China Southern Announces Very Substantial Acquisition & Connected Transactions Regarding Northern Airlines/Xinjiang AirlinesGUANGZHOU, China - November 15, 2004 - The Directors are pleased to announce that on 12 November, 2004, the Sale and Purchase Agreement was entered into by the Company as the purchaser and CSAHC, Northern Airlines and Xinjiang Airlines as the vendors, whereby the Company will acquire the Business and Assets and assume the Debts from the Vendors. CSAHC is the controlling shareholder of the Company holding approximately 50.30% equity interest in the Company as of the Latest Practicable Date. Both Northern Airlines and Xinjiang Airlines are wholly owned subsidiaries of CSAHC and are engaged in the civil aviation business. The Business and Assets to be acquired consist of certain Airline Operations, assets and properties of Northern Airlines Group and Xinjiang Airlines Group, including aircraft, engines, spare parts, aviation equipment and facilities, properties, office facilities, and other fixed, current and intangible assets. The Debts to be assumed consist of all indebtedness in the aggregate sum of RMB15,090,109,000 owed by Xinjiang Airlines Group or Northern Airlines Group in connection with their civil aviation business. Consideration for the Sale and Purchase Agreement The provisional amount of the consideration of the Acquisition, and
of the Debts to be assumed under the Sale and Purchase Agreement are
set at RMB16,912,244,600 and RMB15,090,109,000 respectively. These amounts
are arrived at after arm＊s length negotiations between the Vendors and
the Company, with reference to the valuation of The provisional amount of the consideration of the Acquisition, and
of the Debts to be assumed by the Company will be subject to adjustment
and finalisation based on the book value of the Business and Assets,
and of the Debts as of the Effective Date, as determined in the financial
statements of the Business and Assets of the Target Group A portion of the final adjusted consideration of the Acquisition will be settled by way of assumption of the final adjusted Debts, with the remaining balance to be payable by the Company to the bank account designated by the Vendors in cash. The Company shall make repayments of the Debts directly to the creditors of such Debts in accordance with the terms and conditions of the relevant agreements between the Vendors and the creditors in relation to the Debts. Very substantial acquisition and connected transactions The Acquisition constitutes a very substantial acquisition of the Company under the Listing Rules. Since CSAHC is the direct controlling shareholder of the Company, the Acquisition also constitutes a connected transaction for the Company under the Listing Rules and is therefore subject to the approval by the Independent Shareholders at the EGM. CSAHC and its associates are required to abstain from voting in respect of the proposed resolution to approve the Sale and Purchase Agreement and the Acquisition which will be conducted by poll. Reasons for and benefits of the Acquisition The Directors believe that the Acquisition represents an attractive opportunity for the Company to consolidate its strong market position and improve its financial performance. Both Northern Airlines and Xinjiang Airlines are leading airlines in their respective operating regions. The Acquisition will bring various commercial benefits to the Company in terms of broadening its flight service network, increasing its fleet size and transportation capacity, reducing its costs and boosting its overall efficiency, ultimately strengthening the Listed Group＊s position as one of China＊s largest airlines and enhancing value for its investors. The Board, including the independent nonexecutive Directors, believes that the terms of the Sale and Purchase Agreement and the Acquisition are fair and reasonable and are in the interests of the Listed Group and its shareholders as a whole. Financial effect of the Acquisition Based on the pro forma financial information of the Combined Group outlined in Appendix V of the circular to be dispatched by the Company to its shareholders, assuming that the Acquisition had taken place on 30 June, 2004, there would not be any impact on the net assets of the Listed Group following the Acquisition as of 30 June, 2004. On the same basis, the total assets of the Listed Group would increase by 35%, or RMB15,179 million, which would be offset by an increase of RMB15,083 million in liabilities and RMB96 million in minority interest. Based on the pro forma financial information of the Combined Group outlined in Appendix V of the circular to be dispatched by the Company to its shareholders, assuming that the Acquisition had taken place on 1 January, 2004, net profit of the Listed Group for the first six months ended 30 June, 2004, would increase by 36%, or RMB95 million to RMB361 million