Aviation

Ready for take-off?

China’s fourth biggest airline group taxis towards a Hong Kong listing

No signs of turbulence: the Chinese airline industry tripled profits last year

The new hit movie If You Are the One 2 featured top actress Shu Qui as a flight attendant; and in case you couldn’t guess the airline’s identity from her stylish uniform, the film also featured a long panning shot of an aircraft fuselage emblazoned with its logo.

That carrier is Hainan Airlines, and as its product placement in the Feng Xiaogang film suggests, it’s keen on attention. But when it comes to the capital markets, its parent HNA Group has been grabbing most of the headlines. HNA’s most high profile investment is Hainan Airlines but its holdings include a number of other carriers around China as well as stakes in hotels, retail outlets, financial services and tourism ventures.

According to the South China Morning Post, HNA got the year off to a busy start by attempting to inject its aircraft leasing arm into a Hong Kong-listed toymaker. That just fell through, but it is also has a couple of other equity transactions on the flightpath.

Analysts say it’s looking to list Hong Kong Airlines, which it controls, in a HK$5 billion ($640 million) float in the city later this year.

Bigger still: the group plans, says Economy and Nation Weekly magazine, a revamp at Grand China Air. It’s jointly owned by HNA with the Hainan provincial government and private investors (George Soros is said to have put in $25 million in 2005). HNA plans to raise Rmb10 billion ($1.51 billion) through a private placement before floating Grand China (in Hong Kong again) later this year.

Grand China was conceived as a “number four” airline grouping to challenge larger rivals Air China, China Eastern and China Southern. The rationale was to integrate a number of smaller carriers around the workhorse Hainan Airlines as the consortium’s dominant brand. The latest plan seems to envisage using the private equity cash to achieve deeper integration with two carriers in particular; Western Airlines from Chongqing and Tianjin Air.

Geographically, at least, that seems to make sense, encompassing two of China’s larger cities as hubs for their respective parts of the country. A tripling of airline industry profits to a record Rmb43.7 billion ($6.63 billion) in China last year also means that talk of a Hong Kong listing is timed rather well. Hainan Airlines has been housekeeping in advance of a potential transaction, says Economy and Nation Weekly. Non-core assets, as well as older aircraft have been sold off.

Although it ranks fourth in terms of fleet size, Hainan likes to think of itself as a cut above its competitors, as the first air transport company to list in China (in 1993) and (last week) officially the first mainland airline to earn “5-star” ranking from Skytrax, an aviation service-quality certifier.

Hainan Airlines also tends to position itself as a “privately-owned” carrier – although government retains a stake. That’s likewise the case for Grand China Air, which still counts Hainan’s provincial Sasac as its largest shareholder. Nor are there signs of state bosses wanting to relinquish control quite yet, reports suggest that they will put in money alongside any new private equity cash in order to prevent dilution.

Sounds like a good deal? Certainly a Hong Kong listing would be useful for HNA, which complains periodically that it lacks the access to the cash top-ups often enjoyed by the big three state airlines. Instead, it has had to wheel-and-deal to source much of its own funding, and Economy and Nation Weekly picks up on this point, in looking back at some of Hainan Airlines previous investment initiatives. Yes, airline profits last year were eye-catching ones, it says. But then why would a listed entity with such a clearly stated aviation focus choose to spend so much of its time on property development?

For instance, while divesting itself recently of “non-core assets” (like an aviation maintenance division) Hainan Airlines was also announcing that it would be spending Rmb2.46 billion on three wholly owned real estate subsidiaries of the HNA Group with four pieces of land in Haikou, Hainan’s capital. A series of high-rise commercial buildings are planned. The airline bought the land and then commissioned another HNA Group company to develop it, saying it has no expertise itself in property development.

The purchases, it might be argued, support the development of its home base. Hainan is on a mission to establish itself as China’s tropical destination of choice, after all, so the province’s airline might see strategic value. But the guts of the argument seem to be more direct: that investment in property will offer shareholders a more diverse portfolio of assets, which could prove crucial when the industry enters one of its (fairly frequent) periods of commercial spasm. And then there is just the profitability. “The aviation industry has no way to match real estate,” a company insider told the magazine. “Compared to other industries, air transport has poor profits”.

That would seem to raise a few presentational questions for the IPO prospectus, like why other investors would want to buy into an aviation group in the first place?

All the more so, when some of Hainan Airline’s previous property transactions seem to have involved other shareholders, especially HNA Group itself. According to local securities analysts, the “HNA family” has been associated with related-party transactions before, often in the real estate sector. In July 2009, the airline sold property on Hainan back to HNA Group well below market value, and something similar happened in Beijing when the airline transferred an office block back to its parent company but then bought back the same asset not long after, at a premium of almost Rmb1 billion to the earlier selling price.

Economy and Nation Weekly describes the way these related party property deals were financed as “puzzling”.

And perhaps this high-altitude cocktail of aviation and real estate deals will be a concern for those fund managers looking at Grand China’s IPO.


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