Project Report CP 07

8/6/2019 Project Report CP 07

http://slidepdf.com/reader/full/project-report-cp-07 1/15

Course 6040 Spring 2007

Competition Policy and Business Strategy

Project Report -Cathay Pacific Dragonair Merger: An Efficiency Gain or Anti-Competitive Effect on the Hong Kong-China Aviation Market?

March 16, 2007

Victor So



1

VICTOR SO

Cathay Pacific Dragonair Merger: An Efficiency Gain or Anti-

Competitive Effect on the Hong Kong-China Aviation Market?

“It's a good deal for Cathay because it increases its China exposure substantially

overnight. …… Competitors will feel a great deal of pressure because of Cathay's

economy of scale," said Andes Cheng of Hong Kong's South China Research.1

The Hong Kong-based Cathay Pacific Airways Ltd. (hereinafter referred to as Cathay)made an announcement on June 9, 2006 it would acquire full ownership of Hong KongDragon Airlines Ltd. (hereinafter referred to as Dragonair) which was its main competitorin the Hong Kong-China aviation market. At that time, as the biggest home carrier in

Hong Kong, Cathay only flied to two mainland cities while Dragonair had already had 21routes from Hong Kong to China. Obviously this was the strategy for Cathay to preparefor the liberalizing Chinese aviation market which was believed to be a huge potentialwith the booming Chinese economy.

The aviation market had been putting into a sensitive area and was strictly monitored andregulated by the Government policies. Those included Hong Kong’s so-called “one airline,one route” policy before 2000. While both the Hong Kong and China Government wereliberalizing the aviation market and this was assumed to introduce more competition, themerger between Cathay and Dragonair seemed to be an anti-competitive action. Althoughit definitely improved the operation efficiency of the two airlines in providing the air

services between Hong Kong and mainland, could this create a dominant operation at thesame time and harm the customers or other companies in the industry?

The Hong Kong-China Aviation Market

The skies over China

The reform and opening of the modern China had led to the substantial growth of manymarket segments in mainland. It’s no doubt that the aviation industry would be one of thefastest growing businesses in this 1.3 billion population country. The Chinese airlinesranked 11th in the world in 1995 but jumped to second, only behind US air carriers interms of passengers carried in 2006.2 On the other hand, China had a fast growing aircargo market in the world with an average annual growth of 17 percent over the pastdecade as quoted by China Daily in 2006.3

The Hong Kong-China routes

Hong Kong had been the window of mainland to the international market before themodern China reform and economic opening. During the opening up and development of the China market since the 80s’, Hong Kong continued to play an important role as anentrance for both visitors and goods to enter the mainland. After the Handover of Hong

1 Ilya Garger, MarketWatch “Cathay Pacific to buy out Dragonair for $1.06 billion” Jun 9, 2006 2 Daniel lnman, EUROBIZ “The skies over China” v200608 http://www.sinomedia.net/eurobiz/v200608/story0608.html3 “CITIC planning Air China Cargo sale”, www.chinaview.cn 2006-11-22



2

Kong in 1997, it became the Special Administrative Region of the People’s Republic of China (Hong Kong SAR). This special role and relationship with mainland reinforced thecloser cooperation between the Central Government and the Hong Kong SARGovernment on the regulatory of the airline industry. As a result, the demand on thecommercial air services between Hong Kong and those cities in China had been increasingdramatically. The HK-China routes had become a very critical segment in the Chinaairline industry.

The air service agreement

The airline industry was heavily regulated by the Governments due to the concern on thefreedom of the skies.4 For any route between two cities in different countries, bilateralagreement must be obtained. Any individual airline who wanted to operate for the routemust also get prior approval before entering the market. There was no exception betweenmainland China and Hong Kong after the return of Hong Kong from the UK sovereignty

under the implementation of the “One Country, Two Systems” approach. All air servicesto, from, or through Hong Kong would be regulated by the Air Service Agreements [SeeExhibit 1].

In 2000, there were seven airlines operating scheduled and regular charter services andproviding some 400 services per week between Hong Kong and about 40 cities in themainland China.5 In order to meet the increasing demands brought by the market forces,an Air Service Agreement was signed in that year between the General Administration of Civil Aviation of China and the Hong Kong SAR Government. It was a significantarrangement which granted airlines from both China and Hong Kong equal opportunitiesto increase the air transportation services. Under the agreement, the Hong Kong airlines

could have a 60% increase in shipping capacity.

