China's third-largest airline by market value and Australia's top carrier will invest up to $198 million over three years in the equal joint venture, which will start in mid-2013 with three Airbus A320 aircraft, Qantas said on Monday.

The fleet would expand to 18 aircraft by 2015, and China Eastern said it expected the venture to be profitable in its third year.

"I believe this low-cost model, whether in a high or low oil price environment, will be competitive," China Eastern Chairman Liu Shaoyong told reporters in Hong Kong.

The new Jetstar Hong Kong venture would look after China Eastern's aspirations in the low-cost market while sharing the risks and investment with Qantas. This would leave the Chinese airline to focus on its big, growing domestic network.

For Qantas (QAN.AX), it brings access to China, the fastest-growing airline market, and enables it to take advantage of Asia's lower operating costs, as it looks to turn around its international business which lost A$200 million in 2011.

Earlier this month, Qantas abandoned talks with Malaysia Airlines (MASM.KL) to set up an Asian premium airline.

"This is a good move for China Eastern (600115.SS). They can rationalise their fleet and capacity allocation to this JV, meaning they probably won't over-invest in regional (fleets)," said Patrick Xu, analyst at Barclays Capital.

Shanghai-based China Eastern has a fleet of 377 aircraft and is the country's second-largest carrier by passenger numbers.

The JV would look to tap rising demand not just from Hong Kong, which caters to around 40 million passengers a year, but also from greater China - a market that Qantas says is set to see 450 million passengers by 2015.

The JV would tap into a market where only 5-10 percent of capacity is by budget carriers, compared with half in Australia and a third in Europe and the United States, said Nomura analyst David Fraser.

CHINA DEMAND

Qantas' Jetstar has JVs in Singapore, Japan and Vietnam as well as its own operations in Australia and New Zealand. It competes with Air Asia (AIRA.KL), Singapore Airlines' (SIAL.SI) low-cost carrier, Scoot, and Tiger Airways (TAHL.SI), which is also affiliated with Singapore Airlines.

Asia is becoming the world's busiest hub for no-frills airlines, which typically fly in a single-class configuration and offer tickets estimated by analysts to be at least 30 percent cheaper than full-service carriers.

The low-cost carriers charge extra for in-flight services from food to movies. In June last year, Asian budget airlines from Malaysia to India placed a record $42 billion in plane orders, signalling their high expectations for growth.

Under the tie-up, Qantas will lend its brand, commercial management, maintenance and IT systems, while China Eastern will give access to burgeoning Chinese demand.

"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," said China Eastern's Liu.

There would likely be more opportunities to co-operate in the full-service aviation side with Qantas, he added.

Jetstar Hong Kong's fares will be half those of full-service carriers, the two said in a joint statement.

By setting up airlines in Asia, Qantas can hire pilots, crew and maintenance staff at much lower cost than in Australia and can offer more connecting flights. Its staff costs equal 25 percent of revenue, compared with 15 percent for Asian rivals.

Australian trade unions, which recently fought a bitter wages dispute with Qantas, have been critical of the airline's move to base more of its international operations offshore.

"We would think Qantas should drop all these airline joint ventures in Asia and concentrate on their premium product at home," Stephen Purvinas, federal secretary of the Australian Licensed Aircraft Engineers Association, told Reuters.

"Qantas have cut back on so many services, like their key trunk routes into London and the U.S. that should be their focus."

The Jetstar brand operates up to 3,000 flights a week in Asia Pacific serving almost 60 destinations, including 30 in Asia and eight in Greater China. It has said it is on track to carry more than 20 million people in fiscal 2012.

Qantas shares closed up 2 percent, outperforming the wider market .AXJO. In Hong Kong, China Eastern shares last traded down 1.5 percent at a 3-month low.

(Additional reporting by Maggie Lu YueYang in CANBERRA, Sonali Paul in MELBOURNE and Twinnie Siu in HONG KONG; Editing by Anne Marie Roantree and Mark Bendeich)

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