Delta is gambling on Latam. What does it mean for Brazil’s aviation sector?

</p> <p>Following its aggressive expansion plans for Latin America, Delta <a href="https://ir.delta.com/news/news-details/2019/Delta-and-LATAM-Airlines-to-form-the-leading-airline-partnership-throughout-the-Americas/default.aspx">announced</a> it would pay USD 1.9 billion to acquire a 20-percent stake in Latam—the group formed in 2012 after the merger between Chile&#8217;s Lan and Brazil&#8217;s Tam. Together, Delta and Latam “will serve 435 destinations worldwide and carry more passengers between North America and Latin America than any other partnership,” taking over the leadership in five of the top six Latin American markets from the U.S., according to Delta.</p> <p>In what will be its largest investment in over a decade, Delta will inject USD 350 million to support the establishment of the strategic partnership. The American carrier will also acquire four A350 aircraft from Latam and has agreed to take on the company&#8217;s commitment to purchase 10 additional Airbus A350 aircraft, to be delivered by 2025.&nbsp;</p> <p>For Latam, the deal means better free-cash-flow generation, and should slash over USD 2 billion from its forecast debt by 2025, besides improving its capital structure.</p> <p>For all other competitors, however, the deal spells trouble. Latam will leave the Oneworld alliance, breaking a partnership established with American Airlines in 2013. But no one has been more affected than Gol. The Delta deal will not only embolden its main competitor, but the Atlanta-based carrier will also ditch its 9.4-percent stake in Gol.</p> <h2>What happens to Gol?</h2> <p>Brazil is the largest market for both Gol and Latam. Since Avianca went under, both companies increased their domination in the local market, though smaller rivals Azul are working hard to step into the third place.</p> <p>Delta’s decision happens at a time of change for Brazilian airlines. Congress approved a new law this year allowing foreigners to own a 100-percent stake in carriers operating in Brazil, and allowed companies to charge for dispatched luggage. These measures turned Brazil into an <a href="https://brazilian.report/money/2019/04/01/low-cost-carriers-air-travel-brazil-cheaper/">attractive country for low-cost companies</a>, which experts believe will increase competition and, eventually, <a href="https://brazilian.report/power/2019/09/19/flying-brazil-expensive-regulation-airlines/">lower ticket prices</a>.</p> <div class="flourish-embed" data-src="visualisation/715455"></div><script src="https://public.flourish.studio/resources/embed.js"></script> <p>Brazil&#8217;s air travel market is highly concentrated, according to the Herfindahl-Hirschman Index (HHI), a scale used since 1982 by the U.S. Department of Justice to measure market concentration for purposes of antitrust enforcement. Anything above 2,500 is worrisome; Brazil scored a whopping 3,439.59.</p> <p>In this context, a better-equipped Latam means that others will have to step up their game—and Gol is already feeling the blow. Shares of the company were in free fall, down by almost 7 percent in the first trading day after the Delta-Latam deal. In an attempt to mitigate losses, Gol announced that the doomed partnership with Delta amounts to only 0.3 percent of its revenue, but analysts are looking beyond that.</p> <p>According to <a href="http://mkt.guideinvestimentos.com.br.s3.amazonaws.com/Guide%20Empresas%20(27_09_19).pdf#utm_source=guide_empresas_27_09_19&amp;utm_medium=email&amp;utm_campaign=27_09_19">Guide Investimentos</a>, this piece of news is extremely negative, as Gol will now have to find other partners to share its international flights. The consultancy also highlights that Delta&#8217;s intention of selling such a large stake will push Gol stock prices down. Shareholders must consider whether the sale will happen through a follow-on model (simply offering the stocks on the market), or through a block-trade model, in which two parties negotiate directly.</p> <p>Meanwhile, Smiles, Gol’s frequent flyer program, is set to have fewer flights available and a smaller volume of points. Smiles shares were also hit by the deal, falling 3.4 percent on São Paulo&#8217;s stock exchange. </p> <div class="flourish-embed" data-src="visualisation/715547"></div><script src="https://public.flourish.studio/resources/embed.js"></script> <h2>The light at the end of the tunnel</h2> <p>The short-term scenario looks grim for Gol, but analysts seem to agree that the new partnership may be a game-changer for the aviation sector as a whole. In a report, XP Investimentos highlighted that “minor investments are increasingly common among airlines and new partnerships could happen in the future,” keeping a neutral rating for Gol stock.</p> <p>Guide Investimentos and BTG Pactual point out that former Latam partner American Airlines is the go-to solution for Gol.&nbsp;</p> <p>“We see this as a buying opportunity, as Gol is an attractive, strategic, now unaligned airline for someone like American Airlines, which has no partner in South America and could see Gol as a great fit for its Brazil strategy. We maintain our &#8216;Buy&#8217; rating for both Gol and Latam,” wrote BTG Pactual’s Renato Mimica and Lucas Marquiori.