High Stakes: How HNA Group comes back from the brink

HNA’s debt persists and it has few viable assets left to sell. There is increasing speculation of a political solution. But what’s the story behind the group and its airlines? How did a company that started with a single 737 get into this position? What does HNA mean to Chinese aviation? And where does it go from here?

It is usually difficult to choose a single word to explain airlines in crisis. Are Alitalia’s woes simply about unions? Is Air India suffering from its ages-ago merger with Indian Airlines? Did Japan Airlines in the ’90s have a mindset problem?

HNA is easily described by its debt. Yet the story is so often repeated — a debt-fuelled acquisition spree resulting in tens of billions of dollars to repay — that fitting the HNA-shaped peg into the Swissair- or Etihad-shaped hole overlooks the parts of HNA and its strategy that have worked, do work, and might well be able to underpin its future if the debt can be addressed.

The group’s early private growth came from an unusual local direction

HNA achieved what most airlines around the world have failed at: convincing governments to support aviation as an economic catalyst. HNA partnered with governments to establish local airlines, initially Hainan Airlines, based on the island province of the same name in the South China Sea.

Governments put in capital, and later route subsidies, but their most important contribution to HNA was support. Within China, provinces, municipalities and airports have considerable independence to determine their aviation strategies, lobby for aircraft importation, direct traffic rights and allocate local slots as they choose.

A hometown airline benefits from that favouritism. In return, the city or province has the quantifiable benefits of aviation and the perceived aura of development and importance. There is also a cynical argument that local airlines, shiny new airports and subsidised international flights contribute to the resumés of local officials seeking promotion.

It’s all about the province having a high-profile local airline, in something of the same way that small countries may persist with a flag carrier. In context, local identity is strong in China. Many people will identify themselves not (or not just) as Chinese but as being from their province: Sichuan, Henan, Hainan, and so on. These factors combine for a mindset that is often not ready to abandon a local airline in favour of supporting one of the existing big airline groups, even if they have a local presence.

By partnering with local governments to establish regional airlines, HNA built about a 15 per cent domestic marketshare despite all the pressure from China’s powerful state-owned airlines.

Part of the catalyst for Hainan Airlines’ early growth was that Hainan province has enjoyed greater autonomy from the central government than others. This freedom in the early days enabled Hainan Airlines to launch, and more recently saw the province support HNA’s ill-fated global expansion. Despite the government share in the group, and partial stock exchange listing, HNA is considered privately-owned.

Early freedom helped the province position itself, and specifically the city of Sanya, as China’s Hawai‘i: a warm tropical island with pineapples yet also the comfort of local food and language speakers without the hassle and cost of travelling abroad. For overseas visitors, tax and visa procedures were eased as the province envisioned being linked to the world via Hainan Airlines.

Yet the airline’s vision was bigger. Despite being named Hainan Airlines, its largest hub is Beijing — not as a base to fly to Hainan, but to fly from Beijing to the rest of China and beyond. Indeed, it has no long-haul routes from Hainan. The nomenclature-geography mismatch garners little consumer attention, but in fairness neither does Norwegian flying from the US to Caribbean islands that are EU territory, nor Southwest Airlines’ operations across much of the US and beyond.

Hainan Airlines remains the group’s largest, flagship and arguably most valuable carrier since it is based in Beijing, a cultural, business and government hub. Even if government officials normally fly on Air China, politics and the business around it generates travel demand from Beijing as a whole. There are debates if Beijing or Shanghai is the better hub, underscoring Guangzhou is in a firm third-place, reflected in Guangzhou-based China Southern often having weaker domestic yields.

So Hainan Airlines’ position in Beijing is valuable, even if there is growing competition as the opening of Beijing Daxing airport allows airlines to grow.

HNA may be best known abroad for its long-haul airlines and international acquisitions, but the airline component is mostly domestic. Hainan Airlines has the group’s largest international footprint by far. Beijing Capital Airlines and Tianjin Airlines have smaller exposure while the regional airlines have little international flying.

