It's destination Hong Kong - and at any price
'Then there's the cost of doing business in Hong Kong, and gaining landing slots at the city's already congested airport.'
It is 2007 in the world's new casino capital of Macau, and Qantas executives are knocking on as many doors as they can in the former sleepy Portuguese enclave.
With the botched $11 billion private-equity raid on Qantas fresh in their minds, the airline's executives are so desperate to find a partner in north Asia that they are talking to both of Macau's airlines.
The two-timing with Air Macau and Viva Macau is part of a strategy to gain a north Asian foothold for Qantas' low-cost franchise, Jetstar. With the hurdles too high elsewhere, they are searching for a way into markets on the doorstep of the most-prized market of them all - China.
Several Qantas heavyweights - including then chief executive Geoff Dixon and finance chief Peter Gregg - are flown in for talks with their counterparts at the two Macau airlines. But the talks amount to nothing, with Qantas deciding its potential partners were too much of a gamble.
It was probably just as well. Viva Macau collapsed three years later, and Air Macau remains a small player even as hundreds of thousands of Chinese flock to the city's gaming dens every year. But six years on, the links built in Macau could well prove to be Qantas's trump card as it attempts to gain access to nearby Hong Kong - a Holy Grail for airlines.
The battle for the Hong Kong skies pits oneworld alliance partners Qantas and Cathay Pacific against each other, as well as some of Hong Kong's powerful business people. It also drags in well-connected interests from mainland China.
It is testing the resolve of Qantas chief executive Alan Joyce and his trusted Jetstar boss, Jayne Hrdlicka, and on the other side that of Cathay boss John Slosar and his heir, Ivan Chu.
The former British trading colony's location at the crossroads of Asia has been treasured for centuries. Even today, Hong Kong is ideally placed for the 21st century's preferred mode of transport. Last year, more than 56 million people passed through Chek Lap Kok's vast terminals - about 19 million more than those that went through Sydney Airport.
Importantly for airlines, Hong Kong is within five hours' flying time of all the other major Asian financial centres, making it one of the world's most prized aviation hubs.
Qantas, with Joyce at the helm, is determined to launch its low-cost offshoot into this potentially lucrative market before its Asian budget rivals. But Cathay, the airline that has held the keys to Hong Kong for decades, is putting up the fight of its life - even if that means going to war against its founding oneworld alliance partner.
After deflecting questions for months about the new entrant, Cathay ripped off the gloves a month ago when it filed its formal opposition to Jetstar Hong Kong with regulators.
"The setting up of Jetstar Hong Kong is an attempt by a foreign carrier to gain access to Hong Kong's pool of traffic rights without a fair exchange of value to Hong Kong," it thundered.
The ferocity of its attack surprised many who thought it would be better served lobbying aggressively behind the scenes.
But Cathay has everything to lose. Its fear is not that it has to contend with a budget airline that plans to begin flying with just six planes.
Instead, the worry is that the arrival of Jetstar will open the floodgates to many airlines, including the large Chinese carriers wanting to set up shop on their home turf.
"Cathay's view is that we have to fight this one to the death otherwise there are going to be many more airlines coming after Jetstar," says Andrew Pyne, the former Viva Macau chief executive, who also advised the territory's last governor, Chris Patten, on aviation matters.
"If an Australian carrier, as they see it, is allowed to use Hong Kong as an access point to China, then there is going to be a reaction from the Chinese carriers, and they would want to get into Hong Kong," Pyne says.
As a place to base a low-cost airline, Hong Kong has its pitfalls.
An Australian who knows Hong Kong and aviation better than most is Rod Eddington.
The former chief executive of British Airways and Cathay says the city is both a competitive aviation market and an expensive place to run a business.
"The two most competitive markets in Asia are Hong Kong and Singapore because everybody flies there and everyone wants traffic rights to these places," he says.
"It's one thing to set up in Malaysia and Indonesia. But in Hong Kong and Singapore you are taking on two extremely successful, very combative, major Asian players."
To much fanfare, Joyce unveiled the blueprint for the Jetstar offshoot in Hong Kong in March last year. Trumpeting its "first-mover advantage", the Qantas CEO talked of the "huge potential" to tap mainland China where the number of passengers is forecast to grow from 300 million a year to 450 million by 2015. The plan was for Jetstar Hong Kong to begin flying by the middle of this year using three Airbus A320s, before growing to 18 by 2015.
With Qantas and alliance partner China Eastern each taking a 50 per cent stake, Joyce pointed out that he did not see the need for any other partners for Jetstar Hong Kong. But as a year passed, doubts grew about whether the new airline would get off the ground. The regulatory hurdles were stacked against it amid Cathay's lobbying power.