"Economic, trade, tourism and other links between Hong Kong and the mainland

have been increasing since July 1997. The demand for air services between Hong

Kong and the mainland is very strong and growing steadily. The conclusion of the

arrangement is very important to the development of air services between the two

places," said Stephen Ip, secretary for economic services of HKSAR.6

The market liberalization

Although the Air Service Agreement signed in 2000 was reviewed every year afterward,another most significant arrangement was concluded in 2004 which introduced a cleartimetable on a wider liberalization of the air services market between Hong Kong andmainland China. It further opened up the Hong Kong-mainland China aviation market tomore airlines and for increasing capacity on each route.

Under the new agreement, the number of passenger flights between Hong Kong andmainland China could be increased by 30% to about 1,600 a week and the capacity for all-cargo services for each side would be doubled to 42 frequencies per week (fpw).

4 Ka-Fu Wong “Open Skies: Allocation of Landing Slots at Hong Kong Airport”, Asia Case Research Centre, the

University of Hong Kong.5 The seven airlines were Dragonair, Air China, China Southern, China Southwest, China Northern, China Eastern andChina Northwest.6 People’s Daily Online “Hong Kong and China Sign Air Transport Agreement”, Feb. 04, 2000.http://english.people.com.cn/english/200002/04/eng20000204X101.html.



3

Moreover, the limit on the total number of airlines to operate the Hong Kong-China routeswas lifted. Moreover, the Civil Aviation Administration of China (CAAC) had also agreedto actively liaise with those local government departments to speed up the process on theopening up of the new routes so that the number of destinations in the mainland coveredwould be increased to 44 cities eventually, which included the popular tourism placeLijiang.

There were some examples for the effects on the liberalizing market under the newarrangement:

Hong Kong-Beijing Route- Hong Kong airlines could add 4 passenger fpw right after the agreement signed

and another 7 passenger fpw starting from March 2005, which would bring thenumber of weekly frequencies operated by Hong Kong airlines to 70 on this route.

Hong Kong-Shanghai route- Hong Kong could designate a new airline to operate all-cargo servicesimmediately and the maximum number of cargo flights that Hong Kong airlinescould operate on this route would be increased from 21 to 28 fpw.

- Passenger capacity could be increased about 10% immediately and another 10%starting from March 2005, which reflected a number of 98 fpw could be operatedby the Hong Kong airlines.

- From Oct. 2006, a second Hong Kong airline would be allowed to operatepassenger service in addition to the Dragonair who was the only Hong Kongdesignated airline company operating the route at that time.7

New modes of operation- Airlines would be allowed to combine two mainland points in one service and enterinto code-share arrangement on all routes between Hong Kong and the mainland.

“… I ’ m confident that the new arrangement will give impetus to the further

development of the Hong Kong aviation industry and bring in more competition

and provide consumers with wider choices,” said Stephen Ip, Secretary for

Economic Development and Labor of HKSAR.8

The competition

Under the control of the China Government, all Hong Kong-China routes were straightlyregulated. The routes, airlines and flight frequencies were all subjected to approval by theauthorities. That meant the players in the industry did not compete with each otherdirectly on all routes. For any airline, operating a particular route not only depended onthe economic consideration under the business aspect.

To analyze the market share of each player in terms of dollar value in this particularsegment was not a simple work as it would be only a portion of the listed revenue on theirfinancial report. However, the key operating data of the major players in the marketwould provide a picture on the competition situation and the market concentration [SeeExhibit 2 for a comparison on the key operating data of the major players].

7 Detailed description about this historical situation will be presented in a later part in this report.8 People’s Daily Online “Chinese mainland, HK expand cooperation in air services”, Sept. 08, 2004.http://english.people.com.cn/200409/08/eng20040908_156352.html.



4

The home-based carriers in Hong Kong

There were five home-based airlines in Hong Kong, namely Cathay Pacific, Dragonair,Hong Kong Airlines (previously named CR Airways), Hong Kong Express and Air HongKong as at June 2006.9 (Air Hong Kong was a dedicated freighter airline owned by Cathayand DHL.) As mentioned before, the airline industry was regulated by the Governmentand an approval must be obtained for each airline to operate a particular route. As amatter of fact, it had been a controversial topic about the Government policy to limit thecompetition and development of the air services sector. There was also a liberalizationprocess in the history of the airline industry in Hong Kong.

