China Southern Airlines Posts Heavy Losses

By staff reporters Ji Minhua, Long Xueqing and Cao Haili and special correspondent Pan Xiaohong

yuan (US＄ 225 million) for the 2005 fiscal year, and a further 665 million yuan (US＄ 83 million) loss for the first quarter of 2006. The Hong Kong, New York and Shanghai-listed company attributes the losses to fuel price hikes and costs incurred from previous mergers. But government auditors and analysts suspect the listed company has lost huge amounts of money in a series of faulty stock market maneuvers by its state-owned parent company, China Southern Airlines Group.

State auditing of CSA's financial accounts ended last year and the results are expected to be released this June at the National People's Congress Standing Committee meeting.

Peng Anfa, vice president of the China Southern Airlines Group, and Chen Liming, the group’s financial director, have been detained and are awaiting prosecution on charges of illegally pooling corporate funds for stock brokerages to invest in the market.

Investigators found that 1.2 billion yuan (US＄150 million) in funds had been transferred to the Guangzhou-based Century Securities. The group signed a one-year contract in August 2004 with the brokerage, which promised an earnings rate of about 9 percent. 'The investment has incurred great losses and Chen had to pool more funds for re-investment to make up for the losses, which in turn led to more losses,' an investigator said.

Entrusting investments to brokerage companies is common for the aviation group, which has been struggling financially since 2001. 'We felt that the pressure was increasing,' said a high-ranking manager of the group. 'Domestic carriers kept buying planes, which led to an excessive supply of services and price cuts. Profit levels have been on the decline.' Beginning in the 1990s, the group tried to create extra revenues by expanding entrusted investment.

Many of its departments have been involved in investments through the group's financial operations company, Nanhang Finance. The group’s financial records show that it had increased stock investment dramatically from 1.03 million yuan (US＄128,750) in 2000 to 290 million yuan (US＄36.25 million) in 2003. In 2004, even the listed CSA invested 500 million yuan (US＄62.5 million) in the stock market through Beijing-based Zhongguancun Securities.

As the domestic stock market nosedived from 2001, the group got its bitters. By last May, Century Securities was insolvent and unable to pay for its investment losses, which amounted to 700 million yuan (US＄87.5 million). CSA's stock investment incurred a loss of about 20 million yuan (US＄2.5 million). Making things worse, internal control loopholes at the group's financial company, Nanhang Finance, led to investment losses of up to several hundred million yuan. Insiders say much of the money lost has not been recorded in its financial accounts because many lawsuits that have arisen from these losses are still under way. Its 2005 annual financial report showed a loss of 4.14 million yuan (US＄517,500).

Analysts say it is unbelievable for an aviation company to focus on stock market speculation. 'The market could not always be bullish,' said Yan Zhiqing, former president and chairman of the group in March.

CSA, listed in 1997, has an elite team of independent board directors. In 2003, five of its 15 board members were independent directors, but they have played a very limited role in the corporate governance of the company. 'Many corporate polices were made without informing us,' complained one independent director on the CSA board. 'When something goes wrong, we would be accused of failing to protect the interests of individual investors. But how can we protect them if the company does not inform us about policy-making details?'

Even executive board directors and high-ranking managers do not have access to some policies. 'Even though I have been a director for many years, the board has never told us about its entrusted investment plan,' said Wu Rongnan, a former CSA board director.

Several CSA managers have expressed disappointment for their failure to play a better role in corporate management given the predominant influence of the controlling shareholder, or the parent group. Many problematic deals between the listed company and its parent group were kept a secret even from some senior CSA managers, they say.

Le Gongnan, an independent CSA director and former head of the Hong Kong Government’s aviation department, said, 'A company like CSA should have strict management standards, but I think it is rather loose.' He said he has put forward many suggestions in vain. 'The bureaucracy is unbearable.'

In 2003, when the SARS epidemic hit the industry hard, poor management again hurt the company. The government cut relevant taxes to help domestic aviation companies recover. As the situation improved, Wu Rongnan suggested that the company expand its market share by increasing flights. However, CSA reacted slowly. That year, it profits fell by 97 percent, with per-share earnings of only 0.3 fen (0.038 US cents) – and even those meager earnings would not have been possible without government tax cuts. Using the Hong Kong market’s international accounting standards to calculate CSA’s earnings, the company’s loss totalled 358 million yuan (US＄44.75 million).

In recent years, despite the fact that the domestic aviation market has become saturated, CSA remained unwilling to tap the international market. By the end of 2005, its domestic revenues accounted for 82 percent of its overall income. CSA faces more cost pressures than its aviation conglomerate competitors who service the international market because fuel prices in the monopolized domestic market are higher. 'They (CSA managers) fear risks and do not dare to blaze the trail,' said Le Gongnan.

CSA’s 2002 merger with China Northern Airlines and Xinjiang Airlines also exacerbated the smaller companies’ financial problems. By the end of 2002, Northern Airlines had registered a loss of 670 million yuan (US＄83.75 million) and Xinjiang Airlines a loss of 190 million yuan (US＄23.75 million).

The managerial consolidation process in the wake of the merger was unexpectedly difficult. Management was chaotic, 'recruitment of new employees was out of control in the merging process,' recalled one CSA employee.

After CSA released its first quarter financial loss report, Fitch Ratings downgraded CSA’s rating from BB- to B+, saying in the areas of cost control, the carrier is weaker than its competitors. Meanwhile, Standard & Poor's predicted the company will continue taking losses until 2008.

Staff reporter Yu Ning contributed to the story
English version by Xin Zhiming and Roland Chang