BEIJING (Dow Jones) -- China Eastern Airlines Corp. (CEA) has proposed taking over Shanghai Airlines Co. (600591.SH) through a share swap, a person familiar with the situation said Monday, finalizing the long-anticipated merger between the two struggling state-owned carriers.

The move reflects Beijing’s determination to clean up and consolidate its airline sector, which is plagued by operational inefficiencies, unhealthy competition and the global recession. It is also a long-overdue step toward boosting Shanghai’s status as an international aviation hub, especially as the city gears up to host the 2010 World Expo.
Under the proposal, China Eastern will raise CNY7 billion (U.S.$1.02 billion) via a private placement in both Shanghai and Hong Kong to complete the merger, said the person, who declined to be named.
China Eastern will swap 1.3 of its Shanghai-listed A shares for each Shanghai Airlines A share, the person told Dow Jones Newswires.
The swap price for China Eastern’s shares was set at CNY5.28 each and at CNY5.50 for Shanghai Airlines, with each price representing the average of the companies’ share prices in the 20 trading sessions before June 8, when the two stocks were suspended from trading, the person said.
Based on this structure, the deal offers a 25% share price premium to Shanghai Airlines shareholders, the person said, adding regulatory approval for the proposed merger is still pending.
Spokespeople for both airlines declined to comment on the matter.
To raise funds for the proposed takeover, China Eastern plans to place additional A shares to a maximum of 10 investors, including its parent China Eastern Air Holding Co., the person said, adding there will also be a placement of H shares - which are traded in Hong Kong - to the parent company.
China Eastern has set the minimum price for the proposed A-share placement at CNY4.75 each, and for the H-share placement at HK$1.41, the person said. The proposed minimum H-share placement price compares with China Eastern’s average share price in the 20 trading sessions before June 8 of HK$1.57.
The final private placement prices will depend on investor response, the person said.
On the completion of the proposed takeover, China Eastern plans to conduct a “flash placement” of at least 180 million additional H shares to meet the Hong Kong bourse’s regulatory requirement on a minimum public float, the person added.
The State Council, China’s Cabinet, has already approved the merger between the two carriers but the latest proposal also needs the approval of regulators such as the China Securities Regulatory Commission, the person said.
Talk of a merger between the two Shanghai-based carriers surfaced late last year at a time when airlines around the world were struggling with sinking demand and high fuel costs.
Chinese carriers had also taken bets on derivatives contracts to shield themselves against fuel price swings that went bad.
China Eastern’s first-quarter net profit fell 81% from a year earlier to CNY40.1 million, and Shanghai Airlines’ earnings were down 29% at CNY26.27 million for the same period.
Beijing wants to overhaul the airline industry and create a much leaner structure that would ideally comprise the country’s three biggest operators. The government’s approach to overhauling key industries such as energy, steel and automobiles is to establish industry giants that have strong state control and economies of scale, making it easier to expand overseas and secure cheaper resources.