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HNA Group: A Miracle

in Civil Aviation
ABS Case Study Analysis
Prasun Bansal

HNA Group: A Miracle in Civil Aviation

Question 1
Do Miracles Happen? What about miracles in Civil Aviation? Is there any indication of superior
aviation strategy at work with Hainan airlines?
Miracles do happen, but less often in the Civil Aviation field. There are numerous examples of airlines
having a spectacular launch with the stars all aligned (Air Deccan, Virgin Group, Pan Am) and they do
spectacularly well initially. But the miracle starts to fade for most within a couple of years (like in
Deccan) or a bit later like for PanAm and sometimes it fades but the airline still manages to scrape
through like Virgin Group. Miracles in the civil aviation business, might not be miracles as put in by the
various authors, have to be put into the right perspective.
Is it a miracle that Mr Chen was able to start a new airline, not likely. When China opened its civil
aviation markets, there were a plethora of airlines that were formed. Aside from the 9 airlines owned by
the central government (after breakup of CAAC), a host of airlines were started by each of the
provinces. If not Mr Chen, someone else would have opened up the Hainan Airlines. Afterall, provinces
were getting on top of each other in launching airlines!
Is it a miracle that Hainan Airlines was able to grow the way it did by consolidating other regional
players; again not likely. As the market dynamics played out, there was a consolidation of the industry
taking place. The 9 national airlines merged into 3. And there was also consolidation happening at the
regional level. Hainan Airlines picked up regional airlines, many times having a very different customer
base, operational culture and procedures, geographically the new acquisitions were remote. Most of the
justifications given seem to be rationalizations post facto for the acquisitions. Hainan Airlines acquired
Xinhua Airline, Xhanxi Airline and Changan Airline and was able to turn them around using its
operational and management processes.
HNA airline has a very low cost of operations, significantly lower than other players in the Chinese
market. This does indicate a superior aviation strategy at work at Hainan. The fact that Hainan Airlines
has had a cost of operations even lower than American LCC players till 2002 ($0.0370/ASK as
compared to $0.0400 for JetBlue); it was able to maintain its cost levels in 2003 (as compared to other
Chinese airlines) despite SARS outbreak says a lot about the better strategy followed by HNA. Even
with the SARS outbreak, its costs / ASK rost to 0.0497 which were still among the lowest in the Chinese
market. These figures however have to be put into perspective, that the Global (specifically American
airlines were rebounding from the effects of Sept 11. Also the fact that the Chinese RMB was pegged to
the dollar and not free floating, meant that the costs paid by HNA in RMB were lower then what they
would have been if RMB were fully convertible.

Question 6 1

HNA Group: A Miracle in Civil Aviation

The table below summarizes some of the key financial results for HNA in the year 2003. We see that the
airline made a net loss this year (-23.5%) as compared to moderate profits posted by other airlines. The
dip in the incomes of all the airlines happened due to the outbreak of SARS and the resulting travel
reduction. HNA seems to have suffered the most, mainly due to reliance on tourist traffic (than business
traffic), which was put off by tourists for the fear of SARS. The reason seems plausible, as the profits
dipped throughout the industry, and HNA airlines had a history of profitability before 2003.
In the table below, Red indicated worse then industry, yellow at borderline bad, green that its leading
the industry.
What we also see is that HNA has a high cost of financing (at 13.9%) about 1.5 time the next highest. Its
Debt to Asset ratio and Revenue per employee are at the industry average. But its yield is the highest of
the competition. HNA airlines is able to get a yield of 0.1532 as compared to the next highest of 0.1 for
the next best (China Southern). It also has one of the lowest number of employees per aircraft.
Figures for 2003








Year Founded
Revenue ($ Mn)
Income ($ Mn)
Income (% of Revenue)














Market Cap (31/12/2003)

Debt/Assets (31/12/2003)








Passengers (2003) Mn
RPKs (Mn)
FTK (Mn)
Load Factor








Yield ($/RPK)
Revenue per employee ($















Financing Costs ($ Mn)

Financing Costs (% of




deployed ($ Mn)

