagatelle -- barely enough to purchase a single Boeing Co. 787. With China Southern's Shanghai- and Hong Kong-listed shares collectively worth about $10 billion, the amount would be barely enough to net American a 2 percent stake.

Go West
American Airlines is a laggard on Pacific routes, but it's catching up
Source: Company traffic statistics
Note: ASM = available seat miles, a measure of capacity showing the distance flown by aircraft multiplied by seats available on respective planes.

It's in the high-stakes diplomacy of international aviation that the transaction makes most sense. American has been a laggard on routes across the Pacific relative to Delta Air Lines Inc. and United Continental Holdings Inc. -- but it's been trying to catch up in recent years, especially as a loosening of visa restrictions between China and the U.S. has spurred travel demand.

That shift has been stymied because airlines in China and the U.S. are already butting up against hard caps on flight frequencies in their 2007 air transport agreement. There just aren't enough slots available under the treaty to meet the forecast demand for travel between the countries.

The problem is particularly acute for American, which last month petitioned the U.S. Department of Transport for extra time to start services on one of the last available routes from Los Angeles to Beijing:

The difficulties that U.S. carriers experience in navigating China’s allocation system for airport slots are well documented, and place U.S. carriers at a substantial disadvantage vis-à-vis their Chinese counterparts. The frequent inability of U.S. carriers to obtain commercially viable slots in China in a timely manner deprives them of their bilaterally conferred rights, and harms the interests of the United States and the traveling public.

Deepening ties with China Southern is an alternative way to skin this cat. American can't increase services into China on its own planes, but a code-share agreement with a Chinese carrier would allow it to buy seats on a partner's aircraft and offer "virtual" capacity instead.

Competitive Advantage
China Southern has the lowest operating costs of the nation's state-owned carriers, which should make it the most competitive player
Source: Bloomberg
Note: China Southern, China Eastern and Air China are state-controlled. ASK = Available seat kilometers, the distance flown by aircraft multiplied by the number of seats available.

This mooted investment doesn't yet do that -- but by investing in China Southern, American's Chief Executive Officer Doug Parker raises the odds of getting the Guangzhou-based carrier to join it in the Oneworld grouping, which would open the door to the real prize of coordinating code-shares, frequent-flier programs and airport schedules.

At present, China Southern and its Shanghai rival China Eastern Airlines Corp. are both partners of Delta in the Skyteam alliance -- but Delta has favored Shanghai as its hub for connections to the rest of China, so American should be pushing on an open door in attempting to make itself China Southern's new best friend.

Investors shouldn't look for the investment to make much of a difference in the near term. Lifting the limits on U.S.-China flight frequencies tends to require years of careful diplomacy -- and President Donald Trump's administration has yet to even nominate the senior officials who'd be needed to negotiate changes, according to a Washington Post executive appointments database.

As a result, capacity growth between China and the U.S. is likely to be approximately zero for some time -- but wise airline executives tend to think in decades, rather than years. In 2035, Boeing Co. forecasts that there will be more domestic air traffic in China than in the U.S., while the trans-Pacific market will be almost as large as the north Atlantic one. Even the smallest acorns can grow into mighty oaks.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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To contact the author of this story:
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net