following the Acquisition. On the same basis, basic earnings per share would increase from RMB0.06 to RMB0.08, representing an accretion of 33%. On-going Connected Transactions Certain transactions will be entered into between the Company and connected persons of the Company within the meaning of the Listing Rules, which will constitute On-going Connected Transactions of the Company under the Listing Rules upon completion of the Acquisition. Further details of such transactions are set out in section 2 of this announcement. The Board, including the independent non-executive Directors, considers the On-going Connected Transactions to be on normal commercial terms, in the ordinary and usual course of business, fair and reasonable and in the interests of the Listed Group and its shareholders as a whole. Each percentage ratio (other than the profits ratio) for (i) the Lease Agreements and (ii) the Catering Agreement is on an annual basis less than 2.5% and therefore each of them falls under continuing connected transactions exempt from the Independent Shareholders＊ approval requirement. Pursuant to the relevant rules and regulations of the PRC, however, each of the Lease Agreement 1, Lease Agreement 2, Lease Agreement 3 and Catering Agreement is conditional upon approval by the Independent Shareholders. Financial Services Agreement The Company and the Finance Company entered into the Financial Services Agreement on 12 November, 2004. The Provision of Deposit Service constitutes a non-exempt continuing connected transaction under Rule 14A.35 of the Listing Rules and requires the Company to comply with the reporting, announcement and the independent shareholders＊ approval requirements. The first financial services agreement, first signed on 22 May, 1997 for a term of three years, was extended for six years in 2000 to 22 May, 2006. The Stock Exchange is looking into the matter of whether the Company had complied with the requirements of the Listing Rules during the extended period of the first financial services agreement and the Company will publish further announcement in this respect. Further details of the Financial Services Agreement are set out in section 3 of this announcement. The Board, including the independent non-executive Directors, believes that the terms of the Financial Services Agreement and the Provision of Deposit Service to be on normal commercial terms, in the ordinary and usual course of business, fair and reasonable and in the interests of the Listed Group and its shareholders as a whole. Independent Shareholders＊ approval and independent financial adviser An Independent Board Committee has been formed to advise the Independent Shareholders with respect to the Sale and Purchase Agreement, the Financial Services Agreement and the transactions contemplated thereunder. ICEA has been appointed as the independent financial adviser to advise the Independent Board Committee and the Independent Shareholders in respect of the Sale and Purchase Agreement, the Financial Services Agreement and the transactions contemplated thereunder. Dispatch of shareholders＊ circular and closure of the register of members A circular containing, amongst other things, details of the terms of
the Sale and Purchase Agreement, the Ongoing Connected Transactions,
the Financial Services Agreement, letters from the Independent Board
Committee and from ICEA, further financial and other information of
Northern Airlines Group and Xinjiang Airlines Group and a notice to
shareholders of the Company convening an EGM to approve, amongst other
things, the Sale and Purchase Agreement, the Financial Services Agreement,
the resignation of a director of the Company and the election of a new
director of the Company will be dispatched to the shareholders of the
Company as soon as This announcement has also been previously published on 13 November, 2004, where under the paragraph ※Consideration and payment terms§ of Section 1(a) ※The sale and purchase agreement§, the remaining balance payable by the Company in cash to the bank account designated by the Vendors, on the assumption that the Acquisition had taken place on 30 June, 2004 was mistakenly stated as RMB897 million due to inadvertent printing mistake, instead of the correct figure of RMB1,897 million which is stated herein. The register of members of the Company will be closed from 1 December, 2004 to 30 December, 2004 (both days inclusive). 