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MARCH 2019

Week 9


Cathay Pacific considers HK Express investment: future-proofing home market relevancy

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March 5th 2019

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Cathay Pacific wants to keep the music going. The airline confirmed it is considering an investment in LCC HK Express, saying the business is complementary, implying Cathay will keep the LCC and not just re-purpose its slots. Read More »

The investment is for an undisclosed amount and no timeframe was given to complete the deal. Cathay is not investing in HK Express sister Hong Kong Airlines despite HNA trying to sell its two Hong Kong units together, making beleaguered Hong Kong Airlines the bitter pill to swallow for the more in-shape HK Express. Hong Kong Airlines’ restructuring and future ownership become more challenging, to Cathay’s gain.

Cathay knows it must contend with home market competition. Competitors HK Express and Hong Kong Airlines could be delivering far greater damage if they were free of HNA’s influence, so Cathay is in a competitive sweet spot.

As HNA moves to offload businesses, Cathay faces the short-term possibility of smarter competition if the HNA units are under new management. Longer term, HK Express gives Cathay a head start with a ready-made LCC in advance of Hong Kong’s third runway operating around 2024. The additional slots will certainly bring in foreign competition and might foster a new local airline.

With an approximately 50% increase in Hong Kong slots coming, the timeframe is too short to recoup the investment purely based on marketshare gains. But there is undeniable yield benefit to Cathay from less competition on HK Express’ point-to-point flights. Sixth-freedom traffic can be volatile, so a stronghold on local traffic props up yields.

Cathay has not been severely constrained and desperate for growth. Cathay intentionally over-grew earlier this decade, amassing a slot portfolio it could later optimise. Cathay’s forward capacity growth is arguably too high with too many aircraft on order.

HK Express could gain a sturdy shareholder, and more. Yields could rise from Cathay cross-selling or offering some frequent flyer perks. Trading slots could help.

Cathay’s challenge is to be strong enough with HK Express that it fends off competitors, but not have the government object on anti-competitive grounds.

Combined, Cathay and HK Express flew 54% of passengers at Hong Kong airport in 2017. Their impact is even greater in short-haul markets, such as Japan, which accounts for about a fifth of all outbound Hong Kong travel.

It could be argued a strong hub needs a strong local airline, and HNA’s presence detracts from Cathay and fragments the Hong Kong aviation hub. Asia’s aviation hubs are in a once-in-a-lifetime growth spurt, and regional governments are focused on this.

Market segmentation could be a reason. Cathay says HK Express is complementary, yet Cathay said there is no strict LCC market.

Cathay will likely leverage the Hong Kong government’s naivety. The city’s inexperience regulating aviation was seen when it denied Jetstar Hong Kong a local license. The main justification was foreign governments would see Jetstar Hong Kong as non-Hong Kong and thus refuse traffic rights to all Hong Kong carriers – a groundless argument aeropolitically, but a persuasive one.

HK Express would help Cathay achieve macro positioning. Cathay has increasingly felt out of touch with its home market of Hong Kong. High-yielding corporate accounts largely stick to the airline, but the expanding leisure market is flying HK Express – or rather HK Express is generating new growth.

Cathay has long argued against establishing a LCC subsidiary by saying its brand can stretch across the traveller spectrum while widebody aircraft with dense seating and cargo payload enable low fares. Fresh slots would be better allocated to full-service Cathay.

What has clearly changed is the availability of HK Express. The LCC represents an opportunity to bring more marketshare under the Cathay portfolio. Some passengers could later trade-up to Cathay.

Despite its size, Cathay has been concerned about the risk of decreasing home relevancy. Cathay has felt it lacks what its competitors have: “Hong Kong” in their name. Cathay sought visibility in the growing leisure segment with its weekly “fanfare” promotional tickets, but this was small. The airline is understood to be finalising a new marketing campaign to reinforce its connection to Hong Kong.

The investment notably excludes Hong Kong Airlines, the sister to HK Express. Both are affiliated with HNA under different ownership structures.

HK Express generated interest for being comparatively easy to understand with good appearances: HK Express is mostly a point-to-point business, and a LCC. There were others besides Cathay interested in HK Express, and investors in recent years have favoured LCCs.

Hong Kong Airlines was seen as trying to be Cathay Pacific without the network reach, corporate access and loyalty affinity. It has grown regionally and long-haul, but to be successful either needs a sharp trimming or expansion – neither of appeal to investors. Some say Hong Kong Airlines’ previous business dealings would challenge due diligence.

Aside from Hong Kong slots, tangible assets – fleet, overseas slots and traffic rights – are few. An exception is perhaps Hong Kong Airlines’ Bali and Ho Chi Minh traffic rights while HK Express has no notable traffic rights.

HNA appears so encumbered with larger group challenges that it is not being more strategic about a HK Express sale helping Hong Kong Airlines. Selling HK Express removes incentives for future bidders of Hong Kong Airlines.

LCCs were briefly in the limelight at HNA, with HK Express’ transformation galvanising mainland-based HNA units like West Air and Lucky Air to convert to a low-cost platform, united in the now dormant U-Fly Alliance. Their transformation occurred as Chinese regulator CAAC promoted LCCs.

But then LCCs lost favour at HNA due to slowing mainland momentum, HNA group changes and HK Express’ high-profile cancellations. HNA may see Hong Kong Airlines as more flagship and prestigious, even if it has a weaker outlook.


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