Domestic exposure assures some redundancy in case of setbacks or externalities in particular. Airlines in China cannot grow unchecked. Aircraft imports are centrally approved. Top-level aviation expansion is tied to economic forecasts in Five-Year Plans. In theory all this assures steady growth and prevents over-expansion, but it can be a constraint on ambitious airline strategies.

As HNA grew, the small differences between its airlines — and their owners — caused fragmentation it has never really resolved

Establishing regional airlines made HNA China’s fourth-largest airline group, but it was fragmented. From a passenger perspective, no individual airline came close to matching the market share of Air China, the smallest of the “Big 3” domestically. While HNA’s airlines have a common loyalty program, frequent flyer affinity tends to be lower than elsewhere.

From a business perspective, HNA ideally wanted to run a Lufthansa Group or IAG style conglomerate of multiple airlines with different regional strengths or service propositions. But HNA lacked enough common ownership to coordinate development and achieve the needed synergies. And besides its airlines typically having a local government shareholder, the HNA shareholding was split amongst various HNA companies.

The Air France-KLM Group is considered complex because of French and Dutch ownership interests in the parent group. If this was HNA, Air France would have French government ownership, own part of KLM but also be partially owned by KLM, have the group structure also own part of the group, and then have a tangle of subsidiaries involved for good measure. Business decisions would be prolonged or controversial as the implications worked their way through the shareholding web.

That said, intra-group competition or risk of self-cannibalisation is limited. The detriment is lost opportunity, such as selling each other’s flights and feeding long-haul networks. Deeper partnerships or even joint-ventures would bring benefits but achieving them has a higher hurdle of intra-group cooperation.

HNA’s short-lived quasi-low-cost-carrier-alliance U-FLY started bringing the smaller HNA airlines together to see where they could cooperate within regulatory bounds or merely through establishing interline-like connections, and learn about revenue management and retail merchandising. Although U-FLY was positioned as a passenger alliance, the greatest benefit was bringing the airlines together and starting collaboration behind the scenes.

More widely, HNA’s long-haul flights to North America and Europe are a contrast to its mainland units having limited flying in short-haul international markets, which are competitive but where most outbound Chinese travellers want to go, notably Japan and Thailand. Part of the gap is filled by HNA’s Hong Kong Airlines, which benefits from the Hong Kong hub’s more transparent slots and traffic rights. In context, though, non-stop short-haul competition is increasing, Hong Kong Airlines does not have a particularly extensive Southeast Asia network, and is not ideally placed to hub from mainland China to Japan and Korea.

With mainland China’s prime long-haul traffic rights mostly taken, HNA’s mainland units had to look at secondary options: flying from Beijing to smaller cities like Seattle, or from smaller cities such as Chongqing to major destinations like New York.

The subsidies are tempting to foreign airlines, but they want to build long-lasting markets and not chase short cash. Jetstar made no apologies ending Gold Coast-Wuhan flights once the de facto charter ended.

Even HNA’s flagship hub in Beijing had constraints. International flights needed domestic connections, increasing demand on a short-haul network where passenger catchment exceeded supply. Allocating a domestic seat to a passenger connecting to a long-haul service meant taking a yield hit on one of the flights.

This had wider impacts by deterring international airlines looking to partner for domestic access. In exchange the foreign airlines could have helped HNA’s long-haul network or go beyond traditional route-level partnerships by sharing industry best practices, as Delta Air Lines does with China Eastern or Cathay Pacific with Air China (those partnerships also have equity stakes).

There is much to fix in HNA’s airlines. As big as the problems are individually — under-utilised aircraft, lessor lawsuits, shareholder disputes — they can be fixed with considerable work. They are also relatively small in context of the larger HNA group, indicating the extent of larger group problems.