Question 6 2

HNA Group: A Miracle in Civil Aviation

Cost per ASK






HNA Airlines also seems to have benefitted from the acquisition of various airports around the country
as it was able to leverage the operations at these airports better with its aviation wing, and formulate a
better operational plan by integrating some of the airports in the business strategy. What also seems to
have worked in the favor of HNA is the high aircraft utilization.
At the end of it, HNA has been a profitable airline for the majority of the past 10 years, and this is in
part due to the market conditions that were at play. But these market conditions were there for all to
exploit, so cant be really termed as a miracle. What is definitely at play is the superior aviation strategy
of keeping costs low, leveraging the company to the hilt, superior route strategy to counter the
competition, better plane utilization and foremost the quest to be the best not in comparison to the local
competition but best in comparison with the global standards. The fact that Mr Chen has this ambition
and has been able to meet this through a superior strategy is indeed a Miracle.

Question 2
How would you describe the Market & Industry structure of Civil Aviation in China post 1988? To
what extent was it fragmented/concentrated? How would this matter for Hainan airlines growth
Post 1988, the Chinese market was highly fragmented. There were in all 9 national airlines owned by the
CAAC. There were multiple airlines launched by the various provincial governments to act as feeder
services to the larger airlines. The country had only recently granted the 5 th freedom to foreign airlines
to stop in china enroute to other countries, and had allowed for foreign airlines to fly in and out of
limited number of Chinese airports. In this era, many provinces opened their own airlines, about a
dozen. Sis of these airlines developed into big regional players, HNA being one of them. The other
notable regional players are Shanghai Airlines, Shadong Airlines, Shenzhen airlines, Sichuan Airlines,
Air Macau. Before the turn of the millennium, the 9 national airlines were merged into 3 Chinese
carriers in 2000 (Air China, China Southern and China Eastern; also called the Big three).
There were other small/charter type airlines operating in various provinces with varying degree of
financial/operational viability. In 2004 China saw the next wave of airline boom, with the entry of
LCCs. 4 new LCCs were approved to start their operations and there were applications from Air Asia,
Virgin Blue etc to start operations in China.
The thing to note though is that, despite this plethora of operations by the airlines, the market demands
were not always met. With the mass migration of people from poor to middle class, and the increasing

Question 6 3

HNA Group: A Miracle in Civil Aviation

propensity for travel, the Aviation market was booming. The Chinese, with the new money, wanted to
explore the tourist hotspots of the country. They also wanted to travel to the countryside, esp during
holidays by better and cheaper means. While the other transport methods were developing (roads, rail
and high speed rail) the increase in demand far outstripped these. Resultantly we saw a double digit
growth of aviation.
The fact that the industry was highly fragmented was a good sign for HNA airlines at the start. This
meant that the barriers to entry were lower, due to the fragmented nature of the market, no player was
large and HNA could carve out its niche in the regional market. What also helped HNA was that the
airline was launched in the beginning of the boom. The next wave of airlines came only in the 2004 era.
With a fragmented market though, there are problems of gaining market share and maintaining
profitability. If you do not establish your self fast and make your self profitable fast enough, the
competitor can take away your growth surplus and make you languish at the bottom. For this aspect,
the focus of Hainan airlines on the trunk lines rather than the feeder routes seems to have paid off.
When the market moved towards consolidation in the late 1990s early 2000s, many mergers were seen
in the market. The mantra during this time was either grow large or be acquired by a larger player.
Even though it didnt require the additional capacity of the other airlines and could have grown
organically, HNA acquired other regional players to keep the larger airlines from acquiring it. Hainan
airlines was able to leverage its superior performance and business strategy to acquire other smaller
airlines and turn them around using its operational excellence, in the end becoming the fourth largest
player in the Chinese market.
If the market was not as fragmented, and there was no competition amongst provinces to start new
airlines, I doubt that HNA would have been even established. If the CAAC had not been so aggressive
in its promotion of the airline businesses, they would have seen a slower development of the markets in
china with patchy services in the countryside. With a very aggressive plan, the CAAC was able to a)
establish a rudimentary network of airline services throughout the country, b) establish trunk and
feeder services by careful allocation of hubs and landing rights, c) enabled market discovery of prices
and capacities and d) although there were failures, was able to see that there were about 15 airlines in
the market at the turn of the millennium.
The CAAC also put limits on the entry of foreign players, that helped the development of Chinese
Airlines and HNA. Simultaneously the government allowed the airlines to find equity in the Chinese
markets as well as international markets. It is doubtful that the aviation would have opened to such an
extent if the market was not fragmented to start with.