1. THE ACQUISITION On 12 November, 2004, a Sale and Purchase Agreement was entered into by the Company as the purchaser and CSAHC, Northern Airlines and Xinjiang Airlines as the vendors for the purpose of acquiring the Business and Assets by the Company from the Vendors. The principal business activity of each of the Company, Northern Airlines and Xinjiang Airlines is that of civil aviation. The principal business activity of CSAHC, based on its business license, is that of operating and managing, on behalf of the PRC government, certain state-owned assets, including properties, and state-owned shareholdings in various PRC companies. CSAHC is the controlling shareholder of the Company holding approximately 50.30% equity interest in the Company as of the Latest Practicable Date. Both Northern Airlines and Xinjiang Airlines are wholly owned subsidiaries of CSAHC. The Company has agreed, subject to certain conditions, to acquire from the Vendors the Business and Assets and to assume the Debts. The Business and Assets consist of certain Airline Operations, assets and properties of Northern Airlines Group and Xinjiang Airlines Group, including aircraft, engines, spare parts, aviation equipment and facilities, properties, office facilities, and other fixed, current and intangible assets. The Debts consist of all indebtedness and operating liabilities in the aggregate sum of RMB15,090,109,000 owed by Xinjiang Airlines Group or Northern Airlines Group in connection with their civil aviation business. Conditions precedent The Sale and Purchase Agreement is subject to the following conditions precedent: (a) the Vendors obtaining all approvals of the Sale and Purchase Agreement by the working meeting of the president of CSAHC and the SASAC; and (b) the Independent Shareholders approving the Sale and Purchase Agreement and the transactions contemplated thereunder. Consideration and payment terms The provisional amount of the consideration of the Acquisition, and
of the Debts to be assumed under the Sale and Purchase Agreement are
set at RMB16,912,244,600 and RMB15,090,109,000 respectively. The provisional amount of the consideration of the Acquisition, and of the Debts to be assumed by the Company will be subject to adjustment and finalisation based on the book value of the Business and Assets, and of the Debts as of the Effective Date, as determined in the financial statements of the Business and Assets of the Target Group prepared under the PRC Accounting Rules and Regulations and audited by KPMG Huazhen. A portion of the final adjusted consideration of the Acquisition will
be The Company shall make repayments of the Debts directly to the creditors of such Debts in accordance with the terms and conditions of the relevant agreements between the Vendors and the creditors in relation to the Debts. Funding The Company will finance the Acquisition and the assumption of the Debts through its internal resources, and short term U.S. dollar commercial loans from commercial banks amounting to RMB1,000 million. Such commercial banks are not and will not be connected persons (as defined in the Listing Rules) of the Company. The Company will make use of its unutilized banking facilities to draw down the required commercial loans. Transition period The terms of the Sale and Purchase Agreement provide for a transition period commencing from 31 December, 2003 and ending on the Effective Date, during which if a material change occurs such that any of the Business and Assets is damaged, lost, or the ownership of which no longer belongs to the Vendors, the Vendors shall give notice to the Company immediately. The Vendors must obtain the prior consent of the Company before disposing of any Business and Assets during the transition period. All profits and losses arising from the Business and Assets during the transition period belong to the Vendors. All profits and losses from the Effective Date thereon shall belong to the Company. Delivery terms and ownership The Vendors shall deliver all the Business and Assets, together with all documents evidencing or constituting ownership of such Business and Assets, to the Company within five days of the Effective Date. (b) Reasons for and benefits of the Acquisition The Directors believe that the Acquisition represents an attractive opportunity for the Company to consolidate its strong market position and improve its financial performance. Both Northern Airlines and Xinjiang Airlines are leading airlines in their respective operating regions. The Acquisition will bring various commercial benefits to the Company in terms of broadening its flight service network, increasing its fleet size and transportation capacity, reducing costs and boosting its overall efficiency, ultimately strengthening the Listed Group＊s position as one of China＊s largest airlines and enhancing value for its investors. (1) Broaden flight network (a) The Listed Group is headquartered in Guangzhou with 12 operational bases in central and southern China, offering regular flights on 248 domestic routes to over 69 cities in China, 18 routes to Hong Kong, and 45 international routes to 24 cities in east and Southeast Asia, Australia, North America and Europe, as of 30 June, 2004. However, due to the lack of operational bases, the Company is only capable of offering very limited flight services in Northern China and Northwestern