…speculation of an airline being sold would often place HNA or Etihad Airways as a prospective bidder

There are fundamental questions about just how private HNA really is

From its start, HNA was more than an airline group, positioning itself across the aviation and tourism spectrum. For most of HNA’s life, the diversity was complementary. HNA owns airports in Hainan (other jurisdictions may prevent an airline from owning an airport) and also has a travel agency, useful in a market with sizeable agency and group bookings. LCC Spring Airlines, indeed, originated from a travel agency.

It was only last decade that HNA stepped up investment. The group has said global assets remained under-valued after the global financial crisis and shorter 2012 market downturn.

Unstated is that China was continuing to gain prominence, making it easy to secure favourable loans. The government continued with its “Go Out” strategy that encouraged Chinese companies to make foreign investments, but state-owned companies were not as active as private companies. In contrast to HNA’s multiple airline deals, the only major state-owned airline investment so far is China Eastern’s Air France-KLM stake.

State-owned companies competing for a deal can be disadvantaged by slower internal and shareholder — government — approval than privately-owned companies. Outward investment gained momentum as anti-corruption measures increased, making it even harder for state-owned companies to send money abroad. Privately-owned companies are also subject to capital controls.

Political investments increased in opportunity, partially as China embarked on its One Belt, One Road initiative. State-owned companies have to find a balance between appeasing the strategic interests of their shareholder and the financial performance targets they are given. A privately-owned company can better tolerate an investment that does little financially but is strategic and could be used to curry political favours.

There are no obvious large HNA investments in the aviation space with a strong political objective, but there are curious investments worth keeping in mind. HNA not only invested in Ghana’s Africa World Airlines, it seconded executives, notable since aviation is short on management bandwidth. Direct airline links are not obvious: Africa World only flies regional jets and HNA does not fly to Ghana, or anywhere nearby.

In context, Hainan Airlines in 2014 reportedly received permission to start a Beijing-New York flight, ending Air China’s monopoly at a time the One Airline, One Route policy was still strong. The policy generally allowed only one Chinese airline to fly a long-haul city-pair. The policy is being loosened as China shifts to more market-based measures and needs to provide for long-haul flights from Beijing Daxing airport. The caveat was that, in exchange for flying to New York, HNA had to open a flight to an unspecified African destination. Neither the details of which African route was involved, nor the New York flight itself, ever ended up seeing the light of day.

Discretion is the rule amongst Chinese executives: Alibaba’s Jack Ma is the most prominent internationally, and even he is rare for his prominence. And even by low-key standards, Chen’s public appearances are few. When Chinese President Xi Jinping made a state visit to the UK, Hainan Airlines used the occasion to announce a new Beijing-Manchester flight. Against an HNA backdrop, Xi is in the middle, former UK Prime Minister David Cameron on his left, and on his right is Chen – the only one with a wide smile.

In essence, HNA is playing the role of a de facto state-owned enterprise, spreading the flag and making the investments state-owned companies did not want to. There is also ample discussion of HNA’s ties to party leaders. This makes it especially difficult for the state to confront HNA’s debt and consider failure.

THE HNA GROUP AIRLINES
Hainan Airlines
Hubs: Beijing, Haikou
Fleet: 34 A330, 2 A350, 152 737, 38 787

Tianjin Airlines
Hub: Tianjin
Fleet: 35 A320 family, 6 A330, 3 737F, 51 E190/E195

Beijing Capital Airlines
Hub: Beijing Daxing
Fleet: 61 A320 family, 11 A330

Lucky Air
Hub: Kunming
Fleet: 14 A320, 4 A330, 35 737
West Air
Hub: Chongqing
Fleet: 35 A320 family

Suparna Airlines
(formerly Yangtze River Airlines, Yangtze River Express)
Hub: Shanghai Pudong
Fleet: 9 737F, 8 737, 3 747F, 2 787

Fuzhou Airlines
Hub: Fuzhou
Fleet: 16 737

Urumqi Airlines
Hub: Urumqi
Fleet: 13 737, 1 E190
Grand China Air
Hub: Haikou
Fleet: 3 737

