Spurt in M&As Likely as Asia Airlines Hit Turbulence: Citi

Rising fuel costs and competition from low cost rivals is pushing premium airlines in Asia to consolidate, which will lead to a spurt in M&A activity in the sector, says a recent Citi report.

Ichiro | Digital Vision | Getty Images

Governments in the region are also under pressure to allow foreign ownership in national airlines as these full-service carriers struggle to hold on to market share, says the Citi Research.

The International Air Transport Association in March cut its forecast for industry profits in 2012 to $3 billion from an earlier estimate of $3.5 billion.

“These recently emerging headwinds constitute a ‘new normal’ operating environment for Asian carriers, to which they need to respond and adapt,” Citi analysts wrote in the report. “Forming operating agreements and code-sharing partnerships may be pre-cursors to cross-border M&A (mergers and acquisitions) activities once both parties become familiar with each other.”

Over the past few weeks there has been a flurry of deal making in Asia across sectors, which include China’s state-controlled CNOOC agreeing to buy Canadian oil producer Nexen for $15.1 billion and Dutch brewer Heineken making a $4.1 million bid for Singaporean firm Fraser and Neave’s 40 percent stake in Asia Pacific Breweries.

Such cross-border activity will inevitably spill over to the airline industry in Asia as well, according to Citi. Hong Kong’s Cathay Pacific, Air China, Japan’s All Nippon Airways (ANA), Philippines’ San Miguel and Singapore Airlines are some of the firms that could potentially begin to buy and sell stakes or even merge with other airlines, according to the Citi report.

The report adds that Cathay Pacific and Air China could finally merge because of their growing linkages. Cathay already owns 18 percent of Air China and Air China has a 35 percent stake in Cathay. The two also set up an air cargo joint venture in 2011 and a ground-handling joint venture this year.

“We maintain our thesis that the end-game could be a merger between Air China and Cathay Pacific,” Citi said, adding however that it could be a long way off.

ANA, San Miguel Potential "Predators"

ANA and San Miguel are potential “predators” in the airline industry, according to Citi, after the former raised 175 billion yen ($2.2 billion) in fresh equity in July to buy new aircraft and indicated it wants to buy controlling stakes in airlines.

San Miguel in April bought a 40 percent stake for $500 million in Philippine Airlines, which wholly owns budget carrier Airphil Express. It also indicated that it was looking at several overseas airline deals that could give it access to the U.S. market.

While some airlines will be looking to expand their presence via cross border acquisitions, others like Singapore Airlines will be looking to offload their stake in other airlines, says the report. Singapore Airlines bought a 49 percent stake in Richard Branson’s Virgin Atlantic in 1999 for 600 million pounds ($931 million), but according to Citi benefited little from the deal.

“Virgin Atlantic's position in the U.K. did not really take off as Virgin Atlantic continued to face strong competition from British Airways and had limited ability to grow due to slot constraints at Heathrow (Airport), no short-haul presence and limited connecting traffic,” Citi said. “Since July 2007, SIA has made it clear that the stake is for sale but it has so far attracted little interest,” according to Citi Research.

- By CNBC's Jean Chua.