China. (b) Northern Airlines Group is headquartered in Shenyang with operational bases in Dalian, Changchun and Harbin. Northern Airlines Group＊s operating region is predominantly in northeastern China. It is also the dominant Chinese airline serving flight routes to Korea and Japan due to the proximity of its operating region to those countries. (c) Xinjiang Airlines Group is headquartered in Urumqi, with operational bases and operating region in the Xinjiang autonomous region. It also commands a strong market position on domestic routes between Xinjiang and other parts of China, and on international routes to Russia, Middle East and West Asia. As the flight networks of the Listed Group, Northern Airlines Group and Xinjiang Airlines Group are disparate and complementary to each other, the Acquisition will significantly broaden the Company＊s flight network. After the Acquisition, the Company will have a strong presence in additional key markets in the Western and Northeastern parts of China, enabling it to provide more comprehensive civil aviation service to customers. The Directors believe that the Acquisition provides significant growth potential for the Listed Group, particularly in light of the ※Go West§ and ※Redevelop the Northeast§ campaigns initiated by the PRC government. The Directors also believe that the huge investment made by the PRC government in Western and Northeastern China will lead to rapid economic growth in those regions over the next decade or more, which, in turn, will result in rapid increase in air traffic volume to and from those regions. In addition, the Acquisition will also significantly enhance the Company＊s international air transportation business. The Company will be able to offer flight services between its bases in Southern, Northeastern and Northwestern China and other international cities in North America, Southeast Asia, North Asia, the Middle East as well as Europe. (2) Increase fleet size and transportation capacity The Acquisition will substantially increase the fleet size of the Listed Group. As of 30 June 2004, the Listed Group owned and operated a fleet of 139 medium and large size commercial passenger and cargo aircraft. The Acquisition will bring in 75 commercial aircraft from Northern Airlines Group and Xinjiang Airlines Group thereby increasing the Listed Group＊s fleet size by 54% to 214 commercial aircraft. The increased economies of scale will contribute to greater transportation capacity, higher operating efficiency, lower operating and maintenance cost, more flexible flight scheduling, greater bargaining power in aircraft acquisitions, better financing terms for purchases and improved aircraft allocation for the flight routes. The tables below set out fleet and selected operating data of the Target Group and the Listed Group individually, and on a combined basis, for the year 2003 and the first half of 2004: First six months of 2004 Number of aircraft1 139 55 20 214 Passenger capacity (ASK) (million) 25,928 7,693 3,722 37,343 Passenger traffic Passenger volume (thousand) 13,315 3,621 1,264 18,200 As of 30 June, 2004 including owned and leased (on both finance and operating lease basis) aircraft 6 2003 Number of aircraft1 132 50 20 202 Passenger capacity Passenger traffic Passenger volume (thousand) 20,470 6,474 2,148 29,092 Cargo and mail carried 1 As of 31 December, 2003 including owned and leased (on both finance and operating lease basis) aircraft (3) Minimize route overlap and optimize flight schedules The Directors believe that the Acquisition will yield significant benefits to the Listed Group through optimization of flight routes and schedules. Most of the major flight routes in the PRC are served by more than one airline, and therefore the competition on most major flight routes is intense. Although offering discounts on air ticket prices is still regulated by the CAAC, many PRC airlines rely heavily on such measures to attract passengers. As a result, the Listed Group faces significant pressure on air ticket prices. Prior to the Acquisition, the routes that the Listed Group shares with Northern Airlines Group and Xinjiang Airlines Group account for approximately 8.2% of the Listed Group＊s total routes. After the Acquisition, the Listed Group will become the sole or main operator on many of such shared flight routes. This reduction in market segmentation will allow the Listed Group to gain advantageous air ticket pricing power and improve its financial performance. Moreover, the Listed Group could reduce the number of flights on those shared routes without sacrificing sufficient coverage and service quality. The Listed Group will then have additional capacity to support other more profitable flight routes and thus generate additional revenue. (4) Enhance air ticket sales network and reduce overhead Northern Airlines Group, Xinjiang Airlines Group and the Listed Group each maintains