GX Airlines
(Guangxi Beibu Gulf Airlines)
Hub: Nanning
Fleet: 10 A320, 14 E190

Air Changan
Hub: Xi’an
Fleet: 11 737

Hong Kong Airlines
Hub: Hong Kong
Fleet:10 A320, 15 A330, 2 A350
Hong Kong Airlines Cargo
Hub: Hong Kong
Fleet: 5 A330F

MyCargo Airlines
(formerly ACT Airlines)
Hub: Istanbul
Fleet: 1 A300F, 2 747F

Africa World Airlines
Hub: Accra
Fleet: 8 E145
Data may have changed by time of publication

Hainan’s debt problem is a fundamental issue to resolve

HNA’s debt at the end of June 30, 2019 is estimated around US$80-100 billion depending on whether we take Bloomberg’s or Caixin’s numbers. Interest payments are difficult to cover just using company profits.

The group’s largest overseas airline acquisition was a US$450m stake in Brazil’s Azul, later sold at a small loss. Its next-largest investment was US$115m for Virgin Australia, which HNA still retains. All its other airline investments beyond Greater China are estimated to have been individually bought for under $50m, meaning of HNA’s $40-50b acquisition spree, well under $1b was on airlines.

Leasing acquisitions changed the market but brought debt. HNA spent $2.5b for Avolon and $10.4b for CIT, which when combined with HNA’s existing leasing company Bohai created the world’s third-largest lessor. HNA later sold $2.2b of Bohai but retains majority ownership. Although HNA has substantial debt from these acquisitions, leasing is considered a safe investment and has strategic importance to China. More pragmatically in the short term, leasing generates high cash flow.

As aviation acquisitions grew, strategic value diminished. HNA sold its stake in catering firm Gategroup and is restarting efforts to sell ground handler Swissport, likely at a loss after acquiring it for $2.8b. Those companies served many more airports than HNA’s airlines flew into. HNA even took a stake in South Africa’s Comair, which operates as a British Airways franchise. Comair does not fly to China and HNA does not fly to South Africa. But unlike HNA’s investment in Africa World, HNA was hands-off in Comair, making it a passive investment. HNA ultimately sold it with a small profit diminished by transaction costs.

Other large transactions were outside aviation: extensive investments in hotels, including Hilton, later divested at a 30 per cent profit. Some real estate investments also turned a profit, but others did not. The real estate deals were not connected to aviation and tourism. Likewise for its $10b stake in Deutsche Bank, once 10 per cent but reduced at a loss.

Assets were officially divested to reduce debt while media reports say the government wanted HNA to return to its original aviation and tourism focus, or even be more confined to aviation. Change was also wrought by the death of HNA co-founder Wang Jian, who led the international investment spree.

HNA has mostly sold its easy non-aviation assets, shifting focus to more strategic investments like its leasing portfolio or its airlines. But airlines tend not to fetch high sums. When Cathay Pacific bought HK Express, over half of Cathay’s costs were in debt repayment. HNA only ended up with US$290 million from the sale.

Even HNA’s small mainland airlines are bigger than HK Express, yet selling them would leave a large debt pile and little active business for HNA. HNA has already restructured many of its airlines with most seeing more involvement from local governments but not total detachment from the HNA group. Some HNA airlines may gain more independence yet find there are advantages to piggybacking off a larger group. These revised relationships will evolve.

HNA’s numerous airlines in greater China exist because it could not grow Hainan Airlines as a pan-China brand, nor receive the government support for international expansion, so Hong Kong Airlines became the global alternative. Most of HNA’s international airline acquisitions were inexpensive and did not weigh the group down in cost or management attention, unlike Etihad’s exposure to airberlin, Alitalia and Jet Airways, or Swissair to its many purchases. Nor will HNA’s aircraft orders or excess flying put the group under.

The risk arose from departing its aviation and tourism focus, which Etihad and Swissair never ventured from. For HNA’s Chen, a photo with President Xi at a route launch was proof of airline success, and a graduation certificate to venture beyond aviation.

