Waning star of the east

Grounded: Lan Shili

Chief executives at low cost airlines tend to be a combative lot, few more so than Ryanair’s Michael O’Leary.

The European Commission (‘morons’), UK airports operator BAA (‘overcharging rapists’), British Airways (‘expensive bastards’) and travel agents (‘should be taken out and shot’) have all found their way into the cross-hairs of O’Leary’s ire.

Challengers to the aviation status quo in China need to tread a little more diplomatically, if the experience of Lan Shili, CEO of East Star Airlines is anything to go by.

East Star was forced into liquidation last month, and Lan himself was brought back to the carrier’s home base – Wuhan – under a police escort, according to Caijing magazine.

East Star, with nine aircraft and 500 staff, owes at least Rmb1 billion ($146 million) to creditors.

Although Lan’s detention is unusual, his airline’s difficulties are less so. Other privately-owned airlines are suffering too. Chengdu-based United Eagle Airlines has been taken over by state-run Sichuan Aviation Group and Okay Airways, which was forced to suspend operations at the beginning of the year, is also desperately looking for new investors. Spring Airlines and Juneyao Airlines have managed to remain aloft, but some question whether they will be able to survive independently for long.

Reports this week that domestic passenger volume (and airline profitability) was on the up again for the first quarter this year have sparked talk of a recovery. But 2008 was a disastrous one for the industry in general; China’s big three state airlines (Air China, China Southern and China Eastern) lost upwards of $4.4 billion.

At least the favoured troika can fall back on government bailouts, which have come thick and fast over recent months. Further support may be doled out this year, particularly to China Eastern, the weakest of the three. But the private carriers are not so fortunate and have few options for raising fresh capital.

So another round of industry consolidation seems likely. In East Star’s case, Air China is the predator, with its eye on East Star’s 10% share of flights from Wuhan (a growing hub for central China). This would narrow the gap on China Southern, which dominates at the airport.

Takeover discussions have been going on for a while but Lan seems to have refused to play ball, much to the exasperation of his leading suitor and the Hubei local authorities. Significantly, it was not until he finally broke off negotiations that the provincial government forced East Star into bankruptcy.

This type of strong arm negotiating tactic, East Star supporters say, is typical of the unfair skies in which China’s private airlines are expected to operate.

It’s not just the bailouts. Newcomers face a range of challenges in competing with their better-capitalised rivals, from prising decent aircraft lease deals out of cautious suppliers through to securing regulatory approval to set their own fares. Spring Airlines has even been fined for selling its tickets too cheaply; O’Leary’s response to similar restrictions would surely push the envelope to its expletive limit.

Many of China’s privately-owned airlines appeared in 2005, a year on from the industry’s best results for a decade. But expectations of the type of returns that airlines like Ryanair have enjoyed have turned out to be over-optimistic.

Too many of the factors supporting low-cost success in other markets are lacking in China. State-owned entities control much of the cost base (access to aircraft, fuel, maintenance and repair, airport landing and parking fees etc), which means that up to 80% of expenses remain pretty inflexible. Until the industry landscape changes, it is hard to see entrepreneurs like Lan repeating O’Leary’s success.

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