Shares of China Eastern Airlines, Cathay Pacific Airways and Air China nose-dived on Tuesday after Air China and Cathay said they would not proceed with a plan to buy a slice of China Eastern.
Cathay's shares fell as much as 8%, while Air China and China Eastern both plunged 17%, lagging a flat broader market.
Cathay said late on Monday it had scrapped a plan to team up with the parent of Air China to buy into China Eastern. A deal would have scuppered an agreed $918 million joint acquisition by Singapore Airlines and Temasek Holdings.
Shares in Singapore Airlines were also higher, outpacing a 0.2% gain in the Straits Times Index.
"It's really an Air China-driven deal -- they want to create one strong mainland carrier, and they've said that many times publicly," a source close to the situation said on Tuesday. "As a shareholder in Air China, Cathay plays a secondary role," the source said.
Merrill Lynch cut its share recommendations on China's three biggest airlines on Tuesday, saying Cathay's scrapping of the proposal had dimmed consolidation prospects for the sector.
Merrill Lynch downgraded Air China and China Eastern to sell from neutral and buy, respectively. It relegated China Southern, the largest of the trio by fleet size, to neutral from buy.
But Citigroup recommended a buy rating on China Eastern, on "potential share weakness from the timing disappointment", and said Air China still had a chance to fight the Singapore deal.
"Air China buying China Eastern is a must, and stands a better and better chance," Citigroup's Ally Ma said in a research note. "As we analysed before, to reject the SIA deal at CEA's EGM is Air China's final chance to seize control of Shanghai," the bank said, adding that Air China had the support of China Eastern A-share minority holders.
China Eastern is expected to hold an extraordinary general meeting in December, the bank said.
Speculation of a Cathay-Air China Investment in China Eastern had sent shares of the Shanghai-based carrier up 50% last week. But the stock took a U-turn after an 8% rally to a record earlier on Monday and closed down 10.5% as analysts cast doubt on the probability of a deal.
The Shanghai and Shenzhen-listed stocks of airlines were among the top losers on Tuesday, falling between 5% and 9%.
Shares of Chinese carriers, including China Southern , Hainan Airlines and Shanghai Airlines, had soared over the past three months, partly on rumors that mergers and acquisitions will hot up in the sector.