China aviation

Plans to sell a stake in Shanghai-based China Eastern Airlines have been grounded for the best part of a year.

Now regulators are reviewing the rule book to ease the entry of strategic investors. CEA could clearly use a strategic investor: it is saddled with debt, losing money and runs an inferior service. Foreign airlines, including Singapore Airlines (SIA) and Australia’s Qantas, were quick to register their interest in exposure to the fast-growing mainland market.

Alas, as talks dragged on, the valuation gap between CEA’s local currency A-shares and Hong Kong-listed H-shares ballooned. For the moment, rules link pricing to the A-shares, which on Monday were 140 per cent more expensive than those in Hong Kong. In an ironic twist – and a reminder of just how flexible Chinese rules can be if you play for the home team – Air China, the largest domestic carrier, has quietly amassed an 8.3 per cent stake in CEA’s cheaper H-shares.

That reduces SIA’s chances. The airline is rich but, having been burned by minority stakes in the past, it should be wary of writing too big a cheque. Despite China Eastern’s desire for “strategic” investors, any stake in CEA is initially a portfolio investment – unlike Cathay Pacific’s investment in Air China last year. Air China’s holding in CEA suggests that Beijing, having already restructured its aviation industry a number of times, is again mulling the creation of a national champion.

Air China should avoid falling for that – a portfolio investment in a company where the stock has doubled looks smart; owning an ailing airline does not. But nor should SIA give up without a fight. Changing the rules to allow a blended price of the two classes of shares is logical given current valuations. And SIA has bargaining chips too: were it to walk away, CEA’s share price could well fall sharply on both markets.