China Eastern’s Budget Play: Turbulence Ahead 东方航空成立廉价航空公司：将面临动荡

By newsdoug on March 27, 2012

I don’t usually write about China’s airlines as I don’t think the industry is very exciting as a growth story; but as a Shanghai resident I just had to comment on the big new announcement by my hometown carrier China Eastern (HKEx: 670; Shanghai: 600115; NYSE: CEA), which is forming a budget airline joint venture with Australia’s Quantas (Sydney: QAN). To put it bluntly, I would warn investors that this new venture is destined for major turbulence, if it ever even gets off the ground. Under the tie-up, the 2 sides will form a new airline under Quantas’ JetStar low-cost brand to be based in Hong Kong. (English article) The venture will start off small, with just 3 airplanes, and plans to expand that to 18 over the next 3 years. I don’t like to say bad things about my hometown airline, but frankly speaking China Eastern is the worst managed of China’s major 3 airlines, with frequent unexplained delays and so-so service, and most people I know will take any other carrier whenever they can. The airlines tried to improve its situation in 2008 when it tried to sell 24 percent of itself to Singapore Airlines (Singapore: SIA), one of Asia’s best-run airlines. But that investment was ultimatelyl blocked by Air China (HKEx: 753; Shanghai: 601111), one of China’s other big three airlines which was also a major stakeholder in China Eastern. Frankly speaking, I think that Air China deliberately sabotaged the deal to make sure China Eastern remained a weak player in the industry. I also think the system of cross-stakeholding that allowed Air China to veto the deal will be a major obstacle to China Eastern’s future development, and could easily see Air China trying to meddle in this new Quantas joint venture if it is even slightly successful — a prospect that seems highly unlikely. China Eastern executives said one of the reasons for forming a low-cost carrier was that they noticed that the company’s business- and first-class cabins often had many empty seats, which they interpreted to mean that passengers were more interested in saving money than paying for premium service. But if the airline had bothered to survey passengers who frequently fly in business and first class, it probably would have quickly learned that such travelers avoid flying on China Eastern because they don’t want to pay more only to receive its poor service and frequent delays. Strong management is key to running any successful airlines, and even more important at a budget carrier where efficient cost controls are the only way a company can earn money. Given China Eastern’s already poor management record, I would seriously doubt its ability to effectively run an efficient budget airlines, and would expect even the most cost-sensitive consumers to ultimately become fed up with its new low-cost airline and look for other options.

Bottom line: A new budget carrier from China Eastern and Quantas is destined for major operational problems, and is more than 50 percent likely to fail within its first 5 years.

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