Morgan Stanley Research / Airlines: Major Rearrangement of Partnerships in Latin America

September 27, 2019– Airlines: Major Rearrangement of Partnerships in Latin America
Delta announced it will tender for a 20% stake in LATAM, paying $16 per share (a +70% premium vs. LTM’s closing price), while the US airline will divest its Gol interest. The news is a clear positive for LTM; it suggests some strategic uncertainty for Gol but any P&L impact should be small.

What happened? Delta/LATAM announced a partnership consisting of the following elements: 1) Delta will invest US$1.9bn for a 20% stake in LTM through a public tender offer at US$16 per share (78% premium to the stock’s last closing price and implying a 7.7x 2020 adj. EV/EBITDA); 2) Delta will make gradual down payments totaling US$350mn to support the partnership and LATAM’s transition costs; 3) Delta will acquire 4 Airbus A350 aircraft from LATAM and assume 10 additional A350 aircraft commitments that LATAM was due to receive in 2020-25; and 4) Delta will have a seat on LATAM’s board of directors. The companies intend to implement a joint-business agreement (JBA) in U.S.-Latin America routes, which would imply capacity and route planning. The tender offer and the strategic alliance will be subject to regulatory and anti-trust approvals. Delta has announced that it will sell its 9.4% stake in Gol, which we believe could be done in an organized transaction (such as a block trade).

Strategic alliances. In line with what would be expected, LATAM has announced its intention of ending the partnership with American Airlines and exiting the Oneworld Alliance. The South American airline does not intend to enter into the SkyTeam Alliance; it intends to maintain its partnership with IAG in Europe (a Oneworld Alliance member). So, at least for now, it will have two bilateral agreements and no alliance.

What are the next steps? LATAM and Delta should initiate shortly the process of obtaining regulatory (including anti-trust) approvals in a number of countries for a JBA, a process that could take ~2 years, we understand. In the interim, the companies will announce code share agreements, which we believe could be implemented in the next 3-6 months.

Below we address the implications for both LATAM/GOL and US carriers.

Clearly positive implications for LATAM. The news is a clear positive for LATAM airlines, in our view, for a number of reasons. To begin with, Delta is valuing LATAM at a very large premium to where it has been trading, though the deal brings no new equity (different from the transaction announced with Qatar Airways in 2016 which involved the issuance of new shares – details here). We are also encouraged by the mentioned sales/transfers of the A350 fleet/fleet commitments to Delta. This represents a big additional step forward in rationalizing the company’s fleet and should have favorable (though not easily quantifiable) implications for cash flow and long-term leverage (without sacrificing the ability of the company to grow).

In our view, another positive point is that LATAM and Delta’s route networks have far less overlap than those of LATAM and American Airlines. This means that we are unlikely to see antitrust obstacles to the two airlines doing a JBA (whereas a Chilean judge blocked a LATAM/America JBA effort last May). More important, the lack of overlap may create more opportunities for LATAM to expand and to gain inbound Delta traffic to the region in the coming years. Another basis for a positive view is the mentioned US$350 million Delta will invest in the strategic partnership (which we understand will flow through LATAM’s P&L). Most of this will go to offset real additional costs LATAM will face (such as those associated with terminating its partnership with American) but this US$350mn amount could give a boost to LATAM’s results in the next several years.

A small negative point is that this transaction could further reduce LATAM’s already low liquidity (US$4mn L12M ADTV). We highlight LATAM’s current ownership structure in Exhibit 2. The Cueto Group has signaled that it intends to tender a portion of its shares but plans to remain above 20% (versus the current ~28%). It remains to be seen what Qatar will do.

Implications for Gol: creates stock overhang but any operating impact should be modest. Gol’s stock will likely see some pressure in the near-term on uncertainty related to how/when Delta will divest its position. We believe any P&L impact from Delta leaving their partnership will be small. Customers that Delta feed to Gol represent less than 1% of the Brazilian airline’s revenues. Given the low number of daily flights that Delta operates to Brazil, we believe that American and United are more relevant for Gol (in terms of feeder traffic) than Delta. Today’s news does leave some strategic uncertainty for Gol; one possibility for it is a partnership with American (which might or might not involve the US carrier making a strategic investment in the Brazilian carrier). With LATAM exiting their partnership, American is now the only large US carrier serving the US/Brazil market without a local partner. It’s also worth commenting here that this transaction raises some uncertainty for Smiles because its main foreign airline partners are Delta and Delta’s partners (such as Airfrance, KLM, Aeromexico). As such, we would not be surprised to see SMLS3 coming under pressure in the near term.

What are the implications for Delta Air Lines? Another draw on cash via international investments… The ~$2B equity stake and ~$350M partnership investment are a notable draw on Delta’s balance sheet and cash flow over the next few years. However, management has pointed to available debt capacity to fund the transaction, which our forecast supports (

And from a strategic standpoint, though it came as a surprise, the partnership with LATAM (and subsequent GOL stake exit at ~$200M) does enhance the Central and South American footprint while creating opportunities to apply the airline’s best practices (500bps+ relative margin spread). The benefits may even be seen over the coming months as a codeshare and ultimately a JV are formed. Finally, we estimate the EPS accretion to be limited over the coming years ($50M+ 2020 net income per MSe at 20%) and believe shares may be pressured modestly given the large premium and outlay announced above.

…And a modest negative for those with LatAm exposure in the US. For the industry overall, we believe the announcement is a modest negative with carriers most exposed including AAL, UAL, and SAVE per 7-10% capacity exposure as shown in the exhibit below. This is because DAL is a formidable competitor and has historically shown an ability to enhance operations and networks for its airline investments (e.g. Virgin Atlantic). And on AAL in particular, the airline has noted a limited impact from LATAM’s departure from the Oneworld alliance and from ending its relationship with the airline, especially considering their inability to obtain approval from regulators on a JV.