A merger between the two loss-making Shanghai airlines is expected to change the shape of the aviation market in the city and help develop it into an international air hub.

China's state-owned asset regulator and the Shanghai government have granted preliminary approval for China Eastern Airlines and Shanghai Airlines to merge and details of the merger will be unveiled within 20 days from last Saturday, according to Liu Shaoyang, chairman of the bigger China Eastern.

A working team consisting of four China Eastern officials, including Liu and general manager Ma Xulun, and three executives from Shanghai Air, including Chairman Zhou Chi, has held a meeting to discuss ways to cooperate toward a merger.

There is much anticipation in the market that the two airlines may cooperate through a share swap or making the smaller carrier a subsidiary of China Eastern.

"The two carriers are very likely to swap shares, which means Shanghai Air can still be run independently, as well as generate synergy between them ? but turning Shanghai Air into a subsidiary can fundamentally solve problems for long-term development," said Mao Ang, an analyst at China Galaxy Securities Research.

Liu said the two airlines are exploring possible ways but have yet to make a final decision. "But we have expanded business cooperation and reached agreements on some fundamental issues such as no staff cuts," he said.

Large airline

The merger will create a very large airline which boasts a fleet of about 300 planes flying on more than 600 routes, and also propel Shanghai to overtake Beijing as China's biggest air-travel destination in 2015.

Shanghai is one of the most important air hubs in China with a high turnover in traffic and a well-connected network, but there is at the moment no leading airline to help build it into an international air hub.

A leading airline usually carves up about 50 percent of turnover in a local aviation market. For example, Air China has a more than 45 percent share of Beijing's market and China Southern Airlines has about 50 percent of Guangzhou's market.

But China Eastern owns about 32 percent in the Shanghai market and Shanghai Air owns 17 percent. A merger would result in a combined share of 49 percent which would present a formidable challenge to other carriers.

"Shanghai is the financial capital of China and there are plans to build the city into an international financial and shipping center, so forming a leading airline is a necessity," Mao said. "There is duplication of routes between the two carriers that lead to fierce competition, and a merger will help them adjust flight schedules and networks to increase revenues and save costs," Mao said.

China Eastern lost about 14 billion yuan (US$2.9 billion) last year due to shrinking demand brought by the global financial crisis and its hedging losses. Shanghai Air lost 1.25 billion yuan. The two carriers have been suspended from trading since last week due to the merger talk.

Huang Bin, board secretary of Air China, said it has no plans to adjust its strategy in Shanghai because of the merger between the two local carriers. It set up a branch in Shanghai earlier this year to tap a bigger market share in the city.

Price war

News of the possible merger also threatened the development of smaller and private carriers.

"We don't welcome a monopoly in the aviation market because only fair competition can benefit the market and passengers," said Wang Zhenghua, head of China's first budget carrier Spring Airlines. "A price war is unavoidable and we are also studying how to weather pressure brought by airline groups and the H1N1 virus."

Qian Qimin, an analyst at Shenyin & Wanguo Securities Co, said a recovery in the market is the key factor that will benefit the carriers rather than a merger. Airlines worldwide may lose US$9 billion this year as the slump and swine flu hurt travel demand, according to the International Air Transport Association.

Meanwhile, Singapore's Minister Mentor Lee Kuan Yew told media that Singapore Airlines (SIA) and China Eastern may start talking again about potential cooperation.

But Chew Choon Seng, SIA's chief executive, said it is not looking at acquisitions in China for now.

China Eastern's Liu also said the airline hasn't resumed talks with SIA about a possible partnership, but the carrier is open to all overseas investment including strategic and financial partners after expanding its market share in Shanghai to about 50 percent through the merger.

In 2007, China Eastern planned to sell a 24-percent stake to SIA and Temasek Holdings, Singapore's state-linked investment firm, for US$923 million but the deal was blocked by the China National Aviation Corp, parent of Air China.

CNAC sought a tie-up with China Eastern in a bid to dominate the world's second-largest aviation market but was rejected by the Shanghai-based carrier.

(Xinhua News Agency June 19, 2009)