An Australian Airline With Chinese Characteristics

But they’ll be hearing a lot more about Hainan and its parent, the HNA Group, in the wake of its dramatic investment in June in beleaguered Virgin Australia (VA).

As for Nanshan, it is the surprise buyer for most of Air New Zealand’s Virgin Australia stake. A large privately-owned Chinese conglomerate, Nanshan owns small Chinese start-up Qingdao Airlines, along with interests in sectors spanning aluminium, agriculture, education and property. It does have some other interests in Australia, including the Riverside Oaks golf course and the Pullman Sydney Airport hotel, which it purchased last year for $84 million. Nanshan also purchases bauxite from Rio Tinto for its aluminium production.

Together, given approval by Australian regulators, these two will control more than one third of Virgin and give China a long-sought major foothold in Australian aviation.

Consider this. Singapore Airlines (SIA) and Abu Dhabi’s Etihad Airways may have been seen as powerful shareholders for Virgin, but HNA’s global reach puts them in the shade. In the past few years, according to its own numbers, it has invested some A$15 billion in 34 overseas deals, snapping up ownership or part-ownership in nine foreign airlines and everything from hotels to supermarkets, travel companies and transport-related firms. It recently agreed to buy Swiss airline catering company Gategroup Holding for about $1. 4 billion and is in talks with Air France to buy half of its catering unit, Servair. Other recent buys include Carlson Hotels, which has 1,400 properties and covers the Radisson and Park Plaza brands.

The Chinese conglomerate now has more than $91 billion of assets worldwide and its flagship, Hainan Airlines, is China’s fourth largest carrier with a global network. It is, according to one analyst, on its way to being one of the biggest companies in the world.

For Virgin the arrival of an HNA board member following its $159 million splash for a 13 per cent stake – with the aim of raising that to 19. 9 per cent – changes the game. And it raises questions for other shareholders, particularly Singapore Airlines. Aside from Bali, VA currently doesn’t fly to Asia, let alone China. Its passengers get to China on a codeshare arrangement over Singapore with SIA.

But Virgin has now applied for rights to Hong Kong and China, services it will operate as codeshares with Hainan, allowing its passengers to penetrate the vast Chinese domestic market through the 13 local carriers that are HNA subsidiaries. It’s a mouthwatering prospect and one that finally answers a major criticism of VA, that it seemed to be ignoring the massive Chinese market.

As Virgin chief executive John Borghetti put it in a call with reporters after the announcement: “We carry almost no traffic from China on our domestic network. This will change the dynamics. The way that China is growing, direct services in and out of China are very important. ”

HNA is on its way to becoming one of the biggest companies in the world.

The arrival of HNA and Nanshan goes a long way to clearing the air on VA’s future. It brings to an end speculation SIA might move to snap up Air NZ’s share. Nanshan is paying $232 million for part of Air New Zealand’s stake, giving it a 19. 98 per cent interest. That still leaves Air NZ with about 6 per cent. It is still considering its options on the remaining shares. Tony Carter, Air NZ chairman, said Nanshan will be a very strong and complementary shareholder for Virgin.

“The sale will allow Air New Zealand to focus on its own growth opportunities, while still continuing its long-standing alliance with Virgin Australia on the trans-Tasman network,” he added.

Air NZ has been advised by First NZ Capital and Credit Suisse. Virgin said it understood Nanshan will put forward a nomination for a representative on the board.

“We look forward to meeting with Nanshan Group over the coming weeks to discuss the proposed acquisition,” Virgin said.

HNA has also confirmed it will appoint one person to VA’s board and said it will support the Brisbane-based carrier’s capital raising.

Details of that capital raising finally came in mid-June. Along with the $159 million garnered from HNA’s investment, it will now hold an $852 million capital raising, with existing shareholders able to purchase one new share for every share they currently hold. (SIA, HNA, Branson’s Virgin Group, Nanshan and Air New Zealand all agreed to participate in the raising, while at the time of writing Etihad had yet to commit. ) The raising will load up Virgin’s coffers to the tune of just over A$1 billion which it will use to repair its balance sheet, pay off debts, improve earnings and cash flow and support new growth opportunities.

At the same time a wide-ranging array of initiatives are being implemented aimed at simplifying the group’s business, help build scale and improve productivity. The big step is on the fleet front, with elimination of Virgin’s entire Embraer E190 fleet and a reduction in the number of ATR 72 turboprops it operates. Action, including some inevitable redundancies, will be taken across the entire breadth of Virgin’s operations, says Borghetti.

Given that Borghetti had already raised borrowings by $1. 7 billion, issued $675 million of new equity, and sold 35 per cent of Velocity Frequent Flyer to Affinity Equity Partners for $336 million, it shows just how deep a hole VA has been in, and perhaps why Air NZ was keen to exit its stake.

