As China Southern Airlines’ potential partners waltzthrough their joint-venture negotiations, what hadbeen a keen sense of anticipation among spectatorsis becoming somewhat jaded, if you’ll excuse the pun.Michael Westlake checks out who is leading who.

Germany’s Lufthansa, developmentbank DEG and Shenzhen Airlines havetheir Jade Cargo International jointventure up and running from Shenzhen,only about 30 miles away fromChina Southern’s massive Guangzhoubase.

China Southern’s two major competingmainland carriers, Air Chinaand China Eastern, both have separatecargo subsidiaries.

But a tie-up between China Southernand a foreign partner ¨C Air France-KLM has long been the heavily toutedfavourite ¨C has now been postponed.Officials at China Southern have beenquoted as saying that they had hopedto close negotiations by the end oflast year; now they hope to concludearrangements this year.

However, while China Southernchief financial officer Xu Jiebo saidin public that the foreign partner orpartners being sought would be fromthe SkyTeam grouping, he added thatAir France-KLM was not the only potentialtarget.

The base of the futurejoint venture is also indoubt ¨C either Guangzhou,with plenty of room forexpansion at its massiveand relatively new airportthere, or Shenzhen, goinghead-to-head with JadeCargo’s current three747-400 freighters (withthree more to come) andperhaps better positionedto attract some of the aircargo that now goes byroad to Hong Kong toconnect with internationalflights. China Southernexecutives contacted inconnection with this articledid not reply.

China Southern is expectedto formally joinSkyTeam this year. China’scurrent policy on jointventures is that its statecompanies must hold 51percent, while no singleforeign entity can holdmore than 25 percent.

The obvious point ofthe joint venture wouldbe to improve the backhaulof freight bound forChina, which is a long-standing weakness, compared withChina’s huge volumes of outboundfreight. In 2005, the airline’s statisticssay, a total of 6.33 million tonnes of aircargo were handled, up 14.6 percentover 2004’s figure. Government officialspredict an average of 10 percentexpansion per year for the next fiveyears, though the International Air Transport Association expects a rateof 14.4 percent by 2009.

The SkyTeam Cargo alliance’seight members are Russia’s Aeroflot, AeroMexico, Franco-Dutch Air FranceKLM, Italy’s Alitalia, Czechoslovakia’sCSA, Korean Air and the United States’Delta and Northwest Airlines.

China Southern has stated that itwants partners from the U.S. and/orEurope, apparently firmly dashingthe hopes of Korean Air, which wasinvolved in joint-venture talks with theGuangzhou-based carrier in the middleof last year. This would seem to leaveAir France KLM, Delta and Northwestin the running.

While the potential marriage partnersseem to be expected to take upto 49 percent between them, ChinaSouthern would remain firmly in controlwith 51 percent.

That’s definite, as is a statementin January that the airline expects torecord a profit in 2006 for the first timesince 2002, partly helped by a stronger renminbi, higher fuel surchargesand strong traffic growth.The expected profit wasnot stated, though totalsales (unaudited) weregiven as RMB46.5 billion(US$6.003 billion). It announceda RMB1.79 billionloss for 2005 on salesof RMB 38.3 billion.

China Southern reporteda profit for thethird quarter of 2006of RMB1.2 billion. Howmuch of the profit wasfrom cargo was not stated.Cargo volume rose by 5.6percent to 818,000 tonnes,the airline said.

However, as a practicalmatter, public datashow that each percentagepoints of renminbiappreciation produces again for China Southernof more than 490 millionrenminbi, because mostof its debt is in US dollars.With the renminbi havingappreciated 3.4 percentover the US dollar, thiswould seem to account formuch of the financial happinessemanating from theairline’s headquarters.

China Southern’s announcementin January that it expects to declarea profit for 2006 led to a surge in itsown, Shanghai-based China Eastern’sand Beijing-based Air China’s stockprices.

A practical demonstration of ChinaSouthern’s optimism came with newsin late January that it is consideringordering 12 more Boeing 777 freightersfor US$2.88 billion. It currentlyoperates two cargo 747-400s and lastyear ordered six 777 freighters, withthe large passenger fleet supplyingfurther belly space.

Zhang Zhifeng, senior generalmanager of China Southern Cargodepartment, who is also vice chairmanof the Commercial Steering Committeeof China Southern Airlines announcedthat the airline intends to have 20freighters within the next five years.Analysts point out, however, that the777 freighter order, has yet to be officiallyconfirmed.

But there’s competition. Lots of it,with more to come. And it’s officiallyendorsed by the government, which has liberalised access to China by foreigncarriers, eased regulations for jointventures, simplified purchasing aircraftsuch as 747s and boosted the industry in general as a means of developingChina’s economy as rapidly as possible.Outbound cargo is fine: China is theworkshop for the world and is churningout goods at all levels as fast as it canget investment for factories and raiseskill levels among workers.

The obvious follow-on is the needto import equipment to produce theseexports, but while there is some, localindustries are also developing theirown abilities to produce manufacturingmachinery. Hence the huge tradeimbalances with the U.S. and Europe,which Washington in particular makesa large political pint of complainingabout.

Enter the foreign carriers: of theU.S. carriers, FedEx is shifting its regionalhub from Subic Bay in the Philippines to a US$150 million “superhub”at Guangzhou, to open next year.

UPS is setting up a large hub at Shanghai, while DHL operates withinChina as a forwarder and, apart fromits Air Hong Kong joint venture withCathay Pacific Airways serving China,now has an airfreight licence to operatedomestically within China, covering17 cities.

The two US companies plus DHL accountfor more than 95 percent of theChina-US air express cargo market.

