Sudden Loss of Altitude at China Eastern

Shares fall after a bidding war between Cathay Pacific and Singapore Airlines, aiming at securing Eastern's Shanghai market, fails to materialize

When world travelers think of Singapore Airlines, the award-winning carrier conjures images of service, comfort—even an enjoyable long-haul flight. The same can't be said for China Eastern Airlines (CEA). More likely, if world travelers think of the Chinese carrier at all, many think of bad food and surly service.

Over the past few days, it has been China Eastern shareholders who have gotten the bumpy ride. The Shanghai carrier early this month agreed to sell a 24% stake, worth about $1 billion, to Singapore Airlines and Temasek Capital, the Singapore government's investment arm. But on Sept. 24 rumors spread quickly that Hong Kong-based Cathay Pacific Airlines and its mainland partner, Air China, were looking to make a bid of their own and block Singapore. That caused China Eastern shares to spike. In Hong Kong trading on Sept. 24 China Eastern issues hit a 52-week high of 10.50.

Then the bubble suddenly popped. China Eastern shares plunged, to close at 8.70, as investors grew skeptical that a Cathay bid would materialize. Sure enough, late on Sept. 24, Cathay issued a statement to the effect that "a proposal to make the acquisition was to have been made to China Eastern," but that it "would not now proceed." The next day, Sept. 25, China Eastern shares gave back another 13%, closing at 7.42.

Air Travel Growing Exponentially

China Eastern, the only one of China's three largest airlines to lose money last year, may seem an odd asset for world-class airlines such as Singapore and Cathay to covet. But in winning the duel that never was, Singapore gains a foothold into Shanghai, a crucial business hub in the world's fastest-growing aviation market. China Eastern boasts a 33% market share in its home city, according to Credit Suisse Group (CSGN).

The air travel market in China is growing exponentially. Since 1980, according to Martin Craigs, president of the trade association Aerospace Forum Asia, the number of air travelers in China has grown from 3 million yearly to 187 million. And Craigs expects that, by 2025, the number will swell to 780 million. Shanghai in particular, adds Craigs, "has an airport with fantastic long-term growth potential."

For China Eastern, a deal with Singapore Airlines, one of the world's most profitable, promises to boost its profile in the international market. Especially on those routes, "brand and quality does make a difference," says Craigs. "When you start flying across the Pacific, people get far more picky about the quality of service they are willing to enjoy or to endure."

In 2006, despite a revenue increase of 36.5% to nearly $5 billion, China Eastern posted a loss of around $440 million. In a recent research note, SinoPac Securities Asia analyst Jack Xu wrote that a weak global brand contributed to China Eastern's "poor profitability in its international business." Xu wrote that the Singapore Airlines deal will inject not just capital, but instant management capability, too. And even amid the past few days' worth of turbulence, China Eastern shares have returned more than 336% for the year.

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