Question 6 4

HNA Group: A Miracle in Civil Aviation

Finally, in the competitive landscape, the evolution of the regulatory framework in china along with the
gradual development of HNA helped it grow. I doubt if HNA would have achieved success if it were
saddled with very sophisticated regulatory guidelines when it started off in 1992/93.

Question 6 5

HNA Group: A Miracle in Civil Aviation

Question 3
Who provided the initial financing for the airline? Was it private or institutional investors?
International or domestic? How did the funding develop afterwards?
The funding for Hainan Airlines had very humble beginnings. Hainan was declared as a free enterprise
zone to grow the regional economy, and Mr Chen Feng was invited by the Governor of the province to
start an airline. Mr Chen (and three other founders) didnt have any money with them to fund the
venture. The first round of funding that came was a total of $31.4 Mn; which included a starter loan of
$1.2 Mn from the Hainan Province and initial seed funding from 17 Chinese Investors amounting to
$30.2 Mn. The company was founded in 1989.
Although very modest, the company took off by leasing two aircrafts and began scheduled operations
in 1993. Hainan airlines focused on the trunk routes rather than the feeder routes and other
strategies. It ended 1993 with a profit of $1.16 Mn on a revenue of $20.22 Mn. The company was now
operating a total of 8 leased aircrafts on 15 routes. Most of the funding till now was done by raising
extra debt.
In 1995 when the company wanted to grow, in its 2nd phase, it was not able to take any more loan due to
a very high leverage. The second round of funding saw Mr George Soros investing $25 Mn in the
company. In 1997, the company got listed on the Shanghai stock exchange and got funding of $33.4 Mn
in B Shares (International investors, both private and institutional). It later issues B Shares (for Chinese
local investors) in 1999 and raised further $113.9 Mn.
After 1999, the company survived mostly on Debt till 2004. It had a total debt of $2.22 Bn / RMB 18.4 Bn
($725 Mn / RMB 6Bn being current Debt) with a leverage ratio of 94%. To fund the new plan of
Soaring from the Take-off, Hainan required a Capital expenditure of $338 Mn/RMB 2.8 Bn. In Q1
of 2004 its operating cash flow was $36Mn/RMB 300 Mn, and it would require a substantial equity
infusion to fund its growth plan and still be solvent. Hainan Airlines had now formulated a plan of the
Grand China Airlines, and was looking to infuse $200 Mn/RMB 1.66 Bn in Private Equity from
international PE firms. It hired Benedetto, Gartland & Company based out of New York for this PE
Hainan airlines has prudently followed a funding mix of equity from domestic & international investors
(both private, but mostly institutional). It financed most of its growth by taking on debt and putting
back the profits it earned from its operations in the 10 years of operations from 1993 to 2003. The rising
profits also enabled it to take on more debt. Thus one can say that its profits were also a major source of
funding (directly and by enabling it to take more debt).