The Hong Kong’ s one route one airline policy

When the liberalization of the Hong Kong-China aviation market was discussed, aprevious Government policy to regulate the market should be mentioned. This was the socalled “one route, one airline” policy introduced in 1990. Under this policy, theGovernment would in general designate only one Hong Kong-based airline to provideservices on a particular route. It was strictly implemented until 2000 when Dragonair gotthe approval to operate the routes to the Middle East and Europe and compete with Cathaydirectly.

“There have also been questions about the state of competition among Hong

Kong's three local airlines, particularly whether our "one route, one airline"

policy needs to be modified .…This policy has always provided full flexibility for

Government to designate more than one Hong Kong airline on a route whencircumstances warrant additional designations…” said Ms Sandra Lee, Secretary

for Economic Services of HKSAR.10

However, as the airline operations between Hong Kong and mainland China were alsogoverned by the Air Service Agreement signed between the two sides, the competitionbetween the Hong Kong-based airlines on the Hong Kong-China routes was still quitelimited before winter 2006 as stated in the timetable under the 2004 agreement. As at June2006, Dragonair operated passenger flights to 23 mainland cities while Cathay flied toonly two.

Cathay Pacific Airways - the biggest Hong Kong-based carrier 11

Cathay was the first airline company in Hong Kong and had been taking the leadingposition since it was found in 1946. The American Roy C Farrell and Australian SydneyH de Kantzow found the company in Shanghai initially. Then they moved to Hong Kongand the airline began operations in 1948. With a single Douglas C-47 aircraft, the airlineflow routes between Hong Kong, Sydney, Manila, Singapore, Shanghai, and Guangzhoubut the scheduled service was only limited to Manila, Singapore and Bangkok.

Later then the company was acquired by Swire which was one of the largest UK company

9 A budget airline named Oasis Hong Kong Airlines was established in 2005 but its first flight operated in Oct. 2006.10 SES's Letter at "Hong Kong Letter" Programme, Radio Television Hong Kong, July 21, 2001.http://www.info.gov.hk/gia/general/200107/21/0721188.htm11 Information of the company history was collected from Cathay Pacific’s home page and Answers.com.



5

groups in Hong Kong. Swire bought 52% share of Cathay and began to control thisunique home-based carrier in Hong Kong at that time. While Cathay became part of theSwire Group through the publicly-quoted Swire Pacific Limited, it was no surprise that ithad been the largest airline in Hong Kong during the British colony era.

The airline had been growing steadily since it’s started up. It had carried 1 millionpassengers by 1966. Business grew at an average rate of 20% annually during the 60s.Further expansion in 1970s continued and the first Boeing 747-200 arrived in Hong Kongin 1979. More international routes were operated with the worldwide economy boom andCathay Pacific went public in 1986.

In 1996, one year before the handover of Hong Kong, the state-owned Chinese investmentcompany CITIC bought 25% stake in Cathay. After substantial investment from other twoChinese companies CNAC (China National Aviation Company) and CTS, the share of Swire Group was reduced to 44% although it was still the largest shareholder of the

company.

The Cathay Group had a turnover of HK$50,909 million with a profit of HK$3,298million in 2005 [See Exhibit 3 for the performance trend of Cathay in 2001-2005]

Dragonair - the challenger12

Dragonair was the second-largest airline in Hong Kong. It was found in 1985 by Mr. KPChao and started operations with a Boeing 737 service from Hong Kong and KotaKinabalu in Malaysia – a beautiful tourism place with beaches and resorts. Although itwas only a small new airline in Asia at the first beginning, it obtained the licenses to

operate the routes from Hong Kong to eight cities in mainland China in 1986. Then itbegan charter flights to mainland China in 1987.

