Wuhan Knife-fight: East Star's Battle

Operating in totalitarian societies where the rule of law is fluid can be a tenuous existence even when you're not trying to go up against state owned assets during an economic downturn. So goes the story of East Star Airlines - the only Chinese airline to ever go bankrupt. Was it misfortune or something more machiavelian that did for China's 4th private airline?

The mid-2000s introduced a new willingness to enable private airlines and the fourth to setup business, in June 2005, was East Star Airlines. It was the first private airline to setup in Central China and was backed by Lan Shili's diversified East Star Group. Mr Lan Shili himself was at the time the 70th richest businessman in China, according to Forbes (with a net worth of 2 billion yuan (USD$300 million)). As early as November 2005 a Letter of Intent was signed for the purchase of 10 A320s from Airbus and a leasing deal for a further 10 from GE Commercial Aviaion Services (GECAS).

East Star Airlines Airbus A319 B-6230 Aeroclassics 1:400 Scale Model Airliner

As Lan Shili said:

"The A320 family aircraft is no doubt the best choice for our new airline. Its unmatched low operating costs with the highest level of passenger comfort will help us take off smoothly and successfully. We are very confident that by flying the best-selling aircraft in the world, we will not only ensure a good beginning of profitable operation, but also high standards of service quality for passengers on domestic routes in China.

Staff wave off the airline's first flight

The A320s were to be configured in a 128 seat two class configuration though the first three aircraft (all leased from GECAS) were in fact Airbus A319s. The carrier's first aircraft, B-6229, arrived on May 12 and the first flight took off on May 19, 2006 in concert with an aggressive marketing strategy. The second A319, B-6230, arrived at the end of May and was followed by B-6163, sub-leased from Juneyao Airlines, in February 2007. The initial route system connected the Wuhan base with Guangzhou, Shenzhen, Shenyang, Zhang Jiajie and Guilin.

Despite this promising start it wasn't all smiles in Wuhan. There were questions about how East Star could afford the substantial USD$1.5 billion aircraft purchasing deal but these were batted away since the aircraft were scheduled to arrive over a 4 year period between 2006 and 2010 and had been acquired on favourable deals from the Euro Export Bank and GECAS. Plus Mr Shili expected the airline to be profitable within 3 years and even return a profit by the end of 2007. In fact the carrier managed a 10 million yuan profit in 2006. Further a deal had been signed with Lufthansa for parts and maintenance and East Star had been approved by the CAAC for cargo operations also.

Perhaps more damaging to East Star in the long term was its disruptive impact on entry in the Wuhan marketplace, which seriously put the competing 8 airlines and major local ticket agencies noses out of joint. As well as offering low ticket rates East Star offered every passenger who bought a full price ticket 5 days free travel to Hong Kong and Macau. On top of this East Star Travel Agency (an affiliate company of the East Star Group) quoted low fare prices for domestic tourist itenararies from Wuhan. These competitive steps led to a boycott from all the other airlines and agencies who refused any kinf of co-operation and stopped the East Star agency selling their tickets too. It is hard to see how this lack of goodwill could not impact the new airline later in its life.

In the meantime however success continued as East Star acquired the rights to fly to international destinations in July 2007. East Star built up a 10% market share in Wuhan. New bases were opened at Zhengzhou and Guangzhou and the first A320s began to arrive in August 2007 including the first, and last, owned aircraft (A320-214s B-6609 and 6610). Five further A320s would be delivered  up to December 2008 but though new they were all leased from GECAS (B-6606/07/08/11 and B-6940). Unfortunately by then the situation at East Star had changed dramatically.

The 2008 Global Financial Crisis had a major impact on Chinese airlines with fuel prices rising from $74 per barrel to $174 per barrel. Further environmental factors clobbered East Star when the worst snowstormsin 50 years were followed by floods in Guangzhou and Guangxi provinces and a major earthquake in Wenchuan. These unfortunate events were compounded by a 6 month delay from the CAAC for an approval to operate 4 new A320s. This cost the airline 200 million yuan and the combined impact of this and the other factors, not just on the airline but also other East Star businesses, forced it to take a USD$46 million loan from the Rong Zhong Group. This was something Mr Shili would live to regret. The agreement stipulated an equity transfer and failure to payback the loans would result in loss of ownership of the East Star companies.

Now East Star seemingly became a pawn in the machinations of the Chinese communist state and officials. As well as the CAAC's delays there seem to have been missed opportunities to pay bribes. The Chinese government was busy propping up the Chinese majors and was hardly keen for strong competition at their expense. Plus none of the huge state handouts were available to the new private airlines. The Rong Zhong Group introduced East Star to the China National Aviation Holding Company (CNAC), which is Air China's parent company. East Star was looking for an equity investment but CNAC wanted Shili to sellout. By March 2009 Lan Shili was under residential surveillance.

On March 10 Air China reported that it was close to sealing a deal to buy East Star but this didn't happen and 5 days later East Star was forced to cease operations by the local government and CAAC. It seems the airline didn't officially declare bankruptcy until August, by which time its debt stood at USD$145 million. Six creditors requested liquidation and East Star's accounts were frozen. It is hard to say what really caused the airline to cease operations. It appears the economic situation had caused it to be loss making, however it also seems that corruption and the state had its part to play. Mr Shili was ruined and came to regret his dealings with the Rong Zhong Group when he lost control of his East Star businesses. He accuses the Wuhan deputy mayor Yuan Shanla of being behind the companies fall from grace. Worse still a year later Shili was jailed for 4 years for alleged tax evasion. Was this a state led hatchet job or just inherent corruption? It certainly smells funny to say the least. In 2016 with a wider range of private airlines and the state embracing LCCs it is hard to imagine similar events happening again. Nonetheless East Star is a good example of the perils of working in a totalitarian society.

As for East Star's assets, several of the A319s and A320s went to the struggling private airline United Eagle (itself partly nationalised later as Chengdu Airlines) whilst most of the A320s ended up with Air China anyway. They also took onboard about 600 of the airline's 1000 staff so in the end Air China did effectively take over East Star Airlines by force.

References

East Star Airlines Rises From Hubei. Air Cargo News
2005, Nov 29. New Chinese airline East Star to introduce 20 Airbus A320s. CAPA
East Star’s Lan Shili: ‘Entrepreneurs Have to Be Bold to Do Big Things’. Knowledge @ Wharton
2007, July. China's East Star Airlines wins international opg license - report. CAPA
2009, March. Air China to buy East Star. Air Cargo News
2009. China's East Star Air Faces Liquidation. Global Insolvency.com
2009. East Star Airline goes bankrupt with huge debts. China.org.cn