Hong Kong's Cathay Pacific Airways said on Friday it would pay HKD$8.22 billion (USD$1.06 billion) in cash and shares to take over rival Dragonair in a long-expected deal that expands its access to the fast-growing mainland Chinese market.
Cathay, the world's seventh most valuable airline, has been frustrated by its limited position in mainland China, where its only passenger routes are to Beijing and Xiamen.
Dragonair, which flies to 23 mainland cities including the lucrative Shanghai market, has in turn relied on Cathay to feed it international traffic bound for China.
"It is positive for all parties involved," said Peter Drolet, senior analyst at UOB Kay Hian.
"Gaining China access will give unlimited possibilities to Cathay Pacific, and I believe CX (Cathay) will have the ability to turn around any unprofitable routes that Dragonair currently has, and reduce its costs significantly."
As part of the deal, Cathay and mainland carrier Air China will step up their cooperation, with Cathay paying HKD$4.07 billion (USD$524.4 million) to double its stake in Beijing-run Air China to 20 percent. In turn, Air China will pay HKD$5.39 billion (USD$694.5 million) for 10 percent of Cathay.
Cathay Pacific and Air China said they planned to set up a jointly owned cargo airline based in Shanghai, to be held 51 percent by Air China and 49 percent by Cathay. The companies also said Hong Kong Dragon Airlines, better known as Dragonair, would keep its current branding for six years.
The deal results in Air China offering to privatize China National Aviation Co (CNAC), which is the largest shareholder in unlisted Dragonair, for at least HKD$2.80 a share, a premium of 42 percent over its last closing price, which sent CNAC shares up by 32 percent.
Terms of Cathay's acquisition, which received wide media coverage all week, were roughly in line with expectations. Cathay shares, suspended since Monday morning along with those of the others in the deal, rose by 5.4 percent on Friday.
The deal values Dragonair at roughly three times its book value, a sharp premium to other regional carriers, although analysts have said the attractiveness of Dragonair is the growth that can be achieved by merging into Cathay.
The tie-up creates a formidable rival for mainland carriers China Southern Airlines and China Eastern Airlines, and forms a powerhouse in the lucrative market between Taiwan and mainland China through Hong Kong, as there are no direct air links between China and Taiwan.
A Cathay takeover of Dragonair has long been seen as strategically compelling, but the complicated and interlocking shareholdings between the two, as well as political and regulatory hurdles, have stood in the way of a deal.
Cathay's origins in Hong Kong's days as a British colony -- its biggest shareholder is controlled by London's John Swire & Sons -- had also been viewed as a hindrance to a takeover.
Dragonair, meanwhile, has struggled to generate profits beyond its core Shanghai and Beijing routes. Its net profit fell by 53 percent last year to HKD$300 million (USD$38.6 million).
"Dragonair's long-term outlook was looking less rosy as more competition was coming into Hong Kong from the Chinese carriers, and they didn't really have the ability to leverage their marginal operations elsewhere in the region," said Richard Pinkham, a consultant with the Centre for Asia Pacific Aviation.
Cathay, which already held a 17.8 percent stake in Dragonair, is buying the shares that it does not already own from its own parent, Swire Pacific, as well as CITIC Pacific and CNAC for HKD$820 million (USD$105.7 million) in cash and the remainder in new Cathay shares issued at HKD$13.50 each, a premium of 4.2 percent over their last closing price.
Air China is buying its shares in Cathay for HKD$13.50 each. Combined with CNAC's stake, Air China will effectively own 17.5 percent of Cathay.
Cathay's stake in Air China will be diluted to 17.5 percent -- matching Air China's stake in Cathay -- after the mainland carrier completes a planned domestic share listing.
Cathay will pay HKD$3.45 per share in Air China to double its holding, a premium of 11.3 percent. Cathay also will pay a special dividend of HKD$0.32 per share on completion of the deal.
The deal will see Swire's stake in Cathay pared from 46.3 percent to 40 percent, while CITIC Pacific's holding in Cathay will fall from 25.4 percent to 17.50 percent.
CITIC Pacific said the deal would result in an exceptional profit for it of about HKD$2 billion (USD$257.7 million).