While Air NZ is getting some of its investment back – an investment in which it has never won returns – it is losing out on the deal. It originally purchased its stake in Virgin for around $459 million, according to calculations by Deutsche Bank, meaning it will be selling at a loss. In addition, Luxon is about to face a new competitive threat from Hainan Airlines, which has applied for rights to fly from Shenzhen to Auckland. Additionally, Hainan is the biggest single shareholder in Hong Kong Airlines, which is going to cause Air NZ more pain on its Auckland-Hong Kong route by competing with daily services from November.

Reaction to the HNA bid has been varied. Kuala Lumpur-based analyst Shukor Yusof, head of Endau Analytics, who considers Hainan a very well run airline, said he was not at all surprised by the development.

“It’s not a surprise to anybody. They are flush with cash and seemingly have a mandate from the (Chinese) government to go around the world and source or make lucrative investments. I think it makes sense for them to go into this part of the world where there is a boom in Chinese demand. When you have very deep pockets you can do anything. They have a huge appetite to want to do more things, not just from an airline perspective but also from the whole entire ecosystem of transportation. ” Qantas chief executive Alan Joyce is unperturbed. “We think our position in China and Asia is very, very strong given the fact that we have a massive network from Australia into a lot of destinations in Asia and the partnerships that we have in the region are just phenomenal,” Joyce said on the sidelines of the International Air Transport Association (IATA) annual general meeting in Dublin in June.

“Asia is not just one market. We have a great partnership with China Eastern, a joint venture which is just approved. We have a codeshare with China Southern. We have a network in China that is pretty well established now. ” Joyce points out China is a big market with huge growth. “It’s a market that currently has over 120 million tourists a year of which Australia as we all know gets one per cent. It’s a market that I think is going to more than quadruple in the next few years. I think some estimates have it up to 800 million tourists by the next 20 years. So the numbers for us are going to be extremely important and extremely important for the domestic market as well, given where the tourists go… I’d rather be in our position than in our competitor’s position. ” As for SIA chief executive Goh Choon Phong, speaking during the IATA conference, he refused to be drawn on the impact it might have.

“I think it is all premature to talk about. I think this investment thing as has been announced they are going to do and we will see what comes out of it. ” However, there is a possibility the development may prompt SIA to come to its own arrangement with Hainan Airlines. VA’s Borghetti has implied SIA is happy with the HNA deal. Indeed, the Singaporean flag carrier may see it as an opportunity. SIA and the Singapore Government’s investment arm Temasek tried to buy a 25 per cent stake in Shanghai-based China Eastern Airlines back in 2007 but the deal ultimately fell through. Some analysts believe the new tie-up between Hainan and Virgin could open the door to some sort of partnership between SIA and Hainan.

While HNA has numerous offshore airline investments CAPA – Centre for Aviation believes VA is its most strategically important yet. “It is accompanied by a strategic alliance, subject to approval, through which Virgin Australia will fly to mainland China and Hong Kong. HNA’s past investments have either not met their originally anticipated strategic value (Aigle Azur in Brazil) or are airlines (Africa World, Comair in South Africa) that do not have HNA services and are unlikely to be significant in the near future.

“HNA’s Virgin stake is different: Australia is China’s largest outbound long-haul market after the US but Hainan has had a limited presence. Hainan has previously focused on the US market while regulatory constraints (in both mainland China and Hong Kong) and lack of partnerships have restricted growth. For Hainan Airlines, Virgin presents a partner for Australian connections and a vehicle for HNA to circumvent regulatory constraints by having Virgin fly to China and Hong Kong. HNA can be expected to do most of the selling on Virgin flights, which become quasi-charters. ” A stronger benefit for Virgin, CAPA adds, is access to inbound Chinese tourism and domestic on-carriage.

But to understand the aggressive ambition of HNA it is well worth looking at its history. The group’s founder and chairman, now billionaire Chen Feng, was given $2. 3 million 26 years ago by the government of Hainan, a tropical island in the South China Sea, to set up an airline. He raised an amount 20 times that from other investors and even managed to secure the backing of US investor George Soros. Its growth has been relentless and the airline, still the core asset of HNA, has grown into a global empire with revenues of nearly $40 billion annually and total assets of more than $122 billion.

Just as important, Chen retains strong links to the Chinese government, critical to the success of any big Chinese business. He is a representative of the Communist Party’s National Congress and has in the past been a member of Hainan’s local parliament. In an interview with Bloomberg in 2014 he described himself as “different from the other entrepreneurs in China… I don’t drink, smoke, have banquets, go to karaoke or get massages,” he said. A devout Buddhist, Chen had the company’s headquarters in Hainan’s capital Haikou built in the shape of a sitting Buddha.

While no-one can foresee the future, snaring HNA is undoubtedly a major coup for Borghetti and may go a long, long way to securing Virgin’s future.

Australia is China’s largest outbound long-haul market after the US.