NICHOLAS IONIDES IN HONG KONG Under chief executive Stanley Hui, Dragonair is embarking on the most ambitious expansion of its 15-year history

If the sheer scale of the model aircraft which decorate an airline's headquarters is any indication of its ambitions, then Dragonair and its chief executive Stanley Hui certainly have their sights on the big league. In the case of Dragonair, the impressive display at its brand new base at Hong Kong International Airport, is no deception. Fifteen years after starting out, the carrier is indeed embarking on its most ambitious growth to date. Over the next five years it will more than double the size of its fleet and even start all-cargo services in direct competition with Cathay Pacific Airways.

Dragonair has at least two key factors running in its favour as it embarks on this ambitious growth spurt. The geography of Hong Kong means that half the world's population is within a five-hour flight. Also its 43.3% ownership by the commercial arm of Beijing's Civil Aviation Administration of China (CAAC) puts a political heavyweight in its corner. But Dragonair did not become the "airline of choice" for travel to and from mainland China overnight. Its history has been dominated by political battles and ownership fights.

Hui acknowledges that the carrier's history has been difficult, but believes the current ownership helps put it in a strong position for further growth. That, coupled with a Asia's apparent recovery from its recent economic crisis, means there should be more good times ahead. "Over the past two years we held back expansion plans because of the financial crisis," Hui says at Dragonair's new building, into which the company moved in the middle of this year. "At the end of last year and the beginning of this year it was clear that everything was pointing in the right direction again. We are certainly growing very rapidly."

Dragonair's story began in the early 1980s when a group of Hong Kong businessmen and industry veterans sought to challenge Cathay's iron grip on the local market. For 39 years no-one had attempted to break that hold, believing that Cathay's status as the British colony's de facto flag carrier would make it a futile fight. But things changed in 1984, when China and the UK agreed to terms for Hong Kong's 1997 transfer to Beijing control.

Local businessmen with Chinese connections saw an opportunity and established Hong Kong Dragon Airlines as a wholly owned subsidiary of a local investment company. Cathay, which was then still 70%-owned by Swire Pacific an investment arm of the UK's Swire Group, fought the newcomers vehemently.

Challenging the flag carrier

When Dragonair sought rights to compete to points in mainland China, Cathay's then-chairman Michael Miles responded bluntly. "We think that it would be the worst possible situation to have two airlines from Hong Kong licensed," he told a hearing into the licence applications. However, Dragonair ultimately did win some route licences and initiated its first service in July 1985, flying from Hong Kong to Kota Kinabalu, Malaysia. Shortly afterwards, the company began operating charter flights to Xiamen, China, and continued to expand over the next four years.

Dragonair's successes, however, came against the backdrop of tumult in Hong Kong's civil aviation sector, a situation that would profoundly affect the growing carrier. In January 1990, Cathay and Swire purchased a 35% stake in Dragonair and China-backed CITIC Hong Kong significantly increased its holdings in the company, bringing them up to 38%.

During the licensing fight the government had implemented a "one-airline, one-route" policy that continues to this day and restricts to one local carrier the ability to serve each route originating in Hong Kong. During this period, Cathay's rights to Beijing and Shanghai were given to Dragonair. Later Swire/Cathay increased their holding in Dragonair to 43% and CITIC raised its share to 46%.

Effectively, Dragonair was safely within the control of Cathay and CITIC. Then in 1995 came perhaps the most turbulent chapter in Hong Kong's aviation history. With the 1997 handover approaching, China National Aviation (CNAC), the CAAC's commercial arm, weighed into the arena looking to become a major player in the airline sector of the soon-to-be-returned Colony. To everyone's shock, CNAC applied for its own licence to fly from Hong Kong. The implied threat of establishing itself in competition to Cathay and Dragonair appears to have worked.

After a year-long battle, CNAC managed to secure a HK$2 billion ($250 million) deal from CITIC and Swire/Cathay. CNAC acquired a 35.9%stake in Dragonair but promised not to launch a new airline. Later in 1997, CNAC increased that stake to 43.9%, leaving Swire/Cathay with 25.5% and CITIC at 28.5%. To make up for its loss CITIC also won the right to increase its Cathay stake to 25%.

Nearly a year after the deal was concluded, Hui joined Dragonair, after a career with Cathay that had spanned 20 years. He says, while there have been difficulties over the years, Dragonair is now in a solid position for future growth, in large part because of its Chinese ownership. "In terms of the impact on the airline's operation, there have been benefits since all that changed in 1996," Hui says. "It's no secret of course that CNAC is the commercial arm of CAAC, so in that respect we have been getting sympathetic hearings from CAAC. That certainly has helped, and it certainly helped Hong Kong get a very good agreement with China early this year."

The agreement Hui refers to is a new air services "arrangement" reached between Hong Kong and China in February. Airlines from both sides have equal opportunity for services - a major step up from the previous deal which was thought to have allowed Dragonair to operate only one China flight for every three Hong Kong flights operated by mainland-based carriers. The deal also allowed charter services to be upgraded to scheduled services, facilitating the sale of belly-space cargo service to key points.

Dragonair acted quickly, boosting frequencies to six Chinese cities. It then moved to expand its passenger fleet and committed to doubling it to 26 Airbus wide-bodies and narrow-bodies by the end of 2005 through new purchase and lease agreements.

