Private Capital Takes Control of Shenzhen Airlines

·By staff reporters Zhang Xiang and Wang Xiaobing, interns Cheng Zhe and Bi Aifang and special correspondent Lu Yanzheng (Hong Kong)

Two private companies took control of Shenzhen Airlines at a May 23 auction, marking a breakthrough in China's aviation industry, which has been dominated by state ownership. The restructured company will become the first privately controlled passenger carrier in China.

The deal involved the sale of the largest set of state-owned assets since 1949, when the People's Republic of China was founded. Bright Oceans Corporation and Huirun Investments, two previously unknown firms, outbid flag carrier Air China to purchase 65 percent of Shenzhen Airlines stock with a joint offer of 2.72 billion yuan (US＄ 328.5 million). Shenzhen Airlines boasts a fleet of 27 aircraft, four aviation bases and 40,000 employees. With net assets of 626 million yuan (US＄ 75.6 million), the southern China carrier has been profitable for 13 consecutive years.

Original Ownership

Shenzhen Airlines was founded in 1992 by four investors. China Travel Service Group (CTS Hong Kong) holds a 40 percent stake, Bank of China Credit Card and Air China hold 25 percent each, and the Shenzhen government holds another 10 percent. In 1999, the Guangdong Development Bank (GDB) purchased the assets of Bank of China Credit Card, which was then on the verge of bankruptcy, becoming a new shareholder of Shenzhen Airlines. The next year, CTS Hong Kong sold its 40 percent of shares to the GDB to ease an internal financial crisis, making GDB the largest shareholder of the air carrier.

Guangdong Holding Group, a GDB subsidiary, holds most of the 65 percent stake in Shenzhen Airlines in lieu of its parent company. Starting in 2000, however, GDB encountered financial problems and its financial situation degenerated. In 2003, its non-performing loans amounted to 35.6 billion yuan (US＄ 4.3 billion) and its capital adequacy rate was 3.87 percent, far below the international banking security standard. Selling the Shenzhen Airline stake became part of its restructuring plan. Analysts say the proposed sale is also a result of a new commercial banking law, which was amended last February and forbids commercial banks from investing in non-banking enterprises. GDB also lacks confidence in the prospects of Shenzhen Airlines, which faces cut-throat competition from more powerful carriers in the local market.

Field of Bidders

The auction of GDB's shares in Shenzhen Airlines lasted only 20 minutes, but it took a year for the deal to reach the final stage of public bidding. The American International Group was the first to present GDB with an offer. Other potential buyers included Modern Group, a private company that offered 1.573 billion yuan (US＄ 190 million), CITIC, Ping An Insurance, Air China, the Shenzhen government, Industrial and Commercial East Asia, and CitiBank.

At one point, Air China was seen as the front-runner among potential buyers. According to corporate bylaws, Air China has preferential purchasing rights as the second largest existing shareholder in Shenzhen Airlines. In addition, Air China's IPO at the end of last year in Hong Kong and London made it financially more capable of expanding its business. Analysts say that Air China's business has been particularly weak in the domestic market, and the purchase of shares in Shenzhen Airlines would have strengthened its role in providing domestic aviation services. However, negotiations between the two sides made little headway. Insiders told that the low price offered by Air China was the main obstacle. Air China offered a price of just 1.2 billion yuan (US＄ 145 million), much lower than what GDB had expected.

In January, GDB submitted a report to the Guangdong government stating that it wished to sell the Shenzhen Airlines stake to Modern Group, which had offered the highest bid. "The sale could bring in 1.5 billion yuan (US＄ 181.2 million) and ease the fiscal burden on the government when GDB is restructured in the future," said the report. Analysts say that GDB's choice of a private over state-owned buyer follows the principle of maximizing the value of state assets. The choice, however, upset Air China and other buyers, forcing them to quote higher amounts in order to win the bid. Air China subsequently offered a price of 1.7 billion yuan (US＄ 205.3 million), about 100 million yuan (US＄ 12.1 million) higher than Modern Group's bid. Faced with this new competition, GDB proposed to determine the ultimate buyer through an auction, which was accepted by all parties.

Final Auction

The ShenzhenEnterpriseOwnershipExchangeCenter was chosen as the venue for the auction. On April 20, the exchange center released a bid and tender announcement, setting the date of the auction for April 29. Since relevant government regulations state that a public notice of property rights transfer must be made 20 days before the transfer begins, the auction was postponed until May 23. Despite the delay, however, many potential buyers told that it would take more than a month to assess the feasibility of purchasing such a large amount of assets. Analysts say this effectively excluded listed companies and foreign investors, which must undergo stricter financial assessment procedures according to their internal regulations.

In the run-up to the auction, Modern Group unexpectedly refrained from filing a bid application, and was replaced by BrightOceans and Huirun Investments on the list of bidders. This prompted suspicions that it acted to help GDB manipulate the process and raise the bidding price. Neither GDB nor Modern Group clarified the reason for the group's withdrawal. Zhang Peng, a public relations official from Modern Group, told that the retreat was "due to various reasons." He also ruled out the possibility that Huirun attended the auction on behalf of Modern Group.

Transparency was lacking throughout the auction's implementation, producing speculation regarding the qualifications of the winning buyers. Huirun was established in March with registered capital of 10 million yuan (US＄ 1.2 million). The total assets of Bright Oceans Corporation amount to 1.984 billion yuan (US＄ 239.6 million) with net assets of 612 million yuan (US＄ 73.9 million), according to a public notice released in March by its listed subsidiary, Bright Oceans Intertelecom Corporation. Potential buyers are required by auction regulations to have at least 3 billion yuan (US＄ 362.3 million) in total assets and 1.5 billion yuan (US＄ 181.2 million) in net assets. For this particular auction, however, it was stipulated that GDB would decide who was eligible to bid. GDB declared that BrightOceans and Huirun were qualified.

To challenge the newcomers, Shenzhen Investment Management Corporation, which represents the Shenzhen government, combined forces with Air China to bid in the auction, but still failed to win. In the wake of the auction, rumors were rampant as to who had provided BrightOceans and Huirun with financial backing for the deal. Despite the unanswered questions that clouded the auction, analysts say that based on existing regulations, the transfer of the property rights has so far been done in accordance with the law. State property rights transfer procedures, however, are not without loopholes. Although relevant regulations state that payment for the transfer of property rights must not be postponed, no legal responsibility or punishment is stipulated. Analysts say that this may create room for manipulation of the rules, and stress that the process should be made more transparent.

Staff reporters Long Xueqing and Huang Shan contributed to this story

English version by Xin Zhiming