Category:[world] [CHINA] [National]

When Li Jiaxiang, the chairman of Air China, agreed to sell the airline's Hong Kong unit to Cathay Pacific Airways for $1.58 billion, he held out for more than just money. In exchange for access to the growing Chinese domestic market, Cathay agreed to a partnership with Air China that will help the Beijing-based carrier glean management and technical expertise from Cathay, one of the most profitable Asian airlines.

"They're looking to build their business across the world," said Tony Tyler, chief operating officer at Cathay. "We do most things pretty well; there are not a lot of airlines that do many things better. They're very keen to learn from us."

The agreement could provide a model for Chinese companies to expand through links with overseas rivals, as outright takeovers have disappointed investors. Lenovo Group, which bought International Business Machines' personal-computer unit last year, posted an 89 percent drop in first-quarter profit, partly due to the costs from cutting jobs at the PC unit.

"It's another way of doing M&A," said Ng Kay Ian, a partner in Hong Kong at Freshfields Bruckhaus Deringer who advised Air China in its talks with Cathay Pacific.

"If you are willing to step outside your comfort zone, join the other side's camp as a director or senior manager and thereby learn their method of operating, that's more likely to result in enhanced cooperation between the two sides," Ng said.

As part of the transaction, Air China will acquire a 17.5 percent stake in Cathay Pacific, based in Hong Kong, as well as two seats on the Cathay board. Cathay will buy Hong Kong Dragon Airlines and double its stake in Air China to 20 percent. Cathay Pacific shareholders approved the deal this month.

"This sets a precedent for other state- owned companies to get into international firms so they can better understand the inner workings of a global company," said Jeanette Chan, a specialist in China mergers at the law firm of Paul, Weiss, Rifkind, Wharton & Garrison in Hong Kong.

Merrill Lynch and China International Capital advised Air China. ABN AMRO Holding advised Cathay.

China Eastern Airlines, which has one of the country's biggest fleets of aircraft, said in July that it was talking to potential investors, including Singapore Airlines. The Shanghai-based airline is seeking to improve service after it posted a first-quarter loss of 955 million yuan, or $119 million.

Chinese companies offered to buy $32 billion of overseas assets in the past 24 months, more than five times the figure for the previous four years, according to data compiled by Bloomberg.

Cross-shareholding agreements can reduce political objections and improve chances of getting a deal done, said Peter Ding, a director at UBS who specializes in mergers in China.

CNOOC, the largest Chinese offshore oil producer, failed in an $18.5 billion bid for Unocal last year because of opposition from the U.S. Congress.

China Minmetals, a state-owned metals trader and producer, made an unsuccessful 7 billion Canadian dollar, or $6.3 billion, offer for Noranda, based in Toronto, in November 2004. Two months later, the Canadian industry minister said he would consider rules giving him more power to block sales of domestic resource companies to entities controlled by foreign governments.

Other takeovers have not delivered shareholder much in the way of returns as Chinese managers struggle to run international companies.

TCL, a maker of electronic products based in Guangdong, posted a loss of 320 million yuan last year, partly because of its unprofitable television venture with the French firm Thomson. TCL Communication Technology Holdings bought Alcatel's 45 percent stake in a China cellphone venture in 2005 to end the management differences that had stalled sales.

"The venture didn't work well because of integration reasons," said Christian Doeringer, general manager in Guangzhou for Hewitt Associates, a human resources consultancy. "The two companies did not align with each other at all."

Shares of Lenovo have fallen 17 percent to 2.96 Hong Kong dollars, or 38 U.S. cents, this year as Chairman Yang Yuanqing works to increase profit and integrate the IBM PC unit. Stephen Ward, who worked at IBM for 26 years, quit as chief executive officer of Lenovo after less than a year.

Deals like the Cathay-Air China agreement help take some of the risk out of cross-border mergers by allowing both parties to study their partners, Ng, of Freshfields, said.

"If you don't have people on the ground to run the proper checks, then chances of success will be slim," he said.

Air China is linking with Cathay as China opens its market, allowing rivals like British Airways to add flights to the country. The tie-up could also help Air China against domestic rivals like China Southern Airlines.

The agreement was made easier because Cathay had as much to gain as Air China, Ding, of UBS, said.

With Dragonair, Cathay will gain passenger flights to cities like Shanghai and Tianjin, becoming the dominant overseas-controlled airline serving China.

"It's win-win," Ding said. "The Chinese love that."

Air China and Cathay blaze path for expansion(Over)
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