By staff reporter Zhang Na

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(Caijing Magazine)Most of China's private airlines are only about four years old, but already their wings are bent and broken.

On March 15, East Star Airlines suspended operations after the Wuhan municipal government declared the private carrier insolvent and unworkable due to a management crisis. The company's chief executive has been arrested.

Around the same time, Chengdu-based United Eagle Airlines was nationalized through a share buyout by state-run Sichuan Aviation Group, operator of Sichuan Airlines. The new owner raised its stake in United Eagle to 76 percent from 20 percent.

And private carrier Okay Airways, which was forced to suspend operations at the beginning of the year, is now expected to introduce new investors. Government capital is likely to play a role, since no foreign investors have emerged and Wang Junjin, the airline's controlling shareholder, told Caijing he would not pump any more money into the business.

Only privately owned Spring Airlines and Juneyao Airlines remain at a safe distance from bankruptcy court. Many of the rest are being eyed by state-owned airlines that already control the Chinese market. The future of private aviation looks grim.

Government Intervention

East Star's shutdown was sudden. The Web site of the Civil Aviation Administration of China shows that its operations halted on the same day that CAAC’s central China bureau approved a suspension application submitted by the Wuhan municipal government.

Many insiders told Caijing that it's rare for a local government to apply for an airline suspension. Usually, an aviation enterprise submits such an application. The speed of CAAC's decision was unusual as well; regulations require that an application be submitted 30 days before a planned shutdown, and include detailed reasons.

In fact, the local government played a dominant role in halting East Star and returning its boss, Lan Shili, to Wuhan from another city under police escort.

Behind the Wuhan government's tough attitude are negotiations involving a possible takeover of East Star by China National Aviation Holding Co. (CNAHC), the state-owned parent of Air China. The day before East Star’s halt, the company rejected a proposed takeover by CNAHC, citing clashing corporate cultures.

A senior CNAHC manager told Caijing that East Air had signed an initial agreement to sell 100 percent of its shares, effectively allowing an Air China takeover. At the National People's Congress in March, CNAHC general manager Kong Dong had told Caijing he was confident about acquiring East Star. And the Hubei Province government joined Wuhan officials in eagerly backing a takeover.

On March 10, the Hubei government signed an agreement with CNAHC to create an aviation hub in Wuhan. Under the agreement, CNAHC will develop Wuhan as one of its core hubs and aims to increase the number of large aircraft at the city's airport to 15 by 2010 and 30 by 2015. The plan also calls for more international flights to destinations in Asia, Europe and America. Flights between Wuhan and other major domestic cities would become more frequent as well.

"There is no doubt the local government wants Air China to enter the Wuhan market to expand its aviation industry and promote local economic development,"said Li Xiaojin, professor at the Civil Aviation University of China (CAUC) and director of the Aviation Transportation Economic Research Institute.

A manager of Hubei Airports Group told Caijing that Wuhan government leaders planned to accelerate China Air's takeover by halting East Star's operation.

"The Wuhan municipal government has been longing for CNAHC to take over East Star," the manager said. "If CNAHC were not involved, East Star would halt operations sooner or later due to its current (financial) condition."

Foreign Capital's Retreat

Other private airlines face tough predicaments as well. In early December, United Eagle was nearly locked out of its Chengdu airport base after defaulting on debt owed to Sichuan Airports Group. The airline was unable to find the 30.45 million yuan needed to pay the debt.

That same month, Okay Airways chairman Wang applied for the suspension after saying the company could not ensure safe flights. However, through a mediation process involving CAAC, Okay flights resumed.

Even Shenzhen Airlines, which posted record profits for 14 consecutive years until 2007, lost 500 million yuan in the first three quarters 2008 after its aggressive expansion strategy hit a dead end in the economic slowdown.

Now, a decline in passengers and worsening financial conditions are plaguing China's aviation industry. State-owned enterprises, however, have an advantage based on the potential for government investment. Small, private carriers have to rely on finding new investors to stave off bankruptcy.

Foreign investors used to be interested in China's airlines, Li told Caijing. In 2005, for example, billionaire investor George Soros invested US $25 million in Grand China Airlines, a subsidiary of HNA Group, and in 2007 Korean Airlines set up a joint venture with Sinotrans Air Transportation Development Co. Ltd. But more recently, the global financial crisis has dampened foreign capital's confidence.

