Can Singapore Air teach China Eastern to fly?

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Shu-Ching Jean Chen from Hong Kong
From the standpoint of Asian air travellers, it is a marriage of heaven and hell. The end product could be an indicator of the extent to which stodgy Chinese state-owned companies will open up to modern corporate management practices.
For a price tag of 7.2 billion Hong Kong dollars ($923 million), Singapore Airlines, renowned as the best-managed airline in Asia, and its Singaporean government-controlled parent Temasek Holdings, are taking a combined 24 per cent stake in money-losing China Eastern Airlines, China's perpetual aviation laggard.
The Chinese government will remain the controlling shareholder of the airline with a 51 per cent stake.
The conclusion of the deal, which has been rumoured for more than five years, prompted Morgan Stanley to make China Eastern a top pick among Chinese airline stocks, declaring recently that "a new chapter begins" for the troubled carrier. Investors seemed to agree: China Eastern shares soared 83.91 per cent in morning trading in Hong Kong on Monday to 6.86 Hong Kong dollars (88 cents). By contrast, Singapore Airlines and Temasek are paying 3.8 Hong Kong dollars (49 cents) a share for their stake.
With the Singaporean investment and a capital injection forthcoming from the Chinese government, China Eastern will gain 11.34 billion yuan ($1.5 billion) to pay down debt, reducing its heavy net gearing from as high as 15 times as of the first half of 2007 to only 2.1 times, Morgan Stanley estimates.
Investors were also encouraged by the prospect that Singapore Airlines could lend management expertise to transform China Eastern from the worst major Chinese airline to one that can compete with its two bigger rivals, China Southern and Air China.
Longer term, however, the view gets hazier. While China Eastern's long-lagging shares may be a good bet to catch up with their higher-flying brethren -- China Southern has run up 123 per cent and Air China 56 per cent since China Eastern's unusually long suspension from trading May 22 -- Citigroup analyst Ally Ma questioned whether Singapore Airlines would be able to engineer a turnaround at China Eastern.
"Besides an acute shortage of capital, we believe China Eastern suffers from a bloated organisational structure, unclear strategy, weak management execution and an inefficient decision/operational process. If these are not rooted out, it may face equity depletion again," he wrote in a note on Monday.
Jinqing Li, an analyst with Fitch ratings, wrote that any improvement at China Eastern may be limited to temporarily relieving pressure on an overstretched balance sheet -- operational improvement will take time and be dependent to a large extent on its organisational flexibility.
China Eastern has been bleeding cash despite the blossoming of air travel in China, losing 470 million yuan ($62.6 million) in 2005, 3.31 billion yuan ($441 million) in 2006 and a further 384 million yuan ($51.2 million) in the first half of 2007. Fitch reckoned that its unprecedented leverage, the highest of China's three biggest airlines, is mainly due to the growth of operating lease obligations.
Singapore Airlines will be constrained from reaping synergies with China Eastern without a full merger, which is barred under rules that limit foreign airlines from taking more than a 25% stake in a Chinese carrier. Nonetheless, Singapore will wield influence through the appointment of three members of the 14-member board and the exchange of senior management between the two airlines.
According to the Straits Times, the dominant newspaper in Singapore, Singapore Airlines is set to dispatch 10 to 12 high-level executives to China Eastern's headquarters in Shanghai, with China Eastern sending a similar number of managers to Singapore.
Some analysts pointed to Air China's equity tie-up with Cathay Pacific as an example of why investors should be cautious. Despite having held a stake in Air China for more than a year, Cathay has reportedly encountered resistance to further cooperation.
The new tie-up is also widely expected to lead to a quick exit by Singapore Airlines from Virgin Atlantic, in which it has held a passive and largely unproductive 49% stake since 1999.
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