Enter socialite and businesswoman Pansy Ho, the daughter of Macau gaming billionaire Stanley Ho.
Dispelling fears the game was over, the Hos' listed conglomerate Shun Tak bought a third of Jetstar Hong Kong in June for $US66 million. For Qantas, the dilution of its stake was a small price to pay - the new offshoot stood little chance without the influential support of Shun Tak.
The Ho family is Macau's de facto royal family, controlling everything from casinos to retail, transport, tourism and property assets. Its tentacles stretch into Hong Kong where Pansy Ho holds court at Shun Tak as its managing director.
Her father Stanley, now 91, would be driven around Hong Kong in a burgundy Rolls-Royce with a number plate "HK1". According to those who witnessed his grand entrances, Ho's driver bore a striking resemblance to Oddjob, the henchman to Goldfinger in the James Bond film.
Of Ho's 17 children to four wives, Pansy has emerged as an heir apparent to the Ho empire.
"She is a very shrewd businesswoman and a very tough lady. I would go as far as to call her ruthless in the way she operates but I have a grudging respect for her," Pyne says.
"Within the whole empire there is quite a lot of internecine squabbling, to put it kindly, and she has come out at the top of it. She is quite an impressive lady."
Australians will be more familiar with one of her brothers, Lawrence, who is James Packer's business partner in casino joint venture Melco Crown. But in Hong Kong it is Pansy Ho, the territory's richest woman, who hugs the headlines. In years past, the tabloids christened her "Party Girl Pansy" for her exploits on the social circuit.
She might be the antithesis of budget travel, but with her now ensconced as chairwoman of Jetstar Hong Kong, the airline has given itself a flying chance of setting up operations at Chek Lap Kok Airport.
"I couldn't think of a better local partner - financial business smarts and political connections there [in Hong Kong] and on the mainland," a China-based Australian executive says. "It is a first-class choice [for Qantas and Jetstar] - they have done very well there."
Her arrival reads straight from the Hos' playbook. Shun Tak began in the 1970s as a ferry operator, while its interests in aviation have also included a helicopter shuttle service between Macau and Hong Kong.
It is not the first time Shun Tak has been courted by an Australian airline. Back in 2004, the conglomerate was one of the parties Virgin Blue's then chief executive, Brett Godfrey, talked to about setting up a budget airline in Macau to operate flights to mainland China.
"They have got form in getting involved in tourism and aviation interests. Obviously with the casinos, the whole business is about bringing people to spend their money in Macau," an executive with knowledge of those talks recalls.
"They are a good fit [for Qantas] and natural partner with aligned interests in terms of a low-cost carrier model of getting passengers, particularly inbound passengers, to that region."
But even with Macau's most famous family on board, Qantas faces a battle in getting Jetstar Hong Kong flying. In the other corner with Cathay is its short-haul offshoot, Dragonair - the group's main weapon on routes to the mainland - and Chinese-backed Hong Kong Airlines and its sister carrier Hong Kong Express. Later this month Hong Kong Express will be relaunched as a low-cost carrier, pre-empting the arrival of Jetstar-badged planes from Hong Kong.
Qantas has surprised many people in Hong Kong by fighting what some grudgingly term "a half-decent rearguard action".
"But Cathay are not going to go down without a fight. Even if they did get into the market and it was a three-way battle, it would get brutal very fast. Cathay don't want to lose money but if they have to rationalise the market I suppose they would," one former Asian aviation executive says. "What Hong Kong Airlines would stomach, who knows."
While the Hos are well connected, it is important not to underestimate the power of Cathay and its biggest shareholder, Swire Group, which is synonymous with the "Pearl of the Orient". Cathay's second-largest shareholder is Beijing-based Air China, one of the mainland's big-three airlines.
And Cathay has been one of the best protectors of its turf of any airline in the region. "Cathay are trying to protect their market. Companies all have great free-trade rhetoric except when they are on the receiving end," Commonwealth Bank analyst Matt Crowe says. "They are just trying to tilt the playing field in their favour."
Jetstar's bid to launch flights will rest on the Hong Kong aviation regulator's interpretation of "principle place of business", as defined under the territory's constitution known as the "Basic Law". The law was designed around the Cathay ownership structure. The concept, developed in the 1980s, was designed to ensure Cathay's existence after Britain's handover of Hong Kong in 1997 to China.
With the change in sovereignty, neither the locals nor the mainland authorities wanted the Chinese airlines to descend en masse on Hong Kong. The territory was to be Cathay's sphere of influence with the mainland carved up by the big three - Air China in Beijing, China Eastern in Shanghai and China Southern in Guangzhou.
