Air China Ltd., the world's largest carrier by market value, has started talks with Shanghai Airlines Co. and may bid for a stake to expand in the country's commercial capital after its first choice, China Eastern Airlines Corp., spurned a tie-up.

"Shanghai Airlines can be a good partner in the city," said Sun Yu, Air China's head of planning and development, in an interview in Beijing, yesterday. "The joint efforts may enable us to arm wrestle China Eastern in Shanghai."
Air China aims to dominate the world's fastest growing air- travel market by establishing a hub in Shanghai to match its presence in Beijing. Air China would more than double its market share with the combination, helping it challenge China Eastern.

"Air China's first priority is to get Shanghai, regardless of the cost," said Andrew Au, an analyst at Cazenove Asia Ltd. "Shanghai Airlines is the second-best choice, if Air China can't get the larger China Eastern."

Shanghai Airlines has 15 percent of Shanghai's aviation market by number of passengers, while Air China has 12 percent. Shanghai-based China Eastern has 40 percent.

Shanghai, China's financial center, hosts banks including Citigroup Inc. and HSBC Holdings Plc. It is also the country's second biggest aviation center after Beijing, handling 51.6 million passengers and 2.9 million tons of cargo last year.

Air China's affiliate China National Aviation Corporation (Group) Ltd. offered to buy as much as 30 percent of China Eastern at HK$5 per share in January. The proposal was rejected by China Eastern's management, which prefers a tie-up with Singapore Airlines Ltd.

Government's Role

China Eastern's management will remain hostile toward any bid from Air China for at least half a year, Cazenove's Au said.

Air China and Shanghai Airlines joined Star Alliance on Dec. 12. Shanghai Airlines is controlled by local government-owned companies and the city has not responded to Air China's expression of interest, Sun said.

Shanghai Airlines survived the nation's first round of mergers which created the "Big Three" airline groups in 2002. Nine carriers were merged into China National Aviation Holding Co., China Eastern Air Holding Co. and China Southern Air Holding Co., parents of Air China, China Eastern and China Southern Airlines Co., respectively.

Compared with the previous mergers, triggered by government orders, a "second round" has yet to get government support, said Li Lei, an analyst at China Securities Co. in Beijing. "Nothing is going to succeed without government approval," he said.