Cross-shareholding agreement between Cathay Pacific and Air China expected to raise concerns over competition A tie-up between Cathay Pacific Airways and Air China will create one of the world's most dominant and dynamic airline groups, but is also bound to raise competition concerns. The deal promises to marry Swire Group's western management practices with the world's fastest-growing tourism and trade market. It will also see Cathay take over Hong Kong Dragon Airlines, effectively giving control of the three most heavily travelled air routes in China - between Hong Kong, Shanghai and Beijing - to a single group. Swire will gain a greater presence in the mainland, and Air China access to a talented management pool and strong international sales team. 'When they come together, it will be Fortress Cathay,' aviation analyst Jim Eckes said. 'Swire brings top-level management skills and the three airlines would create a cargo powerhouse. '[Air China and Cathay] would greatly reduce their overhead costs and get a jump on the low-cost carriers in the mainland market.' According to a senior Swire official, the talks over a cross-shareholding structure between Air China and Cathay began in the middle of last year, when the mainland carrier set a date for its December listing in Hong Kong last year. He was coy on when the deal might be completed, but another executive said Cathay had an announcement scheduled for the end of the month that he thought would be a 'follow-up on [Cathay's] 10 per cent acquisition in Air China [last year]'. Ultimately, the Swire official said, approval had to be sought from the General Administration for Civil Aviation of China (CAAC), the State-owned Assets Supervision and Administration Commission of the State Council and the State Council. 'It will take time, even after the terms are agreed upon, for the deal to filter through each of these bodies for stamping their approval,' he said, declining to say if applications had been submitted for approval. However, one banker said he believed all parts of the deal had been agreed, including the announcement date. 'You don't invest more than US$300 million for a 10 per cent stake in Air China without knowing the end-game,' he said. The Swire executive, who described the deal as being driven by Cathay's need to 'find a way to become seriously integrated into the mainland aviation market', said he did not know the final shareholding structure between Swire, Cathay, China National Aviation Co (CNAC) - the biggest shareholder in Dragonair - and Air China. The banker said a rough calculation based on the airlines' estimated market values would put Swire's stake in the enlarged Air China at 32 per cent; the parent of CNAC, the China National Aviation Holding's (CNAH) stake at 30 per cent; Citic Pacific's at 17 per cent and the rest a public float. Despite the enlarged group's obvious potential to control some of the mainland's most lucrative routes, a government official said it would be unlikely to try to reduce its dominance as long as Dragonair and Cathay's principal place of business remained in Hong Kong. 'What [the Economic Services Bureau] can't do is take rights away,' the official said. 'They can't ask Dragonair and Cathay to give up some rights just because they are brought under one ownership. 'But what they can do is go out and acquire more rights for new carriers and then give priority in any future awards to enhancing competition.' The three airlines presently control 88 per cent of flights on the Hong Kong-Beijing route. For Cathay, the Swire executive said, the challenge had always been to find a way to fully participate in the mainland aviation market, especially capturing domestic demand, the fastest-growing sector. The carrier's earlier drawn-out and ultimately unsuccessful discussions with China Eastern Airlines about jointly creating such an opportunity stood as testament to that ambition. When Cathay announced late last year that it would buy a 10 per cent stake in Air China, many in the industry were shocked because the Beijing-based carrier had been for some time courted by the main partners in Star Alliance - Lufthansa and United Airlines. Indeed, Shanghai-based China Eastern had been thought of by most executives in the industry as the obvious long-term partner. 'Air China wasn't in the picture for us because it was not a strong player in the mainland domestic market - it was seen as a mainland carrier with international ambitions,' the Swire executive said. 'Plus, Shanghai had the allure of being a very complementary business hub for Hong Kong.' But he said Swire's thinking began to change when Beijing led the industry into consolidation in 2001. During the consolidation, Air China merged with China Southwest and CNAC. They were later joined by Shandong Airlines. Meanwhile, China Eastern took China Northwest and Yunnan Airlines, two deeply indebted carriers. 'All of a sudden, Air China emerged as a very strong player in China aviation, both in its balance sheet and the size of its domestic network,' the Swire executive said. He said that along with Air China's rising allure, Swire found it now had 'strong strategic cross-relations' with Citic and CNAH. Citic owns 25 per cent of Air China's cargo spin-off - Air China Cargo - along with 25.74 per cent of Cathay and 28.5 per cent of Dragonair. It is thought that Air China's stake in Dragonair makes the deal possible without any further cash having to change hands. 'Air China wants a bigger stake in the combined entity,' said the banker, '[not] more money.' From the Cathay side, the deal will give Hong Kong's No1 airline an exposure to the Beijing Olympics it would not otherwise enjoy. 'Dragonair ties us all together,' the executive said. 'But at the end of the day, Dragonair is not critical to Cathay or Air China, it is down the value chain. The critical aspect will be how the Cathay-Air China integration is done.' He said Cathay's desire to integrate into the China market and its successful management style would also help Air China become a bigger player globally. 'Over the past two years, the CAAC has opened up the mainland market for international airlines so quickly. Last year, it negotiated a deal with the United States that opens up 249 flights per week across the Pacific, and Europe is likely to push for the same.' But mainland carriers, which lack the professional image to compete in world-class commercial centres such as London and New York, struggle to fully utilise their reciprocal rights 'because they just can't compete with the US and European airlines', the executive said. Swire believes its management experience will help Air China.