Concentration trend in Brazil’s airline industry rekindles airfare debate

RIO DE JANEIRO, BRAZIL – The economic disaster that befell the airline industry in the pandemic promises to change the configuration of the Brazilian civil aviation market, generating greater concentration – which rekindles the debate surrounding the risks of little competition for the final price of tickets.

“The significant drop in demand, with the respective loss of fare and commercial revenues, along with the shutdown of services and unexpected variations in exchange rates, complicated things for the sector,” IATA says.

In this scenario, the largest companies are organizing themselves in search of acquisitions in an attempt to regain scale and maintain their routes.

On Tuesday, June 8, Gol announced the purchase of MAP airlines, from Amazonas, for R$28 (US$5.4) million, which should make it the leader in the number of slots (departure and arrival times) at Congonhas airport, the most competitive airport in the market and the second largest in Brazil, second only to Guarulhos International Airport (Cumbica).

On the other hand, Azul spreads its wings over LATAM Brasil, whose parent company, the Chilean LATAM group, filed for judicial reorganization a year ago in the United States, with debts of almost US$18 billion (R$91 billion).

Azul would be waiting for LATAM to present its reorganization plan to make a purchase proposal for the Brazilian operation to the Chilean group’s creditors. Its affiliates, including LATAM Brazil, are also in receivership.

Meanwhile, the company is moving toward the interior of the country. On Thursday, June 10, Azul announced what it called the largest regional expansion plan in the history of Brazilian aviation in the Amazon. It stated that it will add 8 new routes in the state to its air network in the second semester: Barcelos, Apuí, Eirunepé, Itacoatiara, Humaitá, Borba and Novo Aripuanã.

The announcement was made during a meeting with Minister of Infrastructure Tarcísio de Freitas, Minister of Tourism Gilson Machado, and members of the state legislature.

These moves occur at a time when the three largest national airlines – Gol, LATAM and Azul – have reported losses of R$6.2 billion in 2020, due to the novel coronavirus pandemic.

One of their main challenges is to further reduce fixed costs. LATAM alone cut about 30% of its staff last year in Brazil. The impact of these movements on consumers generates controversy.

André Castellini, partner of Bain & Company consultancy firm, recalls that before Gol, there were four major players in the market – Varig, Vasp, Transbrasil, and TAM – with no strong competition. “Fares were expensive and the companies were accommodated, there was no strong capital market, with shareholders demanding performance,” he says.

“With Azul and Gol, Brazil can return to the duopoly of the early 2000s, when the largest carriers were TAM and Gol, and that doesn’t seem bad to me,” Castellini says. “The fierce rivalry between the two guaranteed an increase in supply and a drop in fares.”

Leonardo Nascimento, partner at Urca Capital Partners, has a different opinion. “The scenario is negative for consumers, by concentrating a market that is already very concentrated. Brazil is oligopolistic in commercial aviation,” he says, referring to the shares of Gol (37.8%), LATAM Brasil (31.4%) and Azul (30.3%). That is, in a virtual purchase of LATAM’s local operation, Azul would hold over 60% of the Brazilian market.

According to Nascimento, LATAM’s potential acquisition by Azul is still uncertain and would need to pass the scrutiny of Brazil’s competition regulator CADE (Administrative Council of Economic Defense). “But the talks exist and are advanced, because of the perilous situation LATAM Brazil is experiencing,” he says. The purchase of MAP by Gol, he says, is a “counter-attack” to the potential merger between the rivals.

Questioned, Azul confirmed its intention to grow in the market through acquisitions. In a statement released in late May, the company said that “the consolidation movement is a post-pandemic industry trend and Azul is in a strong position to lead a process in this direction,” it said. The company has already hired consultants to evaluate opportunities. Gol did not reply to a request for comments.

According to Bain’s Castellini, LATAM Brazil is a valuable asset that Azul will have to dispute with foreign players. “Large companies such as Qatar Airways, American Airlines and United Airlines may be interested in the operation, which holds a strategic position in Latin America,” he says.

Another possibility would be the union of a group of investors with sector entrepreneurs. “Incidentally, that’s how Azul was born.”

Irrespective of what configuration the Brazilian civil aviation market takes in the coming months, it is essential that companies promote the restructuring of their services, says Castellini. “It is necessary to renegotiate contracts such as renting and leasing airplanes, for example, because airplanes are an asset that will be in surplus for a long time in the market,” he says.

Debts with creditors and executives’ salaries are also included in the bill. “Anything not to make services worse, not to break the value proposition, because Brazilians may not have money, but they like good service,” he says. “It is not by offering half a glass of water on the flight that companies will solve their problems.”

In the opinion of Henrique Estéter, analyst at Guide Investimentos, Gol and Azul handled the pandemic period better than LATAM Brasil.

“They managed to capitalize in the market and greatly cut costs,” he says. In the consolidation scenario, how aggressive Azul will be remains to be seen. “The company has just raised US$600 million [R$3 billion] in the American market, in 5-year bonds, at a rate of 7.35%,” he says.

“Azul is raising funds to pay short-term debts and the deferrals negotiated with suppliers and partners in 2020. In addition, the resources will be invested in resumption and growth of the entire company’s operation and its business units, such as Azul Cargo, Azul’s logistics operator,” said the company, when asked about the financial operation in the U.S.

In an Itaú bank report signed by analysts Thais Cascello, Gabriel Rezende, Luiz Capistrano and Mateus Raffaelli, another potential chance of merger is raised: Azul and Gol. Whatever the consolidation move – of Azul with LATAM Brasil or with Gol – they say, “this kind of transaction would make sense in terms of network complementarity.”

“But we wonder about the potential structure of a deal (considering Azul’s high debt) and what criteria CADE would take into account when analyzing it,” they say. “We estimate that both merger scenarios may result in a relevant range of synergies.”

In Thursday’s B3 trading session, June 10, Gol’s shares fell 4.37%, quoted at R$26.25, while Azul’s rose 0.31% to R$47.78.