In 1990, Cathay acquired a 35% holding from Chao and CITIC acquired a 38% share.With the introduction of the “one route one airline” policy by the Government in that year,Cathay gave up the rights to serve mainland China and allowed Dragonair to grow afterthe buy-in. Since then Dragonair had became the sole Hong Kong-based carrier operatingflights between Hong Kong and most major cities in mainland China. That included theHong Kong-Shanghai “golden route” which was Hong Kong’s busies air route after Taipei.Shanghai accounted for 35% of the passenger market and 68% of the cargo marketbetween the Mainland and China.13

As at June 1993, The China routes represented more than 70% of Dragonair ’s business. Itoperated services to 14 destinations around mainland, including Beijing, Changsha,Chengdu, Dailan, Guilin, Haikou, Hangzhou, Kunming, Nanjing, Shanghai, Tianjin,Xiamen, Xian and Ningbo.

"We are fundamentally a China carrier from Hong Kong with a rather smaller set

of services to secondary cities in Asia……We are fortunate that China traffic is still growing very strongly……," said Simon Heale, Dragonair's chief operating

officer.14

12 Information of the company history was collected from Dragonair’s homepage and Answers.com13 “monthly essential china – airports airlines & tourism” #50 Jul-06 Centre for Asia Pacific Aviation14 “Destination China” China Economic Review, June 1993. http://www.chinaeconomicreview.com/cer/info/570.html.



6

The company’s Chinese background was further strengthened by the redistribution of shares in 1996, when CNAC bought 35.86% of the airline and became the largestshareholder. In 2006, Dragonair operated 23 routes from Hong Kong to the major cities inmainland.

The head-on competition between Cathay and Dragonair

In July 2002, Dragonair obtained the license from the Government to operate the highlylucrative route between Hong Kong and Taipei, which had been dominated by Cathaybefore. It was a critical route as direct flights between Taiwan and China had been bannedfor more than 50 years. In fact, the head-on competition between the two airlines beganwhile the “one route, one airline” policy was eased in 2000 when Dragonair operated itsfirst dedicated freighter aircraft to the Middle East and Europe.

Although Cathay owned a 17.79% stake in Dragonair and its parent company Swire

Pacific owned further 7.71% at that time, the two airlines had been operating moreindependently when CNAC (owned 43.29%) and CITIC Pacific (owned 28.49%) took thecontrol of Dragonair since 1996. Observers mentioned that the 1996 deal was made forCITIC, Cathay and Swire to sell the major holdings in Dragonair to CNAC in return for apromise that it would not launch a competitor. It showed that the two airlines would entera competition era in spite of the “brother” relationship.

In August 2002, Cathay submitted the application to operate the routes to Beijing,Shanghai and Xiamen in mainland China. Following with this, Dragonair launched apublic objection in Sept.

"Dragonair's position is that the points named in the application are unable tosupport the operation of more airlines, with more than sufficient capacity

currently available on the routes. Allowing the application would therefore result

in the uneconomical overlapping of air services," Dragonair said in the statement.

"Moreover, Dragonair's ability to expand operations to primary destinations

outside China has been constrained in the past, leading to its reliance on the

Shanghai and Beijing routes."15

The objection led the Hong Kong’s Air Transport Licensing Authority (ATLA) to call thefirst public route license hearings in more than a decade.

"Hong Kong is currently being bypassed by China-bound traffic from Europe, North America, Australia and South-East Asia. Our aim is to change these traffic

flows and enhance connectivity through Hong Kong……Other airlines, such asSingapore Airlines, Thai Airways, Japan Airlines and Korean Air, and hubs in the

region, have recognised the potential of the China market and are developing

connecting services of their own. Hong Kong will find it hard to recover ground

lost to competitor hubs if it falls any further." Cathay argued in the hearings.16

After the hearings, the ATLA awarded the licenses to Cathay for the services to Beijing,Shanghai and Xiamen. While this must still be further approved by authorities in China,

15 “Cathay and Dragonair in Hong Kong power battle” Airline Business Oct 1, 2002. Flightglobal.com.http://www.flightglobal.com/articles/2002/10/01/155845/cathay-and-dragonair-in-hong-kong-power-battle.html16 “Cathay and Dragonair in fight over rights to China” Airline Business Mar 1, 2003. Flightglobal.com.http://www.flightglobal.com/articles/2003/03/01/162202/cathay-and-dragonair-in-fight-over-rights-to-china.html



7

Dragonair tried to take legal action to overturn the award through the Hong Kong HighCourt. However, Dragonair dropped the plan to proceed with a judicial review in August2003. Eventually Cathay got the approval on the Beijing route at the end of this year.Until the 2004 Air Service Agreement, Cathay further obtained the rights on the operationfor the passenger service to Xiamen and cargo flights to Shanghai. The opening for theHong Kong-Shanghai passenger route was scheduled on Oct. 2006.

