2nd UPDATE: Qantas, China Eastern Launch Hong Kong Carrier

Hong Kong will soon get a low-cost carrier, with Australia's Qantas Airways Ltd. (QAN.AU) and China Eastern Airlines Corp. (0670.HK) forming a joint venture to corner the fast-growing Chinese market.

Jetstar Hong Kong plans to start flying midway through next year with three Airbus A320 planes, growing to 18 by 2015, both companies said in a joint statement Monday.

The initiative comes as Qantas continues its strategy of expanding outside its home market to reduce costs and position itself better geographically to tap growth in the fast growing economies of Asia. In the five years to 2014, the number of people flying in Asia is expected to rise by 360 million to one billion, according to the International Air Transport Association.

Greater China has a travel market of almost 300 million passengers a year, forecast to grow to 450 million by 2015, and the penetration rate of low-cost carriers is less than 5%, according to Qantas.

Shares in the Australian flag carrier rose 2.6% by 0322 GMT on the Australian Securities Exchange, offsetting recent disappointment caused by its failure to create a new premium joint venture with Malaysian Airline System Bhd after talks broke down.

"This is a positive decision by management, given the latent growth potential of Greater China, as well as gaining an early-mover advantage with only one other official low-cost carrier in China - Spring Airlines," analysts at Macquarie said in a client note.

Qantas has also brought its low-cost Jetstar brand to Japan, Singapore and Vietnam through other joint ventures with regional carriers. Executives from the airline declined to comment Monday on when they expect Jetstar Hong Kong to turn a profit.

"We know from our experience with Jetstar in Australia and in the setup of Jetstar Japan the benefits of both a premium and a low-cost airline operating in the same market," Chief Executive Alan Joyce said.

Jetstar Hong Kong will have a maximum capitalization of up to US$198 million and service short haul routes in Asia, including China, Japan, South Korea and South East Asia. The venture will have to overcome Hong Kong's high airport fees, among cost pressures recently cited by Cathay Pacific Airways for not establishing a budget offshoot in its home market.

Joyce acknowledged in a press conference that Hong Kong has high infrastructure costs, but added that airport fees are also high in other markets served by Jetstar including Australia and Japan. By offering fares 50% below existing full service carriers, Joyce said the venture could "stimulate huge growth" in the market. A competitive advantage would also come from efficient utilization of aircraft and labor and effective online distribution, he said.

Oasis Hong Kong Airlines Ltd., one of the first budget carriers to specialize in long-haul flights, closed down in 2008 less than 18 months after it started operations. The Hong Kong-based company said when it collapsed that although there was demand for its business, it was undercapitalized and wasn't able to ramp up fast enough to get a "critical mass" of aircraft and destinations.

China is attempting to take some steam out of its export and infrastructure-driven economy, forecasting national economic growth of 7.5% next year compared with previous forecasts of 8%. To be sure, China's growth rate remains relatively high and a rebalancing of its economy towards more domestic-driven demand will benefit companies offering products and services to a ballooning Chinese middle-class.

"We believe there are huge opportunities for the Jetstar low fares model throughout Asia, including Greater China, and are excited to be the first major Chinese carrier to bring this travel option to the region," China Eastern Chairman Liu Shaoyong said in a statement.

-By Ross Kelly, Dow Jones Newswires; 61-2-8272-4692; [e-mail]