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MARCH 2019

Week 13

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HK Express acquisition could set new benchmark for competition concentration

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March 29th 2019

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Peers are watching to see how much market concentration Cathay can achieve. Read More »

The region is watching Cathay Pacific’s proposed HK Express (HKE) takeover, especially airline peers keen to learn how much market concentration regulators will allow, a decision that could be a benchmark for other jurisdictions. Most of Asia has yet to experience profound market consolidation.

Cathay’s calculation was that HKE’s HNA owner was looking to off-load assets at a time Cathay’s transformation needed more momentum. Most airline restructuring plans feature aggressive cost reduction. Qantas decreased unit costs by 19% over four years. In contrast, Cathay aims to have flat unit costs over three years. This shifts Cathay’s performance improvements to needing better yields. Acquiring a competitor will do just that.

There are opposing views on Cathay spending US$628m for HKE, including debt repayment. Industry participants believe Cathay got a bargain. Banks think Cathay over-paid based on HKE’s 2017 profit of $8 million and an unaudited 2018 loss of $18m. The banker analysis seems to neglect a few key factors. HKE is still coming out of the LCC start-up phase and its 2018 performance was hindered by aircraft under-utilisation and restructuring. HKE can generate more value and pose a larger competitive threat if under a different ownership.

The Qantas Group also conducted due diligence on HKE, but Cathay Pacific was willing to move faster, according to sources. Qantas was concerned about a setback to its re-kindled relationship with Cathay. Qantas and Cathay are seeking approval for a codeshare that could later lead to a joint-venture.

It is to be seen if the $628m figure is the final price. HKE chairman Zhong Guosong is a shareholder and represents a HNA faction. He is declining to sell as part of a larger tussle within HNA. It is expected he wants a higher price for the holding he represents, but HNA could intimidate him into selling at the agreed price.

The addition of HKE to Cathay will give the expanded group just over half of all slots at Hong Kong. But the impacts will be bigger in specific markets. A quarter to a third of outbound Hong Kong leisure travel is estimated to go to Japan, where Cathay and HKE will have a firm grip, especially in the main markets of Tokyo and Osaka.

The Hong Kong-Korea market sees many airlines on paper, but most are Korean LCCs that do not have a strong Hong Kong point of sale, consolidating Cathay and HK Express’ presence.

Acquiring HKE leaves the territory without an independent short-haul airline. By comparison, Singapore has Jetstar Asia as a competitive check to the Singapore Airlines-Scoot brands. Starlux will soon give Taiwan three major airline groups while Korea has approved three new LCCs, adding to the existing six.

A significant gain for Cathay is the indirect consequence of the purchase of HKE sister Hong Kong Airlines. HNA had wanted to sell the two together. Cathay breaking up HKE and HKA prevents a shareholder from taking both HKE and HKA and making them into a powerful force. Prior to due diligence, HKE and HKA were exploring more collaboration.

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