Obviously, the Hong Kong-China aviation market was critical for both Hong Kong-basedairlines. For Dragonair, most of its earning was from the passenger services to China. ForCathay, it was a huge potential market for the company to grow. Their strategies to thecompetition environment would have significant effects on the survival of their owncompany and also the huge amount of customers who were travelling between Hong Kongand mainland frequently.

“Deal of the Decade” in the Industry

The long-anticipated acquisition

On Jun 9, 2006, a press released was issued by five key companies in the Hong Kong-China airline industry about the takeover of Dragonair by Cathay. As a matter of fact, theplan for Cathay to buy control of Dragonair had been talking in the industry for a longtime. The long-awaited agreement was reached by Air China, Cathay Pacific, CNAC,CITIC Pacific and Swire Pacific for the restructuring of their shareholdings in Cathay andDragonair.

Under the deal, Cathay would pay HKD8.2 billion for the remaining 82.2% shares of Dragonair from CITIC Pacific, Swire Pacific and CNAC (the parent company of theBeijing-based Air China) to acquire the whole company. In the agreement, Cathay wouldalso double its stake in Air China to 20%. Air China would acquire 17.5% stake inCathay from Swire Pacific and CITIC Pacific at the same time [See Exhibit 4 for theShareholding structures of the involved parties before and after the deal].

The cooperation under the agreement included a cargo joint venture in Shanghai betweenAir China and Cathay. Moreover, Dragonair would operate as a separate brand andCathay’s mainland routes would operate with joint profits sharing arrangements with AirChina.

The key outcomes of the agreement could be simplified as follows:

1. Dragonair would become a wholly-owned subsidiary of Cathay and operated underCathay’s management with its brand unchanged;

2. Air China would become a substantial shareholder of Cathay; and3. Cathay’s share in Air China would be increased.

The efficiency gain

In the acquisition, Dragonair was valued at HKD10 billion. Although Cathay paid asubstantial premium for Dragonair, the takeover should be a win-win arrangement thatwould significantly increase the competitiveness of the three airlines in the emergingChinese aviation market.



8

“The deal heralded "a new era for our growth and the development of the

aviation industry" in China and Hong Kong……We will reinforce Hong Kong and

Beijing's position as primary aviation hubs in the Asia-Pacific region and provide

a platform for growth and expansion into the mainland, the regional and

internationally," Said Christopher Pratt, chairman of Swire Pacific, the major

stakeholder in Cathay.

"It's a golden opportunity for Cathay to build on Air China's comprehensive

network……Hong Kong and Beijing would benefit because the "effectiveness of air services are what makes great cities in the 21st century," said Martin Craigs,

president of Aerospace Forum Asia, an industry chamber.17

This strategic move ended the long lasting battle between Cathay and Dragonair. It wasno doubt that there would be an efficiency improvement for the operations on the Hong

Kong-China routes by the merged management. For example, the cost in maintaining theChina outports could be lower and many overhead could be consolidated and betterutilized among the organizations.

On Sept 28, 2006, Cathay made another press release to announce that the shareholdingrealignment was completed after all the necessary approvals and conditions were obtained.

“Work will begin immediately to maximize the synergies and opportunities that

arise from linking Cathay Pacific’s international network with Dragonair’sextensive Mainland services, bringing significant long-term benefits to both

carriers and helping to further cement Hong Kong’s position as a leading

international aviation hub.”18

It was announced that a restructuring would be made resulting in 174 job losses atDragonair in Hong Kong and 17 staff in overseas offices would also be affected. Thisrepresented a 5% of the total workforce in Dragonair.

The elimination of competitor

However, the intention for the deal to eliminate competitors in the market segment wasalso obvious. At that time, Dragonair operated air services to 23 major cities in Chinaincluding Shanghai while Cathay was limited to Beijing, Xiamen and cargo-only service

to Shanghai. After Cathay took over its rival Dragonair, it would own the passengerservices to 23 China cities with all the existing routes immediately. In other words, thetwo home-based airlines serving the Hong Kong-China market would become one.

