Singapore Airlines and China Eastern Airlines confirmed this week that they are in talks for SIA to buy a 20% stake in China Eastern. This would be worth US$130 mln (taking the current market capitalisation of US$652 mln as reported by Reuters as the benchmark) which SIA could afford easily. But given SIA’s chequered history of airline investments shareholders will be asking themselves whether an equity stake is such a good idea.

In December 1999, SIA bought a 49% stake in Virgin Atlantic for GBP 600 mln in cash. It didn’t break out the value of that stake in its most recent earnings announcement on May 9, 2006, but subsidiary companies are valued at Group level at S$1.94 bln and associated companies at S$1.7 bln. These values would include SIA’s stakes in SATS and SIA Engineering, which doesn’t leave a lot of room for the value of Virgin Atlantic. In short, if Virgin was such a good investment they would be trumpeting that at every opportunity.

Then in 2000 it bought 25% of Air New Zealand for northwards of NZ$425 mln, only to have the stake diluted after the government bailed the airline out after Ansett collapsed in 2001. It eventually sold its 4.5% stake for a fraction for what it paid. Whether this was bad investment decisions or just bad luck – SIA for all its value as a premium airline doesn’t exactly have a reputation for making good investments in foreign carriers.

China Eastern Airlines is the result of a merger between China Northwest and Yunnan Airlines, completed in the first half of last year. Its market cap is RMB 13 bln, and it is based in Shanghai. Its earnings history is somewhat cloudy. It reported a loss of RMB 467 mln on revenue of RMB 27 bln last year. By 2007, Tai Fook projects revenue to rise to nearly RMB 38 bln, but losses of almost RMB 300 mln.

Analysts surveyed by Reuters have on average and underperform call on the stock, and expect it on average to halve in value, to RMB 1.35 from the RMB 2.73 currently! No wonder, when it is trading at 3-4 times book value (depending on whether you look at the half or full year numbers) and all the airlines are suffering.

The growth of China’s airline industry cannot be denied. 138 million passengers were carried last year, according to the CAAC China Statistical Yearbook, quoted by Tai Fook Securities. Freight topped three million tonnes. But the same report says China’s airlines aren’t immune from the competitive pressures afflicting other airlines around the world, such as high oil prices. Landing fees are set to rise for the domestic carriers.

Clearly, SIA needs to do something to get a piece of the pie. But shareholders will worry that if it offered a premium to the current price it would be overpaying.

My personal view is that they should go ahead and buy something in China. Whether that's a stake in China Eastern or China Southern or even Air China is irrelevant. What matters is that SIA gets what it pays for, and that it only pays for what it gets.