Question 6 6

HNA Group: A Miracle in Civil Aviation

After its listing on Shanghai Stock Exchange, the HNA group diversified into owning airports, Tourism
companies, Hotels and related industries. It is quite unclear from the case how the funding for the
acquisition of these were done. One signal comes from the listing of the Meilan airport on the on the
Hong Kong Stock Exchange raising $100 Mn. I assume that the funding for the allied activities (airports,
hotels etc) was similarly funded by a mix of raising capital from the Chinese markets and debt based on
the capital and the superior performance of the entities by turning them around and making them

Question 4
What is the significance of feeder markets to Hainans operations? How does it relate to trunk versus
regional routes and their specific economics?
Although the company is reported to have said that the feeder markets were of great importance to
Hainans operations, from the case its not very clear what the significance of these were. We see from
Exhibit 7 and 8 of the case that the size of the regional operations of Hainan airlines was small
compared to the Trunk operations. Of the total of 14698 Mn ASKs in 2003, only 8.5% (1242 Mn ASK)
were from regional (or feeder) operations.
At its inception HNA had focused on developing the trunk routes in favor of the more regional feeder
routes. This seems to have changed when the Chinese markets saw a wave of consolidations happening
in the early 2000. In order to grow (and avoid being gobbled up by larger players) HNA had to grow,
and grow fast. This was not possible to do it organically, not with the limitations it had on its finances
and the limited equity it was able to raise by public offerings. A lucrative way to grow was to acquire
the struggling regional airlines. This was aided by the favorable regulatory environment and a whole
host of consolidations happening in the industry.
Also in 2000s the airline was hitting a barrier of growth. It had covered the markets in the south and
east quite comprehensively, and had to look towards other regions of china for further growth. The
management reasoned that it might be easier for it to gain foothold in the sparsely populated western
provinces, where it could offer services better than what existed by cutting down on costs and time
required to make the travel by bus or train. The management dubbed this the capillary strategy to feed
into the trunk routes which formed the Aorta of the aviation market in china.
HNA acquired airlines in the northern and western provinces (quite some distance from its main routes
in the east and south). These airlines included Xian based Changan airlines, a northern provincial
airline. With its acquisition, HNA controlled about 22 feeder airplanes for its trunk operations
(amounting to about 50% of the fleet of these small aircraft available in the country). With HNA groups

Question 6 7

HNA Group: A Miracle in Civil Aviation

strengths and route network, the revenues of Changan grew by 300% and its ASK grew by 236%.
Limited numbers are available on the impact this had on the operations at HNA.
Later, HNA went on to acquire Shanxi Airlines, based out of the northern province of Taiyun and
Beijing based Xinhau airlines. All three were northern airlines, and helped boost the performance of
HNA in the northern china region. HNA was able to turn them all around by employing better
management practices (from govt enterprises to private enterprises) and cutting down on
/restructuring the routes and fleets they had. I suspect that this turnaround was partly helped by the
economies of scale wherein all saw a large jump in passenger miles flown, possibly due to the better
linkages with the trunk routes of HNA and the desire of the people in the northern china region to fly
to the big cities. One must also not forget that the feeder routes were controlled, in the sense that only
few airlines were given permission to fly these, and HNA now had the feeder routes of three additional
provinces in its system.
From the route network of HNA airline, we also see that they have limited but significant operations in
the western province of Xinjiang. The case doesnt talk about acquisition of an airline in the western
region, but I suspect that the HNA group also acquired some small airlines based out of Urumqi.
All these additions would have helped HNA increase the passengers on its trunk routes, but as noted
earlier, the feeder routes still account for only 8.5% of its total ASKs. It has 28 regional aircrafts
compared to 41 on the trunk routes. This would indicate a lower utilization of the regional aircrafts (7.1
hrs / day against 11 hrs/day) for the trunk routes. Surprisingly, despite all these difference, the Cost /
ASK for the trunk and feeder routes is 0.0454 and 0.0471 respectively. Implying that despite the lower
ASKs, larger number of aircraft (possibly of different make) and lower utilization, HNA is able to
control the costs of operations of the feeder routes.