Some people said that this was good news for Cathay and Dragonair, but bad news forconsumers in Hong Kong as “monopoly is never a good thing for consumers”. In fact,Cathay shares were up as much as 3.86% on the announcement. People believed thatCathay would benefit from the deal in a long run as its market power was furtherstrengthened.

17 Donald Greenlees “Cathay seals Dragonair deal, taking lead in China” International Herald Tribune Jun 9, 2006http://www.iht.com/articles/2006/06/09/business/cathay.php18 “Cathay Pacific completes shareholding realignment making Dragonair a wholly owned subsidiary” Press ReleaseDetails Sept. 28, 2006 Cathay Pacific homepage



9

As there was no anti-competition law in Hong Kong at that moment, the merger would notbe challenged anyway. The airline market had been regulated by the Government for along time and the choices of service providers for the consumers were always limited.While the market had been liberalizing, the action Cathay taken was a smart strategy tomaintain its control power in the particular market segment.

At least from the air cargo industry, there was some noised made from the Hong Kong AirCargo Terminal Limited (HACTL) about the merger. After the announcement of theacquisition, HACTL criticized that there would be a negative impact on the competitiveenvironment in the Hong Kong air cargo industry.

Cathay Pacific and Dragonair's combined cargo volume is currently 40% of the

Hong Kong International Airport total. The merger of the two airlines if combined

with cargo self-handling would therefore create a dominant, vertically-integrated

air cargo operation.19

HACTL stated in a press release that there would be a potential negative impact on airlines,cargo terminal operators, freight forwarders and other participants in the industry whichwas one of Hong Kong's key business sectors.

Proactive strategy to the opening market

From another point of view, when all the players in the market were counted whichincluded those China-based airlines, the market would be still considered as socompetitive. In fact, the deal was not only for the acquisition of Dragonair, but also asignificant alliance between Cathay and Air China was achieved. This cooperation might

be more critical for Cathay to further compete with all existing players and other newcomers in the future as it could be foreseen that the market would be opened continuously.

With the opening of the aviation market in Hong Kong, new Hong Kong-based airlineshad been entering the market. A budget airline Oasis Hong Kong started operation in Oct2006 and positioning as a low-fare airline in Hong Kong. Another Hong Kong-basedairline Hong Kong Airlines (previously named CR Airways) which started their operationsin 2003 was planning to acquire Hong Kong Express by end of 2006 to become the thirdlargest airline in Hong Kong.

Moreover, it was known that both Hong Kong SAR Government and China Government

were investigating on the implementation of anti-competition law. Such kind of horizontalintegration within the industry must be very sensitive and much time consuming once anykind of competition regulation was executed in the country. It was really a proactivestrategy for Cathay to conclude the deal at that time.

As mentioned by Merrill Lynch in a research, “Dragonair had integrated "extremelyquickly" due to lack of regulatory or union obstacles, so benefits of the acquisition couldaccrue quicker than expected.”20

19 “Cathay/Dragonair merger to adversely impact Hong Kong air cargo industry competitive environment” Press ReleaseDetails Jun 11, 2006 HACTL homepage http://www.hactl.com/en/mediactr/press20060611.htm20 Alman Loong “ Cathay Pacific and Dragonair issue first integrated figures since merger” The Standard Feb. 17, 2007http://www.thestandard.com.hk/news_detail.asp?pp_cat=1&art_id=38501&sid=12269922&con_type=1



10

The story was not ended…..

The new air service pact

Right after the Cathay/Dragonair deal, a new air service agreement between Hong Kongand mainland was announced in July 2006. It included the approval of an extension onanother 11 routes between Hong Kong and China, which meant that the total number of routes would be increased from 45 to 56 and the coverage would be enlarged to all majorcities in the mainland.21

In addition, the agreement allowed more airlines to operate the Hong Kong-China routes.Each side could designate up to three airlines to operate air services (passenger and/orcargo services) and another one cargo-only airline on most routes except Beijing,Guangzhou and Shanghai. Cathay was granted the right to fly to Shanghai eventually.

There was a trend for the Government policy to introduce more competition in the market.The Hong Kong-China routes had been regulated for a long time. It was believed thattravelers could have more choices and be able to enjoy more reasonable prices in thecoming future even the market players like Cathay and Air China were working hard tomaintain their market power.

An era of price war is coming?

