VZCZCXRO9262
RR RUEHCN
DE RUEHGH #0044/01 0400240
ZNR UUUUU ZZH
R 090240Z FEB 10
FM AMCONSUL SHANGHAI
TO RUEHC/SECSTATE WASHDC 8542
INFO RUEHOO/CHINA POSTS COLLECTIVE
RHMCSUU/FAA NATIONAL HQ WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RULSDMK/DEPT OF TRANSPORTATION WASHINGTON DC
RUEHMT/AMCONSUL MONTREAL 0028
RUEHBS/USEU BRUSSELS 0044
RUEHGH/AMCONSUL SHANGHAI 9209

UNCLAS SECTION 01 OF 02 SHANGHAI 000044 
 
SENSITIVE 
SIPDIS 
 
STATE FOR EEB/TRA 
STATE FOR EAP/CM 
MONTREAL FOR USMISSION ICAO 
 
E.O. 12958: N/A 
TAGS: EAIR ECON EIND PGOV CH
SUBJECT: CHINA EASTERN-SHANGHAI AIRLINES MERGER HIGHLIGHTS 
COMPLICATIONS IN CONSOLIDATING STATE SECTOR 
 
REF: 09 SHANGHAI 53 
 
SHANGHAI 00000044  001.2 OF 002 
 
 
¶1. (U) This cable contains business proprietary information and 
is Sensitive but Unclassified. Please handle accordingly. 
 
¶2. (SBU) Summary: Central Government-owned China Eastern 
completed its long awaited merger with local rival Shanghai 
Airlines on January 29, with substantial concessions to the 
locally owned competitor. Noting that the Shanghai Airlines 
brand will be retained for at least another three years, China 
Eastern representatives claimed that the merger would result in 
close to 50 percent market share of the lucrative Shanghai 
market. While officials from both carriers declined to speculate 
as to which global airline alliance China Eastern would 
eventually join, a China Eastern representative strongly hinted 
that the Oneworld Alliance is the likely candidate. End Summary. 
 
--------------------------------------------- ---------------- 
Thanks to Expo, China Eastern Optimistic about 2010 prospects 
--------------------------------------------- ---------------- 
 
¶3. (SBU) China Eastern's (CEA) merger with Shanghai Airlines 
(SAL) catapults CEA ahead of Air China as China's second largest 
carrier by fleet size, behind China Southern Airlines. During a 
January 12 meeting, CEA representatives told CongenOffs that 
CEA's market share in Shanghai will rise to around 46 percent by 
passenger volume. With 70-75 million visitors predicted to 
attend Shanghai's six-month long 2010 World Expo, CEA expects 
2010 will be a profitable year with revenues rising by 20 
percent. CEA anticipates 10-15 million Expo visitors will travel 
to Shanghai by plane, 3-8 million of whom CEA hopes will fill 
its flights. Following three years of massive losses from 
2006-08 due to rising fuel prices, the global economic downturn 
and bungled fuel hedging contracts, CEA announced in early 
January that it anticipates 2009 will ultimately prove to have 
been a profitable year, albeit still having required a capital 
injection of RMB 14 billion (approximately USD 2 billion) from 
the Ministry of Finance. CEA's revenue is split 70/30 between 
its domestic and international routes, and the ultimate goal is 
to achieve a ratio of 50/50, according to the CEA 
representatives. 
 
¶4. (SBU) In response to a question regarding competition from 
several high-speed rail routes coming into service in the near 
future, the CEA representatives admitted rail would probably 
pose a challenge, especially for travel between 800-1500 km in 
length where travel times would be comparably close to air 
options. On routes longer than 1,500 km, air transport would 
likely provide the more attractive option in spite of high-speed 
rail availability, they commented. In addition, while security 
check-in procedures for high-speed rail remained relatively less 
burdensome in comparison with that at airports, the CEA 
representatives highlighted a recent incident whereby a smoking 
passenger on the Wuhan-Guangzhou line triggered a prolonged 
delay as potentially foreshadowing more onerous security 
procedures for rail travelers. Should security check-in 
procedures at train stations become more time consuming, they 
reasoned, air travel would remain an appealing option. 
 