Question 5
Why was the pursuit of external growth through repeated acquisitions chosen? Is this a strong
pointer to operational excellence and inherent competitive advantage? What other reasons may have
Some of these have been answered in the analysis of Question 2 and 4. I think that the airline pursued
growth through acquisition repeatedly because of these reasons
1) It was constrained financially to grow organically
2) The market in China was consolidating and if you were not a large player, you would be acquired
3) There was a control of the routes given to airlines. Only regional airlines were allowed to fly certain
feeder routes. Even if HNA grew organically, it would not gain access to the feeder routes.
4) The capacity it had in the trunk routes had strong competition from the big three and feeder routes it
controlled could only take in so much capacity

Question 6 8

HNA Group: A Miracle in Civil Aviation

5) A lot of the airlines (esp regional) were government controlled and had a lot of inefficiencies in them.
HNA could acquire them at a lower cost and improve on the inefficiencies existing in them by smart
route planning, financial restructuring, and resource reallocation.
6) Lastly, it could deploy the economies of scale by consolidating the route network and offering a
seamless travel experience throughout china.

While these are pointers towards a superior operational strategy, I am doubtful if they represent an
inherent competitive advantage. The fact that the competition was doing things worse and you were
doing them bad, makes your better then the competition, but not point towards any inherent
HNA was able to infuse in the acquired airlines, a sense of belonging and work ethics. It streamlined
their processes and improved their resource allocation (financial , people and aircrafts). The fact is that
with the explosion of airlines that china witnessed in 1990s there are a lot of airlines that are small and
inefficient. These are a very lucrative target for acquisition by HNA for reasons outlined above. With the
consolidation now coming to an end, I suspect that the next wave of growth will be spurred by better
operational performance. HNA has a history of meeting the international benchmarks, but the recent
outbreak of SARS has exposed a chunk in its armor, with it reporting a loss of 24% of the revenues. The
competition is fast catching up to the costs of HNA and there is a host of new LCCs that are starting
up. HNA has maintained the cost leadership so far, I am doubtful that it would be able to maintain the
edge as other airlines in china improve their operations rapidly too.

Question 6
What do you think of the diversification into airline-related businesses by Hainan Group? Would
such moves be possible into other countries? Please explain.
I am intrigued by the diversification by the Hainan Group into airline related businesses. They are now
into running airlines, airports, hotels, travel agency, department store, IT company etc.
Due to a very different regulatory environment, somehow the Hainan group has ventured into owning
and operating airports. I donot think that this would have been possible in any other country. The
regulators in countries generally frown upon anti-competitive practices, and a company owning both
airline and airport, might lead to it curtailing operations of its competitors. This has evolved uniquely in
china because of the license structure where a particular airline is given the rights to particular routes,
which leads to the dominance of a single airline in that region. In the 1930s with the Air Mail act,
groups in the US were forced to break up operations of manufacturing airplanes, manufacturing
engines and running airlines for the fear of anti-competitive policies that they might deploy. These
airport operations donot have major contradictions as the HNA group is the largest operator out of
these airports. I forsee that with the growing market in china and the entry of new airlines in the

Question 6 9

HNA Group: A Miracle in Civil Aviation

second wave, there would be a growing dissonance between other airlines and HNA about the
operations of airports by HNA (and other airlines too).
That said, the diversification of HNA group into airports is a very sound business strategy. It allows the
airline to streamline its operations and put them in sync with the operations of the airports. It also
learns a lot about the operations of airports and can use these learnings to leverage its operations at
other airports. Although they contribute only 9% of the group revenues, I suspect that airport
operations have a higher punch due to the synergies associated with the airline operations.
The group also owns its Hotels and tourism businesses. Together they account for 5%of the revenues.
The other industries that the group is in account for the last 8% of the revenues. There are many
instances of airlines around the world diversifying (and later consolidating back) into different
businesses. The Tourism and Hotels businesses are related and help out in giving the customers a better
value proposition. There are risks too, as any deficiencies in services across any of these arms directly
decreases the reputation of its airline business and vice versa.
There are groups like the Virgin group which has interests into virtually everything from airlines to
music. I think that these diversifications by the HNA group represent the thinking of an entrepreneur
(Mr Chen) who is behind the HNA group. There is only so much a company can grow in one field
(aviation here). China has been growing rapidly since late 80s and many entrepreneurs and companies
have leveraged this growth to get returns. The HNA group is using the visibility it has access to from its
airline business to start and profit from the China growth story. It seems to have aims to becoming a
conglomerate with diverse business interests, and have airlines at its core.

Question 6 10