LATAM Brazil And Azul – Could The Airlines Merge?

Yesterday, the Brazilian Equity Research team of Bradesco BBI Bank suggested that LATAM’s best option would be to sell its Brazilian branch to low-cost carrier Azul Linhas Aereas. If this were to happen, it would be a seismic shift in the South American air industry. But is it a real possibility?

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Could LATAM and Azul end up in a merger? Photo: Getty Images

Step one: sign a domestic codeshare agreement

Last month, LATAM Brazil and Azul signed a domestic codeshare agreement. It initially includes 50 non-overlapping local routes to/from the cities of Brasilia, Belo Horizonte, Recife, Porto-Alegre, Campinas, Curitiba, and Sao Paulo.

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Both carriers left possibilities open. These are the expansion of the codeshare agreement, both domestically and internationally, and the integration of frequent flyer programs.

Bradesco Bank said that a full merger seems unlikely. Nevertheless, “as part of their turnaround plans, LATAM Airlines Brazil could be sold to Azul.”

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Currently, Azul has 25% of the domestic market share. With a merger, it could go up to 62%. Photo: Getty Images

Would a merger make sense?

According to the bank, LATAM Brazil has been underperforming since 2012, when the LAN and TAM merger took place. The Brazilian branch has reported an EBITDA margin of 15 points lower than the rest of the company. EBITDA stands for Earnings Before Interests, Taxes, Depreciations, and Amortizations.

LATAM has had weak operational performance in Brazil due to three main reasons. First, there is a fierce competition with GOL and Azul (and previously Avianca Brazil). Second, the merger of LAN and TAM has experienced some integration difficulties. Third, LATAM downgraded its domestic operations to low-cost, only to shift back to business travelers a few years later.

LATAM Airlines Group operates in six different countries. It should not be afraid to pull the plug if one of the branches doesn’t work. It recently did just this, by ceasing operations in Argentina. If LATAM sells its Brazilian subsidiary, it could reduce its financial leverage to five times the net debt and EBITDA of 2021.

Meanwhile, Azul could benefit from a more significant aircraft fleet and a faster EBITDA growth, said Bradesco. Additionally, Azul could increase its domestic market share from 25% to 62%.

Are the airlines interested?

Publicly, both airlines have been stating that they are not interested in a merger. The launch of the domestic codeshare agreement offers both carriers what they need to succeed. Azul provides a highly connected network within Brazil. LATAM brings to the table its complementary fleet and networks. Jerome Cadier, LATAM Brazil’s CEO, said,

“This codeshare agreement will provide customers with access to two of the country’s leading air travel networks.”

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It is very unlikely that we will see this merger because there are too many issues to solve. Photo: Getty Images

Why will it never happen?

In theory, a merger between both companies looks like a good deal; the reality is far more complex. We don’t think we’ll see a merger between LATAM Brazil and Azul.

We don’t think LATAM Group is eager to lose its presence in the largest hub in South America, Guarulhos International. LATAM relies intensely on its international connectivity, mainly long-haul flights. Sao Paulo International Airport is LATAM’s door to Europe and North America.

There are other reasons which make a merger hard to come by. LATAM Group is currently under Chapter 11 in the US. This filing “could be prohibited for Azul, as the company could be dragged into this process,” said Bradesco.

Also, in case of a merger, Delta and United Airlines would have seats on the board of directors, which could lead to anti-trust issues. Finally, David Neeleman, Azul’s founder, would have to share control of this new company, which seems unlikely.

Would you be surprised if LATAM and Azul merge? Let us know in the comments.