an extensive air ticket sales network in major cities and large ground services teams at major airports in China. The Listed Group can achieve significant cost savings by rationalizing the sales network and consolidating the ground service operations of the three airlines. After the Acquisition, the Company plans to close a total of 14 geographically overlapping domestic air ticket sales offices (eight belong to Northern Airlines Group, four belong to Xinjiang Airlines Group and two to the Company) and four overseas air ticket sales offices (all belong to Northern Airlines Group). (5) Improve allocation of aircraft, engines, spare parts and crews The Directors believe the expanded fleet will provide the Listed Group greater flexibility in allocating aircraft between the combined routes of the Listed Group, Northern Airlines Group and Xinjiang Airlines Group. For each of the three airlines, there is excess capacity in low seasons, but limited or inadequate capacity during peak seasons. As most of the flight routes served by them are different, each of the Listed Group, Northern Airlines Group and Xinjiang Airlines Group has relatively staggered peak and low seasons. After the Acquisition, the Company will be able to re-deploy an enlarged team of aircraft, pilots and flight personnel to the highest traffic routes and better ensure a balance of demand and supply for capacity throughout the year. Furthermore, since the Listed Group has already been operating Boeing 737, 757 and Airbus 319, 320 aircraft that Xinjiang Airlines Group and Northern Airlines Group are either currently operating or will be acquiring according to their aircraft replacement schedules, the Listed Group will be able to improve the internal allocation of engines and high-value aircraft spare parts. For instance, the Directors believe that after the Acquisition, the Listed Group may be able to purchase fewer aircraft engines and spare parts. Through redeployment of aircraft, pilots and crew, and better allocation of spare parts, the Directors believe the Listed Group can improve its operating efficiency and reduce operating costs and capital expenditures. (6) Reduce maintenance costs The Directors believe significant reduction in maintenance cost can be achieved through more centralized maintenance functions and sharing of maintenance personnel and equipment. The Company plans to centralize fleet maintenance functions at five national maintenance bases which are Guangzhou, Shenyang, Urumqi, Zhengzhou (or Wuhan) and Xiamen in the next few years. These maintenance bases will be responsible for major overhauls on all aircraft while the local bases will be responsible for minor maintenance tasks on their own aircraft. The Directors believe that this initiative will significantly improve efficiency and reduce the cost of fleet maintenance. (7) Strengthen marketing efforts Since its listing on the Stock Exchange, the Company has implemented many changes to its remuneration policies in order to improve the effectiveness of marketing efforts by its business units. Under the Company＊s current performance credit policy, its branch office located in the city that a particular flight originates from (including both non-stop and connecting flights) receives performance credit for the flights to the immediate next destination. Previously, all performance credit earned by a particular aircraft was given to the office in which that aircraft was based in, which did not provide incentive for the offices in intermediate cities to market the air ticket of that particular flight. After the Acquisition, the Company plans to implement this remuneration policy to the marketing units newly acquired from the Target Group. The Directors believe that this will lead to a more effective and concerted marketing effort by all the offices, and therefore result in higher sales revenue. (c) Information regarding the Target Group Northern Airlines was established on 19 October, 1990 following its separation from the Shenyang Bureau of the CAAC. Xinjiang Airlines, which began operations on 1 January, 1985, was formally separated in 2001 from the Urumqi Regional Bureau of the CAAC. As part of the reorganization initiative of the PRC civil aviation industry in late 2002, Southern Airlines (Group), Northern Airlines and Xinjiang Airlines were restructured and consolidated into CSAHC. Both Northern Airlines Group and Xinjiang Airlines Group are the leading airlines in their respective regions, offering passenger and cargo air transportation and other related services. (a) Key operating data Passenger and cargo air transportation are Northern Airlines Group＊s principal businesses. However, due to its lack of freight aircraft, Northern Airlines Group relies heavily on its passenger air transportation business. In 2003, revenues generated from passenger air transportation business accounted for approximately 