There’s more competition from thesouth: Cathay Pacific, having purchasedformerly China-owned shares in second-tier Hong Kong carrier Dragonairlast year, is consolidating operationswhile ¨C for the meantime ¨C maintainingboth carriers’ separate brands.

For how long this will apply to cargois anyone’s guess. Also, Cathay and AirChina, the country’s principal carrier,have shares in each other and haveobvious strategic as well as economicinterests in co-operating.

Is China Southern likely to feelsomewhat squeezed? Perhaps – Sydneybasedconsultancy CAPA said in Januarythat it thought it likely that Shanghai basedChina Eastern would be mergedwith China Southern to become one oftwo Chinese mega-carriers ¨C the otherbeing the Cathay Pacific/Air Chinaalliance.

The Guangzhou-based carrier wasone of three major operators createdby the splitting up of the former combinedregulator and operator, the CivilAviation Administration of China ¨C theother two were Air China in Beijing andChina Eastern in Shanghai.

All three were centred on CAAC’sformer main operating hubs. Theircreation was intendedto separate the roles ofairline regulator andoperator, as well as tocreate more manageablecompanies from the behemoththat CAAC hadbecome.

After its founding as aseparate entity in 1995,China Southern issuedshares on the New Yorkand Hong Kong stockexchanges. In 2000 thethree majors were namedas leaders of the furtherrestructuring of China’saviation industry, eachof them being forced toabsorb smaller and sometimesfar from profitableregional carriers. By latelast year China Southern was China’slargest carrier by fleet size, with morethan 290 aircraft.

Somewhere between 70 percentand 80 percent of the airline’s revenuecomes from domestic services; cargorevenues accounted for 8.5 percent ofits total revenues in 2005, though thispercentage has increased since then.So what of the future? In the short-to-medium term, it would appear that¨C barring disasters such as anotheroutbreak of disease in southern Chinasuch as 2003’s Severe Acute RespiratorySyndrome or a collapse of the USeconomy ¨C demand for China’s exportsis likely to hold up.

This being so, more flights will beneeded to carry them. The only worryhere is that so much capacity might beadded so fast that yields fall throughthe floor.

If that potential obstacle can beavoided, then the obvious pitfall is thatof competition from (a) Cathay Pacificfrom Hong Kong and (b) Air China/Cathay Pacific via Beijing. But it seemsmore likely that with China Southern’sdomestic network well placed to feedcargo to either Guangzhou or Shenzhenfor its international services, thecarrier should have plenty of roomwithin which to grow its business.

Apart from domestic flights, it is alsoheavily involved with acquiring cargovia local trucking companies from thenearby manufacturing zones surroundingShenzhen and Guangzhou.

In the longer term, there is still apuzzle. Is Hong Kong’s border to becomemore transparent to economicinfluences? Will the predominance ofair services to and from Hong Kongbe maintained above those availablefrom southern China?And will Hong Kong beable to control its pricing?If the answer to anyof these is negative, thenHong Kong’s perceivedadvantages of service andthe rule of law in businessdisputes may melt away.

It is often said that itis in the interests of thecentral government inBeijing and of China asa whole that Hong Kongshould continue to be aneconomic success story,in some respects actingas a model for the rest ofChina’s development.

The deal and potentialco-operation betweenCathay Pacific andAir China reflects that thought.But Guangzhou is a long way fromBeijing.

Also, southern Chinese entities holdsway so far as access to the border crossingsis concerned, and it has long beenthought that officials in GuangdongProvince adjoining Hong Kong wouldprefer to see more of their exports beingshipped via their own airports.

Whether this form of local loyaltywould extend to actively helping thelocal major airline has yet to be seen.

Guangzhou to serve as hub in major airline expansionChina Southern Airlines has announced a major international expansion with new air routes to eight nations including Cambodia, India, Japan, Laos, United Arab Emirates, Nigeria and Angola. This new international expansion is a major step in China Southern’s construction in building Guangzhou as a major global business and logistics destination, the airline said in a statement. Si Xian Min, president of China Southern Airlines, said, “this announcement marks the first time for China Southern to announce this major international expansion originating from Baiyun International Airport and the first time China Southern will open such an extensive route expansion within one single year.” His announcement comes on the heels of China Southern’s recent opening of new service from China to Lagos, Nigeria and Kathmandu, Nepal. Si added that, “as we race towards the end of China’s eleventh five-year plan, China Southern Airlines will continue to add more flight capacity to its home Guangzhou market. “We plan to add 68 new modern jet aircraft to the China Southern fleet by the end of 2007 – with the goal of 440 aircraft.” Si stressed the importance of China Southern Airlines forthcoming full membership in the global SkyTeam Alliance, slated for the second half of 2007. International routes slated for opening in 2007 include: Services from Guangzhou to Dubai, Luanda, Sendai, Sapporo, Kathmandu, Delhi, Siem Reap, Phuket, Yangon and Vientiane. By the close of February 2007, China Southern Airlines will operate 82 international and regional services. Guangzhou and Beijing will serve as its major airport hubs, with regional airports in Urumqi in China’s north east and Shenyang in the north west serving as an air network covering all of Asia with convenient connections to Africa, Australia, Europe and the US. As the US$3 billion Guangzhou Baiyun International Airport enters its second phase of expansion, China Southern Airlines’ hub construction has gained significant momentum as it quickly expands the Southern Chinese marketplace to the world. As these 10 new routes are launched, international outbound routes from Guangzhou will nearly double from the current 18 to 26. Weekly international frequencies will rise from the current 136 to 182 flights ¨C an increase of more than 30 percent.