Why market fears of an Air China takeover of Cathay Pacific proved unfounded

The Cathay bailout was, in the end, remarkably similar to those of other airlines around the world
Air China, Cathay’s second-largest shareholder, is facing a coronavirus crisis and any rescue plan could also have jeopardised the city’s aviation rights

David Dodwell

Published: 9:30am, 15 Jun 2020

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When trading in Cathay Pacific shares was suspended early last week, the local stock market rumour mill went into overdrive. Foremost was speculation over whether Air China, the second-largest shareholder in the airline after Swire Pacific, might be riding to the rescue.

As Forbes magazine noted, this is the “default rumour” whenever Cathay Pacific has news lined up – ever since Air China first took a stake in 2006, and in particular since in 2009 it bumped up against the 29.99 per cent maximum stake it could hold without making a full bid for the company. But, as usual, the rumour was incorrect.

The Cathay bailout was in the end much more straightforward, and remarkably similar to airline bailouts that have recurred across the world as the global pandemic grounds the aviation industry, with no prospect of a recovery being mounted.

Recognising the indispensable role the airline plays at the heart of Hong Kong’s business economy, it was logical and perhaps inevitable that the Hong Kong government should come to the rescue. As the grounded airline was losing in the region of HK$3 billion or US$387 million a month, the question was not whether Cathay would need rescue, but what the size and the structure of the package would be.

By pumping HK$19.5 billion into the airline through a new company, Aviation 2020, the Hong Kong government is taking a 6.08 per cent stake in preferential shares with restricted voting rights, and with warrants that could lift the equity investment by a further HK$1.95 billion.

A bridging loan of HK$7.8 billion lifts the government package to around HK$29 billion. A rights issue for other shareholders could raise a further HK$11.7 billion.

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Hong Kong government to bail out Cathay Pacific with HK$30 billion in loans and direct stake

All this provides welcome and timely relief – but when you are bleeding HK$3 billion a month, there is no time to relax. Cathay chairman Patrick Healy last week predicted “tough decisions” ahead, after a full re-evaluation of Cathay’s business model, to determine its optimal size and shape, is completed by the end of the year.

Across the world, almost all airlines have been cutting similar rescue deals and giving similarly gloomy forecasts, with the International Air Transport Association (IATA) predicting industry losses of US$300 billion due to the pandemic, with 25 million jobs at risk.

IATA says airline revenues will fall 50 per cent, to US$419 billion from US$838 billion in 2019, while passenger numbers are expected to crash from 4.54 billion to 2.25 billion. The only “bright spot” comes from cargo, with revenues expected to rise from US$102.4 billion last year to US$110.8 billion this year.

Singapore Airlines has received a US$13.3 billion bailout from the state-owned Temasek Holdings, which already holds a 55 per cent stake in the airline.

In Europe, Lufthansa has secured a €9 billion (US$10 billion) lifeline in exchange for the government taking a 20 per cent stake. Like the Hong Kong government, the German government is promising “silent participation”, with the intention to dispose of the stake in due course.

Air France-KLM has secured loans and guarantees amounting to as much as €11 billion from the French and Dutch governments. The British government has indicated it is preparing its own rescue plan for British Airways.

In the US, 10 leading airlines – including American, United, Delta and Southwest – have received a US$25 billion rescue package in return for promises not to dismiss staff or cut salaries. Boeing has escaped a formal bailout (it originally approached Washington for US$60 billion) by succeeding in raising US$25 billion from private investors.

This litany of airline distress explains in part why an airline like Air China was never likely to come to Cathay’s rescue. Flightglobal has reported that Air China carried 2.9 million passengers in March – a bare 31 per cent of the passenger load in March last year.

Unlike Cathay, it has the good fortune of a large domestic passenger market, but with the opening of the new Daxing airport in Beijing, it is facing unprecedented competition at its home hub from China Eastern and China Southern.

But it is not just financial distress that kept Air China on the sidelines in the Cathay bailout. Nor is it just that, with a 29.9 per cent holding, it cannot raise its stake without making a full takeover offer.

Perhaps most important is that an Air China takeover would change the “nationality” of Cathay Pacific, and put in jeopardy the globally negotiated air traffic rights that give the airline, with Cathay Dragon, about 50 per cent of the landing and take-off slots at Chek Lap Kok.

As Financial Secretary Paul Chan Mo-po said last week: “It’s not a random person or a random company. We have to safeguard [the city’s] aviation rights...” Aviation supports an estimated 300,000 jobs in Hong Kong, and underpins the economy’s role as a leading business and tourism hub.

As the Post noted in an editorial last week: “Thanks to the ‘one country, two systems’ concept, Hong Kong can negotiate air rights on its own, on equal terms, without having to compete with other Chinese cities for routes, traffic rights, landing slots, airspace and the like.”

The Cathay rescue is nevertheless just the first step in what we can confidently predict is going to be a precarious and slow recovery. Most airlines are expecting a smaller global aviation industry to emerge, with consolidation in Europe, and with many low-cost carriers, which with no cargo income rely exclusively on passenger revenue, in particular jeopardy.

We need to remember that, for most of its history, the aviation industry has been perilous. The Financial Times’ Miles Johnson reminded us last week that, from 1960 to 2000, the aggregate profits of the US airline industry “would have been enough to pay for the delivery of just two 747 jumbo jets”.

Profitability has been a recent and precarious luxury linked with already-extensive consolidation. And the pandemic crisis has put even this in jeopardy. Cathay’s long-standing efficiency, and its lucky location, mean it is likely to be among the survivors, even if profits are going to be elusive for several years.

Meanwhile, the strategic intent behind Air China’s investment in Cathay Pacific is likely to remain an enigma.

David Dodwell researches and writes about global, regional and Hong Kong challenges from a Hong Kong point of view

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