"Singapore Airlines was so eager to invest in China Eastern Airlines," Li noted. "Now the project is on pause."

Aggressive State Capital

Currently, only state-owned airlines have the power to take over China's private airlines. Li said state carriers are eyeing valuable assets built by the privates, including the rights to operate busy air routes, and their experienced pilots.

Air China would benefit from a takeover of East Star, which used Wuhan Tianhe International Airport as its hub. The private airline operated about 48 daily flights with 18 routes connecting Wuhan with Shenzhen, Guangzhou, Shanghai, Hong Kong, Macau and other destinations.

"The central China market has always been an Achilles" heel for Air China," Li said. "Taking over East Star would be a shortcut for Air China's expansion in the market."

Meanwhile, Sichuan Airlines plans to consolidate and reduce competition by increasing its share in United Eagle, boosting its clout at the Chengdu airport -- the region's busiest. Chengdu is a southwest China aviation hub for tourists and cargo, and its airport ranked sixth nationally in terms of passengers and cargo volume last year.

Wang Liuxing, Sichuan Airline's executive president, said a takeover would lead to cooperation in areas such as aircraft, resources and management. But United Eagle would operate in a separate niche market by focusing on commuter flights, he said.

Okay's future is more complicated due to an internal stakeholder struggle that may scare away potential investors.

The airline currently has five shareholders, and the largest is Okay Traffic and Energy Investment Co. Ltd., with a 63 percent share. But Juneyao Group indirectly controls Okay through a 71 percent stake in Okay Traffic. Conflicts between Juneyao officials and other shareholders as well as Okay managers have festered for a long time, and lawsuits are expected.

Private Obstacles

Just before many of the new airlines appeared in 2005, China's civil aviation industry posted fantastic results. Combined annual profits for all airlines in 2004 exceeded the amount earned during the previous 10 years. Thus, in early 2005 CAAC issued the Public Aviation Transportation Business Regulation to encourage domestic and foreign investments in the industry.

The government's Regulation on Domestic Investment on Civil Aviation was issued a few months later, which allowed private capital investment in the industry. Facing promising prospects and encouraging government policy, private airlines took off.

Over the following two years, profits rose 100 percent, and the three largest airlines posted profits – an industry rarity.

But the aviation sector plunged from zenith to trough in 2007 – the same year that 60 airlines went bankrupt around the world. Airlines in the Asia-Pacific region suffered with the rest of the world, while China’s airlines lost more than 7 billion yuan between January and November.

As the downturn continued, China's private carriers weakened. Now, since civil aviation is such a capital-intensive industry, only large amounts of capital can help the privates survive and develop, said Que Lianzhong of the Civil Aviation Management Institute of China.

But while private carriers rely on credit and equity markets, state-owned airlines have access to government pockets and can weather market fluctuations. State-owned airlines also can borrow money from state banks and issue corporate bonds backed by the government.

Recently, the Chinese government pumped 9 billion yuan into China Eastern Airlines and funneled 3 billion yuan into China Southern Airlines. Currently, Air China's parent CNAHC is applying for government subsidy.

Another CAUC professor, Zheng Xiwu, said the predicament of private airlines is not only tied to the economic downturn but also can be blamed on unfair government policies and an immature domestic capital market.

An obvious example of policy unfairness is the preferential treatment toward state-owned airlines in terms of aircraft, flight time allocation and pilots.

Zheng said only a few newcomers to the global airline business have survived over the past 30 years. Some went bankrupt, others were acquired by rivals. However, new airlines have continued to emerge, he said, and China's industry is likely to follow this track of development.

Zheng said a greater degree of market fairness is needed to give private airlines a chance to develop. "How can private airlines grow in an unfair market?" he asked.

But even state-owned airlines have to struggle sometimes. Shenzhen Airlines, for example, has had trouble raising capital from its second largest shareholder, state-owned Air China.

Air China tried but failed to take over Shenzhen Airlines in 2005 to build up its southwestern China hub. Later, Air China and Cathay Pacific agreed to cooperate. And now, an industry insider told Caijing, Air China is not expected to invest more in the Shenzhen carrier.

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