In January 2007, two airlines running the Hong Kong-Shanghai route offered promotionalpricing for the round trip ticket. They were China Eastern, and Shanghai Airline which

just began to operate this “golden” route since Dec. 2006. The price was as low as

RMB600 plus tax and misc. charges which made the total fare less than RMB1,100 for around trip ticket from Shanghai to Hong Kong.22

This was really a “shocked” price as the normal price for the same ticket was RMB2,500-3,000. The high pricing for this route had been complaining not reasonable by thetravelers when comparing to other similar distance flights in Asia. In the past, the routewas only served by the Hong Kong-based Dragonair and Shanghai-based China Eastern.

Although this was just a short period promotion with limited seats on selected flights, thiskind of pricing had never been happened before. Maybe this was an implication for theemerging competition in the market and the consumers would benefit eventually.

21 “China opens Hong Kong market” Air Transport Jul 11, 2006. Flightglobal.comhttp://www.flightglobal.com/articles/2006/07/11/207716/china-opens-hong-kong-market.html22 “沪港航线出现 600元超低价往返机票”XinHua Net Jan 10, 2007 http://news.xinhuanet.com/tai_gang_ao/2007-01/10/content_5589212.htm



11

EXHIBIT 1: Joint Declaration of the Government of the United Kingdom of Great Britainand Northern Ireland and the Government of the People's Republic of China on theQuestion of Hong Kong.

Annex I - Elaboration by the Government of the People's Republic of China of its Basic Policies

Regarding Hong Kong.

IX. CIVIL AVIATION

Air services

The Central People's Government shall, in consultation with the Hong Kong Special Administrative RegionGovernment, make arrangements providing for air services between the Hong Kong Special AdministrativeRegion and other parts of the People's Republic of China for airlines incorporated and having their principalplace of business in the Hong Kong Special Administrative Region and other airlines of the People'sRepublic of China. All Air Service Agreements providing for air services between other parts of the People'sRepublic of China and other states and regions with stops at the Hong Kong Special Administrative Region

and air services between the Hong Kong Special Administrative Region and other states and regions withstops at other parts of the People's Republic of China shall be concluded by the Central People's Government.For this purpose, the Central People's Government shall take account of the special conditions and economicinterests of the Hong Kong Special Administrative Region and consult the Hong Kong SpecialAdministrative Region Government. Representatives of the Hong Kong Special Administrative RegionGovernment may participate as members of delegations of the Government of the People's Republic of China in air service consultations with foreign governments concerning arrangements for such services.

Air Service Agreements

Acting under specific authorisations from the Central People's Government, the Hong Kong SpecialAdministrative Region Government may:

renew or amend Air Service Agreements and arrangements previously in force; in principle, allsuch Agreements and arrangements may be renewed or amended with the rights contained in suchprevious Agreements and arrangements being as far as possible maintained;

negotiate and conclude new Air Service Agreements providing routes for airlines incorporated andhaving their principal place of business in the Hong Kong Special Administrative Region and rightsfor overflights and technical stops; and

negotiate and conclude provisional arrangements where no Air Service Agreement with a foreignstate or other region is in force.

All scheduled air services to, from or through the Hong Kong Special Administrative Region which do notoperate to, from or through the mainland of China shall be regulated by Air Service Agreements orprovisional arrangements referred to in this paragraph.

The Central People's Government shall give the Hong Kong Special Administrative Region Government theauthority to:

negotiate and conclude with other authorities all arrangements concerning the implementation of the above Air Service Agreements and provisional arrangements;

issue licences to airlines incorporated and having their principal place of business in the HongKong Special Administrative Region;

designate such airlines under the above Air Service Agreements and provisional arrangements; and

issue permits to foreign airlines for services other than those to, from or through the mainland of China.