The company has also moved into all-cargo operations. After winning government licences in July, it wet-leased a Boeing 747-200F from Atlas Air and launched flights to Manchester via Dubai and Amsterdam. Shanghai services were inaugurated soon after that. The long-haul cargo services are Dragonair's first flights outside of Asia and represent its first direct competition with Cathay and its cargo affiliate Air Hong Kong. Like Dragonair, the cargo carrier was established in 1986 as a competitor but is now 75%-owned by Cathay.

Application approved

The Hong Kong Government's decision to approve Dragonair's application to fly the routes is particularly significant in that it is an exception to the one-airline, one-route policy. The government further has said it will allow for more such exceptions where extra competition is needed, especially in the cargo arena.

On the back of this development, Dragonair plans a large dedicated-cargo expansion, says Hui, adding that the carrier will buy two 747s for conversion into freighters. Those aircraft should enter service in 2001, followed by another in 2002. Further wet-leasing is also possible, particularly on US services, for which 747-400Fs are better suited. "We could very well in two years' time end up with effectively four or five freighter aircraft," says Hui, who knows cargo well, as his last task at Cathay was to run Air Hong Kong. "It is faster than we expected - three aircraft of our own and possibly five overall in a few years is quite a big jump for us. But it is certainly very doable."

Even though Dragonair has entered into a competitive sector, while at the same time rapidly growing its passenger fleet, Hui is not worried about being able to make it work. "Our expansion next year will be three aeroplanes on the passenger side and two on the cargo side. People say it's a huge expansion, and I obviously agree, but really what we are doing is going into very established markets on the cargo side, so I am not concerned about that. There is more competition, but that is the name of the game, whether you are starting new or whether you've been around for a long time."

Five years ago, cargo revenues represented 5-6% of total sales but by last year it had increased to 12%. "This year without the freighter it would be 15-16% but now it's more like 21-22%," Hui says, predicting that expansion should eventually lift cargo sales contributions to 30%.

Dragonair's overall cargo strategy is to build on the strength of its China network, he adds. Of its 26 passenger destinations, 17 are in mainland China and the amount of cargo carried by its aircraft is growing rapidly. Its nine other passenger routes are to secondary Asian destinations not served by Cathay.

"We have a very strong China network and now we have to give it legs, with all the beyond-Hong Kong services," Hui says. Accordingly, operations to Europe will be strengthened next year with frequencies of "up to about daily". All-cargo services will also be launched to Osaka in Japan, points in the USA, Taiwan and Southeast Asia, plus "a few more destinations in mainland China".

While bullish on cargo, Hui is circumspect about adding regional passenger routes apart from seasonal service to Kathmandu, Nepal. There has been much speculation that as Dragonair grows it will seek to launch long-haul passenger operations as well as challenge Cathay directly within Asia, but Hui says that will not occur anytime soon. "It's so difficult to say what will happen 10 years from now, but for the time being our focus is to grow up our China network and [concentrate on] cargo, which is a different story," he says, adding that the international nature of Dragonair's projected cargo growth will bring it into further competition with Cathay and Air Hong Kong. He is quick to state, however, that Dragonair has no plans to compete with Cathay on passenger services.

Alliance questions

Another longstanding subject of speculation is Dragonair's alliance intentions. Hui, however, says there are no immediate plans to join one, as "this is a big game for the big boys. We are taking a careful look at it, but for the time being, given our route structure and given our business relationships with other airlines, we think the best approach will be to expand the bilateral relationships we have," he says. "Whoever can give us the business is our friend." Hui says 30% of the carrier's revenue comes from interline or bilateral arrangements, the biggest of which is with Cathay, a founding oneworld alliance member. And while speculation continues that there is growing animosity between the two camps, Hui says Dragonair's relationship with Cathay is "very cordial", adding: "There is a bit more competition, no doubt, but that hasn't changed the very important co-operative relationship between the two airlines."

Hui also notes that Cathay and Swire remain "significant shareholders and continue to exercise influence over the airline through their shareholding". He further adds that Dragonair "[relies] on Cathay in many different areas - in computers, engineering and as our general sales agent throughout the world. Obviously we have what they don't and they have what we don't, so it makes a very good match. That relationship, as far as we can see it, will continue."

A stock exchange listing is also a prospect. Under the terms of the 1996 ownership settlement, a listing was due "as soon as practicable". Hui says this is for shareholders to decide. "My understanding is they have the intention to list the shares at some point in future, but there is no timetable set for that to happen." Some see a flotation as inevitable, as the costs involved with Dragonair's expansion programme put pressure on financial resources.

While a listing would "help tremendously" in the search for capital, he says for the time being Dragonair does not need new cash. Credit for aircraft purchases has been raised through export bank loans and the carrier has already secured the financing necessary to meet its other obligations.

Hui suggests that Dragonair has been successful in raising cash in part because its growth plans are based on fundamentals, and because so much more growth is feasible. While "easily 80%" of revenue comes from China operations, just 11% originates in China. With the mainland's impending entry into the World Trade Organisation, and more Chinese nationals travelling abroad, this percentage is "growing every month and that's a very big consideration for our expansion".

The chief executive is also not bothered that some look at the carrier's ambitious expansion with raised eyebrows, betting against its success. Dragonair is, after all, an airline that has proven sceptics wrong throughout its history. And there are those who bet it would not get off the ground in the first place.

Source: Airline Business