June 12 (Bloomberg) -- Tam SA’s acquisition by Lan Airlines SA is creating the world’s most valuable carrier with a leading position in Brazil. Now the merger must defend its value as Brazil becomes Latin America’s worst-performing economy.
Lan and Tam, based in Santiago and Sao Paulo, respectively, will have to adjust to Brazilian economic growth that has fallen below Japan’s as they chase annual savings and new revenue of as much as $700 million. Lan’s bid to retain the highest credit rating among global carriers may require a cut in dividends, according to ING Groep NV and Larrain Vial SA.
The transaction’s value surged 24 percent to $3.5 billion in the almost two years since it was announced while Brazil’s main index and a gauge of global airlines slumped 29 percent and 27 percent, respectively, in U.S. dollar terms. Lan and Tam’s combined market value would overtake Air China Ltd. as the world’s biggest, while the tie-up will only be the 12th biggest in terms of revenue, according to data compiled by Bloomberg.
“Expectations were set too high,” Pedro Balcao-Reis, an analyst at Banco Santander SA’s Brazilian unit, said by telephone. “It’s going to be very tough to deliver on that. The market seems to be excessively benevolent toward them.”
An offer to receive 0.9 Lan share for each Tam stock closed yesterday, with 94.4 percent of shares tendered, the two airlines said in regulatory filings today. As acceptances fell short of a 95 percent threshold that allows Tam to compulsorily buy back leftover shares, the offer was extended 10 days and results will be registered June 22 at 10 a.m. Sao Paulo time.
Tam will be delisted if owners of at least two-thirds of the stock from minority holders accept the offer. Tam holders will receive depositary shares in Latam Airlines Group SA, the company formed by the merger, within three days.
Latam’s fleet will be about a quarter the size of Chicago-based United Continental Holdings Inc., according to data compiled by Bloomberg. The new carrier would retain Lan’s spot as the 20th most efficient airline with average revenue per employee of almost a third of leader EasyJet Plc, the data show.
Since the acquisition was announced Aug. 12, 2010, Tam’s shares have surged 46 percent to 41.51 reais for a total value of 6.3 billion reais, or $3.07 billion. Lan Airlines is up 0.1 percent to 12,908 pesos, with a market value of $8.74 billion, while Air China, based in Beijing, slumped 44 percent to $11 billion and Singapore Airlines Ltd. dropped 35 percent to $9.25 billion.
Lan won over Chile’s antitrust tribunal in September and Brazilian regulators in December, for a deal that will give it almost half of routes in Brazil. With Tam, Lan is gaining an airline that is 39 percent larger by sales and will give it one of the leading positions in the biggest emerging market after China, according to data compiled by Bloomberg. Tam had revenue of $7.8 billion last year compared with Lan’s $5.6 billion.
Brazil’s economy will expand 2.5 percent this year amid softer demand for its exports, according to the median estimate in a central bank survey of about 100 analysts published yesterday. Growth was 2.7 percent in 2011, the second-worst performance since 2003 and the weakest pace among major Latin American economies, and 0.2 percent in the first quarter, less than half the pace analysts predicted, and slower than Japan’s 1 percent expansion.
The deal will probably increase annual operating income before depreciation and taxes by $600 million to $700 million by the fourth year, according to a statement on Lan’s website. Of the total, 40 percent would come from higher passenger sales, 20 percent from cargo and 40 percent from cost reductions.
United Continental struggled to unify union workforces after the $3.47 billion all-stock combination that promised $1.2 billion in savings and new revenue.
Brazil was the missing element for Lan given that country’s foreign ownership restrictions. Because Brazilian law caps foreign capital in airlines at 20 percent, Tam controlling shareholders will retain 80 percent of the voting stock of the Brazilian company while Lan shareholders will own about 70 percent of Latam. Lan’s Enrique Cueto will be chief executive officer and Tam’s Mauricio Rolim Amaro will be chairman.
Both airlines will continue operating separately with their own brands, a structure that adds to risks, according to Robert Mann, president of airline consultancy firm RW Mann & Co. Inc.
“The structure suggests that synergies should be more modest as it’s not a complete takeover situation so there is a discount on what can be achieved,” Mann said in a phone interview from his office in Port Washington, New York.
Raymond James Financial Inc. reiterated “market perform” ratings for Lan and Tam on June 11 “due to the execution risk related to the merger, with the required combination of very different corporate cultures and control structures adding complexity,” it said in an e-mailed note to clients.
“Daily affairs won’t be easy between Chileans and Brazilians,” said Santander’s Balcao-Reis. “There’s a war for power brewing among these two families and that won’t be good for business.”
Tam declined to comment for this story because of a quiet period before the deal closes, according to an official who asked not to be identified in compliance with internal policy. Lan didn’t respond to e-mail and phone requests for comment.
Lan operates a fleet of 135 passenger aircraft and 14 dedicated freighters, while Tam has 156 planes, according to a joint statement distributed in January.
While Lan has posted annual profits since 1994 and turned quarterly profits throughout the global financial crisis, Tam has had annual losses in two of the past four years because of increased competition and higher fuel prices.
Another challenge for the combined carrier will be maintaining Lan’s investment-grade credit rating to contain borrowing costs as the Santiago-based carrier engages in an $8.9 billion seven-year fleet expansion.
Lan is rated BBB by Fitch Ratings and A- by Chile’s Feller Rate, a local affiliate of Standard & Poor’s. The only other major airline that Fitch rates BBB is Southwest Airlines Co., according to data compiled by Bloomberg. S&P also rates Qantas Airways Ltd. BBB. Tam is rated B+, four levels below investment grade, by S&P.
Maintaining ratings would require channeling operating cash to paying off debt, selling more shares or assets or cutting dividends, said Eric Conrads, who manages $1 billion at ING in New York, and Patricia Pellegrini, an analyst at Santiago-based brokerage Larrain Vial.
“The most logical scenario would be to cut dividends for a time,” Pellegrini said by telephone yesterday.
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