September 21, 2007
Singapore Air May Face Competition For China Eastern

Vivian Wai-yin Kwok

China Eastern Airlines’ stock gained 37% over two days as investors are expecting a counterbid by Air China in response to Singapore Airlines’ 7.2 billion Hong Kong dollar ($923 million) acquisition of the Shanghai-based carrier.

Shortly after Hong Kong's stock market opened on Friday, shares of China Eastern Airlines (nyse: CEA) were changing hands at 9.72 Hong Kong dollars ($1.25), 12.4% higher than the previous closing price. The airline’s stock had already spurted 22% on Thursday in Hong Kong and rose by the 10% daily limit in Shanghai, generating the momentum that sent China's key Shanghai Composite Index to a record closing at 5,470.07.

Ally Ma, an analyst with Citi Investment Research, said Friday that the dramatic surge suggested "Air China may take aggressive actions to derail China Eastern Airlines' stake sale to Singapore Airlines before the deal obtains general meeting approval in November."

Singapore Airlines (other-otc: SPAAF), renowned as the best-managed Asian airline, and its Singapore government-controlled parent Temasek Holdings earlier this month agreed to take a combined 24% stake in money-losing China Eastern Airlines. (See " Can Singapore Air Teach China Eastern To Fly?")

China Eastern Airlines is an attractive takeover target since it has a dominant 40% market share of Shanghai's domestic and international flights. Although the Chinese government will remain the controlling shareholder, with a 51% stake, if Singapore Airlines and Temasek acquire 24% of China Eastern, they will have the first right of refusal for future shares sold by the holding company set up for China Eastern as well as the right to take a bigger slice of China Eastern should Beijing eventually ease restrictions on foreign investment.

Air China's parent, China National Aviation Corp., has accumulated 11% of China Eastern Airlines' Class H (Hong Kong) shares and has the potential to rally retail investors to block the Singaporean deal, which needs two-thirds approval from minority shareholders.

Citi Investment Research reiterated a "buy" rating on both China Eastern Airlines and Air China, predicting that China Eastern Airlines' minority shareholders will be the biggest winner. "If Air China counter-bids at HK $5-6 [64 to 77 cents] for the 3 billion new shares … [the bid, which would be 32-57% higher than Singapore Airlines' offer,] would raise its fair valuation to HK $9.10-10.44 [$1.17 to $1.34]," the brokerage estimated, figuring its target price by calculating 3.2 times price to book value plus 9% appreciation of the yuan by the end of 2008.

Founded in 1988, China Eastern Airlines is one of the big three air carriers in China. As of the end of June 2007, China Eastern Airlines operated 205 aircraft and flew passengers on 398 routes, of which 292 are domestic, 17 serve Hong Kong and 89 are international.

Air China (other-otc: AIRYY) is the biggest airline in China and the sole and formal airline partner of the 2008 Beijing Olympic Games. With 224 aircraft under operation at the end of 2006, Air China has significant international exposure, with 46% of passenger revenue derived outside of China.

(Source: Forbes.com)