LATAM Airline Marriage: The Perfect Couple?

| About: LATAM Airlines (LFL)

by Marta Dhanis

LAN and TAM airlines may appear Latin America's 'perfect couple', but what are the strengths and weaknesses of the LATAM (NYSE:LFL) marriage? Let's start with the weak points. While the June 22nd merger was called a takeover, it's not a full takeover. In fact, due to Brazilian law restrictions, TAM's current shareholders are keeping 80% of voting power. At the same time, LAN shareholders have 70% of the ownership of the merged company. Enrique Cueto (of LAN) is assuming the new LATAM company's CEO position and Mauricio Rolim Amaro (of TAM) will remain chairman. The two companies will continue to operate on their own, which presents risk for experts.

Adding to the different control structures, there is a culturally difficult relationship between Brazilians and Chileans. This can only broaden risks. Recently, analysts at Raymond James kept both shares under 'market perform' given this complexity.

Then there's the global airline alliances issue: the Chilean Antitrust Authority (Tribunal de Defensa de la Libre Competencia) said LATAM could not join the OneWorld Star Alliance due to the conflict with AviancaTaca. Given that LAN is already a member of Oneworld, that would be the natural move for the merged company. However, Enrique Cueto said last week that they "will negotiate to get the best deal" and that there are "several options".

Another hiccup might be borrowing costs for LATAM. Analysts are frowning about the credit ratings of both companies and believe that maintaining them will be a challenge. They are betting on a dividend cut as a solution. Brazilian growth also remains a challenge, thanks to the eurozone crisis and its global echoes. Additionally, national competition is increasing and fuel prices keep surging, which has led TAM to report losses twice in the last four years.

Enough with the bad news. As far as the 'perfect match', LAN and TAM's routes have an overlap of only 3% and, as Mr. Cuero underlines, "this is a growth merger." The Brazilian market is still the largest in the area. Plus, it may allow for better negotiations on network agreements with European and U.S. airlines.

The merger puts 40% of passenger traffic within South America in the hands of LATAM. The company will also rank as the second-largest airline by passengers after American Airlines (AAMRQ.PK) on routes to the U.S., and third-largest to Europe. Moreover, Standard & Poor's stated the market value of LATAM will exceed all other airlines in the world. Estimates point to a $13 billion market cap.

The other good news is the annual operating income gains. They are expected to rise by $600 million to $700 million by the fourth year due to higher passenger sales, cargo, and cost reductions. LATAM will be able to create larger route networks and efficiencies to offset high fuel prices.

Finally, LATAM shares will begin trading Wednesday on the New York Stock Exchange, the Santiago Stock Exchange and the São Paulo Exchange. TAM shares will be delisted in Brazil and the U.S., which poses a problem for minority shareholders. According to experts, the best option is to exchange stocks from a company with some managing problems (i.e. TAM) for the new one (LATAM), with synergy gains.

Investors should also keep an eye on Brazilian TAM's competitor Gol Linhas Aéreas Inteligentes S.A (NYSE:GOL), as well as Brazilian jet manufacturer Embraer (NYSE:ERJ).

Disclosure: No positions

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