VZCZCXRO3397
PP RUEHCN RUEHGH
DE RUEHHK #2404/01 1601035
ZNR UUUUU ZZH
P 091035Z JUN 06
FM AMCONSUL HONG KONG
TO RUEHC/SECSTATE WASHDC PRIORITY 7201
INFO RUEHOO/CHINA POSTS COLLECTIVE PRIORITY
RULSDMK/DEPT OF TRANSPORTATION WASHDC PRIORITY
RUCPDOC/USDOC WASHDC PRIORITY

UNCLAS SECTION 01 OF 02 HONG KONG 002404 
 
SIPDIS 
 
SIPDIS 
 
STATE FOR EAP/CM AND EB/TRA 
STATE PASS USTR 
TRANSPORTATION FOR PAUL GRETCH AND MARY STREET 
USDOC FOR ITA/EUGENE ALFORD AND ANN-MARIE CAMPBELL 
 
E.O. 12958: N/A 
TAGS: EAIR ECON PREL PGOV HK CH
SUBJECT: CATHAY AND DRAGONAIR ANNOUNCE MERGER 
 
REF: HONG KONG 2335 
 
SUMMARY 
------- 
 
¶1. (U) In a joint news conference in Hong Kong on June 9, Air 
China and Cathay executives announced a deal that would lead 
to Cathay Pacific assuming 100 percent ownership of Hong 
Kong's second largest carrier Dragon Air.  Cathay Pacific and 
Air China would each own 17.5 percent of the other.  Cathay 
Pacific, Dragonair, and Air China would generate savings by 
code-sharing in passenger flights and combining support 
services, such as procurement, aircraft maintenance, and 
repair.  As an indirect consequence of the merger, Air 
China's planned tie-up with the Star Alliance may fall 
through.  End Summary. 
 
¶2.  (U) On June 9, Swire Pacific Chairman Christopher Pratt, 
Cathay Pacific Chief Executive Philip Chen, Air China 
Chairman Li Jiaxiang, China National Aviation Corporation 
(CNAC) Chairman Kong Dong, and CITIC Pacific Managing 
Director Henry Fan held a news conference to announce 
ownership changes among Cathay Pacific, Dragonair and Air 
China.  Cathay Pacific is paying HKD 8.22 billion (USD 1.05 
billion) to increase its share of Dragonair from 17.79 
percent to 100 percent, paying about three times book value. 
(Swire Pacific, Cathay's parent, had also held 7.71 percent 
of Dragonair's stock; Cathay is also buying out the Swire 
share.)  Dragonair will become a wholly owned subsidiary of 
Cathay, but would continue as an independent brand for at 
least six years. 
 
¶3.  (U) The Cathay-Dragonair combination will become the top 
foreign carrier in China, as well as the Asia-Pacific 
region's number one carrier in terms of revenue, by combining 
Dragonair's 23 mainland Chinese destinations with Cathay's 
profitable long-haul network.  Cathay will also enjoy 
strengthened ties with the strongest of China's state-run 
carriers.  Cathay Pacific will pay HKD 4.07 billion (USD 522 
million) to double its ownership of Air China from 10 to 20 
percent.  However, Air China will issue new shares, diluting 
Cathay's share to 17.5 percent.  Air China and its holding 
company CNAC will increase its share of Cathay to 17.5 
percent. 
 
¶4.  (U) Cathay expects to generate cost savings by 
integrating Dragonair's back-office departments and 
management with its own.  The two carriers should also be 
able to use their combined fleets more efficiently.  Cathay's 
hopes that it can increase demand on Cathay's flights by 
offering attractive packages in combination with Dragonair. 
Cathay recorded a 78.7 percent load factor in 2005, 14.3 
percentage points greater than Dragonair.  Cathay Pacific and 
Air China also plan to establish a jointly-owned all-cargo 
airline based in Shanghai, with Air China owning 51 percent 
and Cathay holding 49 percent. 
 
¶5.  (U) According to Swire's Pratt, the negotiation for 
Cathay to assume control of Dragonair has been going on for 
more than two years.  He said that 100 percent control of 
Dragonair was a "landmark development" in Cathay's history. 
The formation of a significant alliance with Air China would 
reinforce and strengthen Hong Kong's position as a global air 
hub.  Swire would remain the controlling shareholder in 
Cathay, and the firm has no intention of further reducing its 
stake.  (Note:  Swire has a controlling, but not majority, 
ownership share in Cathay Pacific.  Under the agreement, 
Swire's share of Cathay would fall from 46.3 percent to 40 
percent, thus still higher than the 35 percent to be owned by 
Air China, CITIC, and CNAC.  End note.) 
 
¶6.  (U) Air China's Li claimed that, although Air China and 
Cathay Pacific would only cross-hold 17.5 percent of each 
other's shares, their partnership would achieve the economic 
efficiency of a 50-50 enterprise.  Cathay and Air China will 
generate savings by code-sharing in passenger flights and 
combining support services, such as procurement, aircraft 
maintenance, and repair. 
 
¶7.  (U) The Hong Kong Government was supportive of the deal. 
Secretary for Economic Development and Labour Stephen Ip told 
 
SIPDIS 
the press that "it would help strengthen Hong Kong's role as 
an aviation hub because both Cathay Pacific and Dragonair can 
make the best use of their network...We believe that it will 
also result in an increase in synergy and also help to 
enhance the efficiency of both companies."  Hong Kong has no 
 
HONG KONG 00002404  002 OF 002 
 
 
anti-trust legislation, and there is no likelihood of 
Government opposition to the merger because of competition 
concerns. 
 
A COMPLICATED WEB OF INVESTORS 
------------------------------ 
 
¶8. (U) The deal actually involves five listed 
Hong Kong companies, all of which have a complicated web of 
cross-holdings, and all of which suspended trading between 
June 5 and 8 due to reports of the merger.  The list below 
updates the information provided in reftel. 
 
o Cathay Pacific, the Hong Kong-based airline, which will 
assume 100 percent control of Dragonair, and eventually own 
17.5 percent of state-owned carrier Air China. 
 
o Swire Pacific, a Hong Kong-listed entity of the British 
conglomerate Swire Holdings, who will own 40 percent of 
Cathay, higher than the 35 percent held by Citic, CNAC, and 
Air China. 
 
o Citic Pacific, a Hong Kong-listed red chip of the mainland 
financial conglomerate Citic.  The firm's ownership of Cathay 
is decreasing from 25.42 percent to 17.5 percent.  Cathay is 
purchasing its 28.5 percent share of Dragonair. 
 
o China National Aviation Company Ltd, the Hong Kong-listed 
red chip, which owns 43.29 percent of Dragonair, and is 66.36 
percent held by Air China. 
 
o Dragonair, which was 97.39 percent owned by the four noted 
entities. 
 
¶9. (U) Shortly before the merger was announced, Air China 
signed a Memorandum of Understanding to become a member of 
the Star Alliance -- which includes United and Lufthansa. 
This would have left Cathay, which belongs to the "oneworld" 
code-share alliance along with British Airways, American 
Airlines and Qantas, without a strong code-share partner on 
the mainland.  After the merger was announced, however, there 
has been considerable speculation that Air China would pull 
out of its agreement with the Star Alliance in favor of 
joining "oneworld." 
 
Cunningham