93% of the total revenues while those from cargo services accounted for approximately 7%. Northern Airlines Group also provides aircraft maintenance and repair, and other aviation related services. In the past three and a half years, Northern Airlines Group＊s passenger air transportation business continued to improve with overall passenger load factor increasing from 60% for 2001 to 67% for the first six months of 2004 and passenger yield per RPK rising from RMB0.58 for 2001 to RMB0.61 for the first six months of 2004. The cargo transportation business also showed material improvement with cargo yield per RFTK increasing 12% from RMB1.90 for year 2001 to RMB2.13 for the first six months of 2004. Passenger and cargo air transportation are Xinjiang Airlines Group＊s principal businesses. In 2003, passenger air transportation business generated 96% of total revenues with freight transportation business accounting for 4%. Xinjiang Airlines Group has managed to improve its domestic passenger load factor to 66% in the first half of 2004 from 59% in 2001. Passenger traffic as measured by RPK has also increased over the past three years. However, passenger yields suffered in 2003 and first half 2004 due to increased competition. Operational bases Shenyang, Dalian, Harbin, and Changchun are the primary bases for Northern Airlines Group. Urumqi is the principal base for Xinjiang Airlines Group. (c) Routes network From the four bases in northeastern China, Northern Airlines Group currently offers regular flights on 106 domestic routes to over 46 cities in China and 29 international routes to North Asia and Russia. Headquartered in Urumqi, Xinjiang Airlines Group is the leading air
traffic service Top 10 routes of Northern Airlines Group by revenue 1. Changchun-Beijing Changchun-Beijing Top 10 routes of Xinjiang Airlines Group by revenue 1. Urumqi-Beijing Urumqi-Beijing (d) Fleet As of June 30, 2004, Northern Airlines Group owned and operated 55 medium to large size aircraft with an average fleet age of 8.08 years. The table below sets out details of its fleet: Northern Airlines Group＊s fleet details (as of 30 June, 2004) Xinjiang Airlines Group has gradually phased out the Soviet-made TU-154 and IL-86 for commercial flights. The airline has recently purchased and leased a large number of Boeing and ATR commercial aircraft. As of June 30, 2004, the average age of the 20 aircraft owned or operated by Xinjiang Airlines Group was 5.90 years. Details of the fleet are set out in the table below: Xinjiang Airlines Group＊s fleet details (as of 30 June, 2004) (e) Aircraft acquisition and disposal program Northern Airlines entered into an aircraft sale and lease back agreement on 4 November, 2003 with ILFC. Under the agreement, Northern Airlines Group agreed to sell the 22 MD82 aircraft owned, or to be owned to ILFC in four phases according to the schedule listed below: MD82 aircraft to be sold under Under the same agreement, Northern Airlines Group also agreed to lease back the abovementioned MD82 aircraft from ILFC immediately after the sale. The average term of the lease back agreements is 15 months. In addition, Northern Airlines Group also agreed to replace each of the 22 MD82 aircraft with one new Airbus 319-100 aircraft or one new Airbus 320-200 aircraft from ILFC upon the termination of the lease back agreements. The table below sets out the replacement schedule: Phase I 1. A319-100 May 2004 (delivered) Phase II 5. A319-100 January 2005 Phase III 12. A319-100/A320-200 January 2006 Phase IV 18. A319-100/A320-200 February 2007 In addition to the above agreement, Northern Airlines has also committed to the addition of two more A321s from Airbus by the end of 2005. (f) Sales and marketing Northern Airlines Group and Xinjiang Airlines Group have historically
marketed their Frequent flyer programs Both Northern Airlines Group and Xinjiang Airlines Group operated their respective frequent flyer programs prior to consolidation into CSAHC. Following the consolidation of Northern Airlines Group and Xinjiang Airlines Group into CSAHC, the two frequent flyer programs merged with the Company＊s frequent flyer program, namely, the China Southern Airlines Sky Pearl Club. Ticket sales channels and reservation system Northern Airlines Group and Xinjiang Airlines Group conduct ticket
sales through a variety of sales channels, including the airlines＊ own
network of exclusive sales offices, (g) Safety Aircraft safety involves three major operational areas: flight operations,
aircraft Xinjiang Airlines Group has established a reputation for safety. To
date, it maintains a record of transport flight safety since its founding
and is perceived to be one of the safest airline operators in China.
On 7 May, 2002, a MD82 aircraft of the Northern The aircraft was fully insured and compensated under the insurance arrangement.
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