JOINING FORCES: China Eastern and Shanghai Airlines are edging toward a merger to defend against the global downturn (XINHUA)

By pursuing a merger with Shanghai Airlines Corp. Ltd., the struggling air travel giant China Eastern Airlines Corp. Ltd. is injecting some steam into what looks to be a languid season.

Since June 8, when shares of the two companies listed in Shanghai were suspended from trading, speculation has been proliferating that the long-anticipated alliance is in the pipeline.

Liu Shaoyong, Chairman of the Board of China Eastern, first confirmed the news on the sidelines of a June 13 shareholder meeting but declined to provide any further details. Both sides have reached an agreement in principle on major portions of the merger plan, which would be announced within 20 days, he said.

China Eastern is one of the country's "big three" airlines under the State-owned Assets Supervision and Administration Commission (SASAC) of the State Council while its merger target is controlled by the Shanghai municipal branch of SASAC. Both carriers are based in Shanghai, a major hub for air travelers.

In a statement, Shanghai Airlines Chairman Zhou Chi said the company would remain an independent entity and retain its brand after becoming a subsidiary of China Eastern.

"The legal entity can help keep our traffic rights, which will benefit the merged group," he said, adding that the proposed merger is still being discussed with the government.

The two carriers have so far set up a joint task force, headed by Liu, to proceed with the deal. According to a report by the China Securities Journal, China Eastern is likely to pursue the union through a share swap with Shanghai Airlines.

An arranged marriage

China's aviation industry had put more seats in the air than demand could handle. Then the financial crisis plunged the whole sector into the red last year.

Of all China's afflicted airlines, China Eastern was in the worst shape due to a poorly-timed bet on derivatives contracts that hedged against price swings in the global jet fuel market. A subsequent price crash left China Eastern in such deep financial distress that only the government could fix it. A series of industry revitalization measures provided some respite, but, overall, the company's balance sheet got mauled. Its annual report pointed to a painful loss of 14 billion yuan ($2 billion) last year, with the debt-to-equity ratio hitting a high of 105 percent.

The financial distress of Shanghai Airlines was no less acute. It has been in the red for two consecutive years and will be delisted if it fails to turn around this year. Both companies are now under special treatment on the Shanghai A-share market.

Nevertheless, the good news is the deal has received the blessing of the Chinese Government—the State Council has reportedly given a green light to the merger. In addition, China Eastern Air Holding Co., the parent group of China Eastern, late last year received a state cash injection of 7 billion yuan ($1 billion), making it possible for the company to get a grip on its piling debts. On June 24, China Eastern announced it had won regulatory approval to obtain cash aid by issuing private shares to the parent group, indicating another step had been taken toward the merger.

The government has a reason to be a matchmaker between the two companies. A merger with its smaller rival will give China Eastern a remarkable edge in flight route allocation and ticket pricing, as well as cost control. For example, the two carriers now have their own ground crew teams and operate in different airports. The alliance will allow the merged companies to get a handle on flight costs. This could also be a long-needed boon for the fragmented Shanghai air travel market, which has been plagued by operational inefficiency and unhealthy competition.