In the not too distant past, speculation of an airline being sold would often place HNA or Etihad Airways as a prospective bidder. Further back, we look at Swissair’s disastrous Hunter Strategy as the historical harbinger of doom. Both Etihad and HNA have been seen as expansionist, a sort of Hunter Strategy Mark II or III. Yet this is not just a simple case of history repeating: HNA accumulated a matrix of airlines for different reasons than Etihad and Swissair. Those reasons may well be the reasons it is able to right the ship and once again point it in the right direction.

From its start, HNA was more than an airline group

HNA holds the cards in the airplane trading game

HNA’s burgeoning debt pressured risky long-haul expansion increasingly dependent on local subsidies. Widebody aircraft deliveries increased to Chinese airlines as major traffic rights, such as to the US, decreased. Markets with available access, like Australia, are saturated. Widebody aircraft became superfluous.

And thus the game of finding homes for the aircraft the group’s airlines aren’t using began.

A Hainan Airlines 787-9 less than 1.5 years old left to join Bamboo Airways. In its last few months with Hainan, it flew long-haul but also thinner domestic markets like Haikou-Guiyang, according to Flightradar24. Bamboo signed an agreement to lease two used 787s from GECAS, and the ex-Hainan frame is most certainly part of that deal. The identity of the second 787 is unclear, but options are aplenty.

Of Hainan’s remaining 29 787-9s, seven have not flown since typically October or November 2019, Flightradar24 data suggest. One frame has not even flown since last May. All have GEnx powerplants, so the Rolls-Royce Trent 1000 issue is not at fault (but it is affecting Air China). The -8 fleet has two aircraft that have not flown in a month. Almost a quarter of Hainan’s 787 fleet is grounded.

Sister airline Suparna has two active 787-9s. That brings HNA’s 787-9 deliveries to 32. The projected -9 fleet size is unclear but has often been pegged at 38 – six more aircraft than were ever delivered to HNA. Less clear is how many -9s Boeing had in its backlog for Suparna and Hong Kong Airlines, the latter of which never publicly ordered the 787.

The bulk of the aircraft are widely expected to be taken by Bamboo and Vistara, not as new orders but as they bring forward their originally scheduled deliveries, although both moot more orders. Biman Bangladesh last October signed an unidentified order for two -9s made public in November and delivered in December. Local media say they were ex-HNA delivery positions, representing a new order for Boeing.

HNA’s A350 movements are more complicated. South African Airways has assembled twins of unwanted twins: its four A350s comprise two A350s from Air Mauritius and a further two from Hainan. The Hainan frames were unwanted from LATAM, which has its own aircraft trading game. It has sent A350s to Qatar Airways and will send four to Delta, which will assume 10 of LATAM’s A350 delivery positions.

Fiji Airways acquired two A350s due for Hong Kong Airlines, which received six. Only two are left, both active in late January. At least three were ferried to Tarbes in southern France. Tarbes in early January was seen to have three Hainan A350s and two Hong Kong Airlines A350s as well as some A350s unpainted but due for lessor ALAFCO, likely for HNA units. ALAFCO had previously leased A350s to the group.

Hong Kong Airlines planned a fleet of 21 A350s – 15 from Airbus and six from lessors, partially inheriting Azul’s A350 delivery positions. Airbus at the end of last year showed the airline’s commitment was 13 and cut by eight to a remaining five, three of which Airbus said it delivered. Airbus does not show Hainan’s A350s ordered directly from the airframer.

Less clear is the loss of orders expected but never officially made, such as A350s for HNA’s mainland units. As the US-China trade war eases, Boeing expects widebody aircraft orders from China, building on discussions initiated a few years ago at a time HNA would have featured more prominently.

Then there are impacts to other aircraft: A330s and narrowbodies. Yet as difficult and costly as this aircraft trading is for HNA, lessors and airframers, it is the easy part for HNA.

Shedding aircraft and orders does not make a substantial dent in its debt. If debt is to be written-off, it is unclear what the trade-off will be.