Source: http://www.info.gov.hk/trans/jd/jd3b.htm



12

EXHIBIT 2: Key operating data for the major airlines having business on the Hong Kong-Mainland routes in 2005

T o t a l R e v e n u e

A T K

A S K

R P K

T o t a l

H o n g K o n g / M a c a u #

M a i n

l a n d - b a s e d A i r l i n e s

( R M B

M i l )

C h i n a E a s t e r n

2 7 , 4 5 4

8 , 7 5 1

5 2 , 4 2 8

3 6 , 3 8 1

2 4 , 2 9 0

2 , 3 2 1

1 6

C h i n a S o u t h e r n

3 8 , 2 9 3

1 1 , 5 0 9

8 8 , 3 6 1

6 1 , 9 2 3

4 4 , 1 1 9

1 , 5 5 6

1 5

A i r C

h i n a

3 8 , 2 9 1

1 1 , 4 2 2

7 0 , 6 6 2

5 2 , 4 0 5

2 7 , 6 9 5

8 8 2

9

H o n g K o n g - b a s e d A i r l i n e

( H K D M i l )

D r a g o n a i r

4 , 6 9 9

3 , 0 2 8

1 0 , 0 6 5

6 , 4 8 5

5 , 2 6 1

3 , 5 7 7

2 2

C a t h a y P a c i f i c

5 0 , 9 0 9

1 7 , 7 5 1

8 2 , 7 6 6

N o

t p r o v i d e d

1 5 , 4 3 8

N o t p r o v i d e d

2 + 1 ( c a r g o - o n l y )

R e m a r k s :

* K e y o p e a r t i o n s t a t i s t i c s i n c l u d e :

# # N u

m b e r o f r o u t e s o p e r a t e d b y t h e C h i n a - b a s e d a i r l i n e s w e r e c o u n t e d a s o f M a r c h 2 0 0 7 .

S o u r c e s : D a t a w e r e t a k e n f r o m t h e 2 0 0 5

a n n u a l r e p o r t o f e a c h a i r l i n e a n d C

N A C w h i c h h o l d 4 3 . 2 9 % o f D r a g o

n a i r .

# A s o

n l y C h i n a S o u t h e r n p u b l i s h e d t h e r e v e n e u e g e n e r a t e d f r o m t h e H o n g K o n g / M a c a u a r e a , t h e n u m b e r o f p a s s e n g e r s c a r r i e d i s

u s e d h e r e t o s h o w t h e i r s h a r e o n t h e H o n g K

o n g - M a i n l a n d m a r k e t . A l t h o u g h C a t h a y d i d n ' t p r o v i d e t h i s f i g u r e , i t s h o u l d b e v e r y

s m a l l

c o m p a r i n g t o o t h e r s a s t h e y o n l y o p e r a t e d t w o r o u t e s a t t h a t t i m e .

A v a i l a b l e s e a t k i l o m e t r e s ( “ A S K ” ) - P a s s e n

g e r s e a t c a p a c i t y , m e a s u r e d i n s e a t s a v a i l a b l e f o r t h e c a r r i a g e o f p a s s e n g e r s

o n e a c h

s e c t o r m u l t i p l i e d b y t h e s e c t o r d i s t a n c e .

A v a i l a b l e t o n n e k i l o m e t r e s ( “ A T K ” ) - O v e r a l l c a p a c i t y , m e a s u r e d i n t o n n e s a v a i l

a b l e f o r t h e c a r r i a g e o f p a s s e n g e r s , e x

c e s s

b a g g a g e , c a r g o a n d m a i l o n e a c h s e c t o r m u l t i p l i e d b y t h e s e c t o r d i s t a n c e .

K e y o p e r a t i n g d a t a f o r t h e m a j o r a i r l i n e s h a v i n g b u s i n e s s o n t h e H o n g K o n g - M a i n l a n d r o u t e s i n 2 0 0 5

R e v e n u e p a s s e n g e r k i l o m e t r e s ( “ R P K ” ) - N

u m b e r o f p a s s e n g e r s c a r r i e d o n e a c h s

e c t o r m u l t i p l i e d b y t h e s e c t o r d i s t a n c e .

N o . o f r o u t e s o p e r a t e d

- H K / C h i n a c i t i e s #

#

K e y O p e r a t i o n S t a t i s t i c * ( M i l )

N o . o f p a s s e n g e r c a r r i e d ( ' 0 0 0 )



13

EXHIBIT 3: Performance Trend of Cathay Pacific Airways Ltd in 2001-2005

Source: Cathay Pacific Airways Limited Annual Report 2005



14

EXHIBIT 4: Changes of the Shareholding Structures in the Cathay/Dragonair Merger

Source: “monthly essential China – airports airline & tourism” #49 Jun-06 Centre for Asia PacificAviation

Project Report CP 07

Documents

Transcript of Project Report CP 07