Beijing Is Buying Hong Kong But At Its Own Price

It's snapping up the territory's airlines for a song. Who's next?

Since last year, Cathay Pacific Airways Ltd. has been rocked by threats that China would start a rival airline in Hong Kong. In late April, Cathay's British owner, Swire Pacific Ltd., seemed to have solved the problem. But the cost of peace was high. Swire ended up giving the Chinese a large share of Cathay as well as Cathay's high-flying affiliate Hong Kong Dragon Airlines Ltd. at a cut-rate price. The bottom line: the British are now minority shareholders in both airlines, fulfilling a longtime Beijing goal.

With the return of Hong Kong to China only 14 months away, the Cathay episode shows that the Chinese are ready to push for a bigger corporate stake in Hong Kong. For British-affiliated companies with government-granted franchises, it will become increasingly difficult to withstand Beijing's pressure. "It is probably not enough to localize your management," says Merrill Lynch & Co. analyst Adam Quinton. "You have to localize your ownership to some extent as well." While many businessmen figured that China would interfere in Hong Kong's political scene, they didn't think the reach would extend to business. Now, that's looking less certain.

PREY? The forced share sale puts television companies, port operators, and perhaps even utilities on notice that they could find themselves prey for Chinese companies. UBS Securities (East Asia) Ltd. Managing Director John M. Mulcahy worries that the airline sale smacks of what he calls "nationalization through the stock market." Says Mulcahy: "Will people celebrate because China is buying its way into Hong Kong, albeit at discounted prices, rather than simply taking the assets?"

The next candidate set for a change in its ownership may be Hong Kong Telecommunications Ltd., the monopoly long-distance provider that's 57%-owned by Britain's Cable & Wireless PLC. Analysts expect that Cable & Wireless, which is in merger talks with British Telecommunications PLC, will have to reduce its ownership to around 45% by selling a stake to a mainland company. One likely buyer: a company affiliated with the Ministry of Posts & Telecommunications.

There are other disquieting signs that China is meddling in Hong Kong business. Beijing has refused to approve six licenses for local companies to start offering a new generation of mobile telephones, saying that it's concerned there could be too much competition.

In the Cathay deal, there's no question that Beijing-owned China National Aviation Corp. (CNAC) came out a big winner. It paid a bargain price for a controlling stake in Dragonair, a fast-growing and extremely profitable regional carrier. CNAC will pay $255 million for a 35.9% stake in the line, which earned $93 million last year. Those shares, analysts say, are worth as much as double that. CNAC will put its imprint on Dragonair, which Cathay has run since 1990. "The management of Dragon will definitely go," says Stephen H. Miller, managing director of Trinity Aviation Ltd., a Hong Kong consulting firm. Cathay and Swire will still have a say in Dragonair, but their combined share will drop from 43.2% to 25.5%. Dragonair is also expected to be floated in an initial public offering as quickly as possible. Because the deal hasn't closed, none of the companies involved would comment.

Some analysts insist that the Chinese won't push the ownership drive too far for fear of turning off foreign investors. And for now, Cathay's shareholders are happy. The day after the announcement, Cathay's stock shot up 5%, after suffering for the past year.

Having made peace with Beijing, the company has for the moment eliminated a potential rival in Hong Kong. But that could change in the future. Most analysts expect the aggressive CNAC eventually to turn Dragon into a fierce competitor for Cathay, vying with it for international routes. The Chinese have agreed to let Swire be the largest shareholder in Cathay, but after the Union Jack comes down for good, Beijing's companies may want the British to offer a bigger piece of the pie. For Swire, there are bound to be more rough times ahead.

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