Cathay embraces the dragon

The Hong Kong airline has spent billions in demonstrating its commitment to the territory but, says Patrick Hosking, its willingness to establish close ties with China could carry a sting in the tail

IT IS 50 years since Roy Farrell, a Texan adventurer, paid $30,000 for a second-hand Douglas C47 transport plane, named it "Betsy", stocked up with a cargo of morning coats and toothbrushes, and flew it from New York to Shanghai.

Cathay Pacific expanded from that makeshift cargo flight, relocated to Hong Kong, and is now one of the biggest airlines in Asia with 57 planes and annual sales of HK$27bn (pounds 2.3bn).

Today, it faces a future almost as uncertain as it did in 1946. At the end of June 1997, Britain hands Hong Kong back to the People's Republic of China, which has promised that "the previous capitalist system and way of life shall remain unchanged for 50 years." The business community is cautiously confident about the handover, while the stock market is buoyant again and at a two-year high.

But that has not stopped some Hong Kong companies from relocating their head offices outside the territory, or at least establishing potential bolt-holes elsewhere. HSBC, owner of the Hongkong Bank, is now based in London. Jardine Matheson is registered in Bermuda.

Cathay, by contrast, is embracing Chinese rule, welcoming the PRC as a major shareholder, setting up joint ventures in China, and investing heavily in Hong Kong. It is ploughing HK$3.5bn into Chep Lap Kok - the new airport being built on an artificial island in the South China Sea.

According to Tony Tyler, the main board director in charge of the airport investment, the money demonstrates Cathay's commitment to the territory. "You can't fly away $3.5bn of glass and concrete. We are putting our money where our mouth is. We really do believe Hong Kong has a great future as a connecting hub.

"The Swire family [which owns 52 per cent of Cathay] have been in Hong Kong for 150 years and they have discovered that if you stick with Hong Kong through thick and thin, it is immensely rewarding."

Certainly, if the handover goes smoothly, Cathay looks well placed to benefit from the rocketing economic growth in both China and South-east Asia. Today, Asia accounts for 25 per cent of air passenger traffic. By 2010, it will account for more than 50 per cent, according to forecasts by Iata, the airline body.

The existing airport at Kai Tak is already the fourth busiest international airport, despite a desperate shortage of capacity and an 11.30pm curfew. Passenger traffic has grown 360 per cent since 1980 and Iata predicts it will more than triple again to 87 million passengers by 2010.

Cathay is also investing in China itself through its separately quoted aircraft maintenance subsidiary, Haeco. Haeco has taken a 10 per cent stake in a maintenance venture in the special economic zone of Xiamen.

Keith Law, Haeco's engineering director, is bullish about the prospects for the venture. Strolling round the company's cavernous hangars at Kai Tak, he points out the PRC mechanics who are learning the trade, easily distinguishable from local labour by their dark blue uniforms. After their two-year training, they are just as good as local labour and cost one- fifth in wages.

Mr Law says the Xiamen joint venture will be able to bill client airlines at $30 a man-hour, compared with $50 a man-hour in Hong Kong, and still make a bigger profit.

After six years of stagnating earnings, Cathay is starting to deliver profits growth again. But alongside the confidence is an unspoken unease about the PRC government, which controls 20 per cent of Cathay through three entities.

The doubts erupted recently when it emerged that one PRC organisation, the China National Aircraft Corporation, which owns 5 per cent of Cathay, had hired an ex-Cathay manager as a consultant and was applying to operate a new airline out of Hong Kong in direct competition to Cathay. The worries are exacerbated because CNAC is 100 per cent owned by the Chinese airline regulator, the Civil Aviation Administration of China.

"It's a legitimate concern for us," says David Turnbull, Cathay's deputy managing director in charge of corporate development. "Will the playing field be level?"

Cathay's concern about CNAC mounted again last month, after reports in the South China Morning Post that it was having second thoughts about investing in Dragonair, a regional airline jointly owned by Cathay and Citic Pacific, the PRC-controlled, Hong Kong-quoted investment body. One school of thought has it that CNAC, having had access to Dragonair's confidential books, now knows which routes are the money-spinners and is intent on poaching them for its putative airline.

A third setback came last month when Cathay pulled out of a deal to buy a third of Xiamen International Airport for HK$366m.

The picture is further complicated by the presence of four PRC appointees on the Cathay board, including Hu Yizhou, chairman of CNAC, and two from Citic Pacific. Simon Heale, deputy managing director of Cathay, describes the Chinese as "excellent long-term shareholders" and denies that it is awkward having the boss of a potentially rival airline on theboard. "From a European perspective it may look a bit strange. From an Asian perspective, where relationships are so important, it's not at all strange."

The thinking seems to be that having PRC officials on your board may be uncomfortable, but not having them on your board is commercial suicide. In an industry as regulated as the airline business, strong allies in Peking will be crucial after 1997.

When Jock Swire bought the Cathay stake for pounds 175,000 in 1948, he described it as a "terrifying" business. The next few years may not be quite the seat-of-the-pants gamble he took, but the risks are still there.