----------------------------------------- 
Shanghai Accepts Merger...with Conditions 
----------------------------------------- 
 
¶5. (SBU) Prior to the merger, SAL was a locally administered 
state-owned enterprise (SOE) of the Shanghai Municipal 
Government. (Note: China Eastern Air Holding Company, CEA's 
parent company, is also largely state-owned but by China's 
central government. The Communist Party's Central Organization 
Department approves CEA's chairman although the State Council's 
State-owned Assets Supervision and Administration Commission 
selects the senior vice presidents. End Note.) The CEA 
representatives claimed that Shanghai municipal authorities were 
supportive of the merger because the consolidation would enhance 
Shanghai's goal of becoming an international shipping and 
transportation center. Furthermore, CEA's resulting market share 
for the lucrative Shanghai market would approach 50 percent. 
Retaining the Shanghai Airlines brand, the CEA officials 
explained, would also prevent additional entrants to the 
Shanghai market due to a Civil Aviation Administration of China 
(CAAC) regulation restricting the number of airline branch 
offices per airport. 
 
¶6. (SBU) SAL Senior Vice President Ms. Shao Xiaoyun told the 
 
SHANGHAI 00000044  002.2 OF 002 
 
 
Deputy Principal Officer February 4 that, while SAL would become 
an independent, fully owned subsidiary of CEA, SAL's cargo 
operations, marketing, ground maintenance, and unspecified other 
departments would be consolidated with CEA. Furthermore, since 
both airlines previously were registered in Shanghai, the 
Shanghai Municipal Government would experience no significant 
change in tax revenue as a result of the merger. (Note: 
Enterprise income tax revenues accrue to the jurisdiction where 
the firm is registered. End Note.) 
 
¶7. (SBU) When asked about management personnel changes, Shao 
stated that SAL's Acting President and Communist Party Secretary 
Mr. Gu Jiadan had been appointed as a vice president of China 
Eastern Air Holding Company. Shao claimed that no lay-offs would 
result from the merger although some personnel "adjustments" 
could not be ruled out. The Shanghai Airlines brand would 
remain, she noted, while CEA representatives told us the brand 
would be maintained for a minimum of three years post-merger. 
Shao was similarly hopeful that 2010 would be a profitable year 
for SAL, stating that the Central Government's State-owned 
Assets Supervision and Administration Commission (SASAC) issued 
a decree prohibiting SOEs from entering into any derivative 
trading, to include fuel hedging contracts. 
 
------------------------- 
Oneworld in CEA's Future? 
------------------------- 
 
¶8. (SBU) Both CEA and SAL representatives demurred when asked 
about future international airline alliances. SAL's Shao said 
that once CEA decides which alliance it will join, if it is not 
the Star Alliance, then SAL's Star Alliance partnership would be 
canceled. In the interim, however, SAL's Star Alliance 
membership would continue. The CEA representatives pointed out 
that given Air China's membership in Star Alliance and China 
Southern's Skyteam partnership, CEA's options were more than 
likely limited to Oneworld, the third of the largest global 
airline alliances. Media reports indicate that CEA will make an 
announcement mid-February concerning which global alliance it 
will join. 
 
------------------------------------------- 
Outstanding Boeing Orders for CEA to Decide 
------------------------------------------- 
 
¶9. (SBU) When asked about the nine Boeing 787 Dreamliner 
aircraft that SAL had on order, Shao noted that CEA itself had 
fifteen on order for a total of 24 between the two airlines. CEA 
plans for SAL to focus on shorter, regional routes while CEA 
continues its expansion into longer, international routes, Shao 
explained. Thus, ultimate disposition of the Boeing orders would 
be for CEA to decide. (Note: China Eastern announced in late 
December 2009 its intention to purchase 16 Airbus A330 aircraft 
for delivery between 2011-14, a deal worth USD 2.6 billion. End 
Note.) 
 
--------------------------------------------- -------- 
Taking on Shanghai's Airline Means Taking on Shanghai 
--------------------------------------------- -------- 
 
¶10. (SBU) Comment: On its face, China Eastern's acquisition of 
Shanghai Airlines looks appealing for both sides since both 
stand to gain from larger market share of one of China's most 
lucrative aviation markets. Nevertheless, despite the assurances 
received from China Eastern regarding continued branding and 
employment, the Shanghai Municipal Government, given Shanghai 
Air's close ties to local leadership, will surely miss the 
ability to dole out patronage in the form of attractive senior 
management positions. (Shanghai Executive Vice Mayor Yang Xiong 
is a former president and chairman of SAL.) More than half a 
year in the making, the deal has received widespread media 
attention with speculation focused on the inherent bureaucratic 
and political difficulties associated with consolidating a 
centrally administered SOE and a firm controlled by a (powerful) 
local government. End Comment. 
CAMP