In a nutshell, the law means that it does not matter who owns a Hong Kong airline - whether onshore or offshore - provided its genuine place of business is the territory. It cannot be an affiliate of another airline or controlled from somewhere else. If it meets this criteria, it is designated as a Hong Kong airline and in turn gains the benefits that flow from that.
One of the tests is where the ultimate decision making of a Hong Kong airline rests. In this regard, Cathay has always been careful that its board meetings are held in Hong Kong.
Both the Cathay CEO and Jetstar's top brass in Australia and Hong Kong declined requests for interviews. Jetstar has maintained it is confident its Hong Kong airline will be flying soon, and is attempting to win in the court of public opinion by promising to serve the territory's flyers with low fares. It has repeatedly pointed to research which claims there is overwhelming support in Hong Kong for a local budget airline.
For Qantas shareholders, the question is whether it is worth the fight. Jetstar has a chequered report card in Asia. Almost nine years after its largest offshoot was launched in Singapore, Jetstar Asia is still struggling to post strong results.
In Vietnam, Jetstar Pacific has had its fair share of troubles. They include secret police barring two Australian executives from leaving the country for six months in 2010.
In Japan, the Jetstar joint venture is still in its infancy, having been launched last year.
Now, much faith is being placed on making Jetstar Hong Kong fly. To date, Hong Kong and Macau haven't been easy hunting grounds for budget airlines - the failed airlines Oasis Hong Kong and Viva Macau are cases in point. But Qantas and Jetstar executives are expending considerable efforts on this bid.
Working in the shadows for Qantas as a consultant in China is Geoff Raby, the former ambassador to China regarded as the man for hire for Australian companies wanting advice about the diplomatic dance required in the world's second-largest economy. It also has the lobbying power of China Eastern to call upon in the mainland.
Debate has long raged internally at Qantas about where to position the airline group's centre of gravity in Asia. Many have favoured Singapore because Jetstar's main Asian operations are already operating from the city's Changi Airport.
But others support Hong Kong because it is in the middle of Asia - and, importantly, much of its wealth. The territory is one step into China but yet governed by a clear rule of law as opposed to that on the mainland.
Hong Kong has been on the Qantas radar for a long time.
In 2008, a paper to Qantas management recommended Hong Kong as a base for the so-called north Asia "mega region", encompassing China, Japan and Korea. It was seen as a logical spot because most of the biggest cities in Asia are within five hours flying time - about the maximum distances for Jetstar's workhorse A320s.
But even if Jetstar Hong Kong gains a licence to operate commercial flights, it faces a higher set of obstacles in gaining the right to fly to destinations in mainland China.
Drawing upon his knowledge as Cathay CEO from 1992 to early 1997, Eddington says one of the big hurdles for Jetstar will be gaining access to routes from Hong Kong to mainland China and other Asian destinations.
That's because it will require the airline to negotiate for access to bilateral air-rights agreements between countries.
While countries such as Singapore have relatively liberal views on access to foreign airlines, others including China take a more measured approach to negotiations.
"It requires Jetstar to negotiate traffic rights to fly to these other places from Hong Kong. The Chinese authorities in Beijing aren't necessarily going to be handing out these rights immediately," he says.
"They will want to ensure they gain benefits and access from the countries at the other ends of the routes. And current Hong Kong-based carriers will have their own ambitions for additional Hong Kong traffic rights as they become available."
Then there's the cost of doing business in Hong Kong, and gaining landing slots at the city's already congested airport. While Jetstar might be able to bring in cabin crew from the mainland, it will have to hire pilots and engineers based in Hong Kong, where the cost of living is among the highest in Asia.
Of course, the same assumption could have been made of Sydney or Melbourne more than a decade ago. But Virgin Blue and Jetstar were able to establish themselves in the market. The battle now raging in Hong Kong offers riches to the winners but costs aplenty to those who fall short.
This weekend, Joyce will be in Seattle, the US city that is the home of Nirvana, Starbucks and Boeing. There, he will finally take the keys to Jetstar's first state-of-the-art 787 Dreamliner - albeit almost four years late. He has described the plane as a game changer.
Across the Pacific Ocean in Hong Kong, the other game changer now rests in the hands of the city's regulators. If history is any guide, it promises to be a long and bumpy ride.
InvestSMART FORUM: Come and meet the team
We're loading up the van and going on tour from April to June, with events on the NSW central & north coast, the QLD mid-north coast and in Perth, Adelaide, Melbourne, Sydney and Canberra. Come and meet the team and take home simple strategies that you can use to build an investment portfolio to weather any storm. Book your spot here.
Want access to our latest research and new buy ideas?
Start a free 15 day trial and gain access to our research, recommendations and market-beating model portfolios.Sign up for free