The economic crisis in Latin America is making the region's carriers focus on capitalisation and potential consolidation. Report from the annual meeting of airline chief executives in Miami.

Latin American carriers, shaken by liberalisation, open skies agreements and the continuing encroachment of US airlines into their territories, must come to terms with the realities of doing business in tough economic times.

The crisis that has rocked the region this year is forcing Latin American carriers to look long and hard at the costs and benefits of their alliances with major US carriers. Their priorities are to increase financial stability and seek access to capital markets that will enable them to fund future development and essential new aircraft in an increasingly privatised and competitive environment.

These new anxieties were brought into sharp focus at this year's Aviation Latin American & Caribbean Airline chief executive conference in Miami, Florida, in May. "This conference was supposed to be about alliances," former US Transportation Department official Jeffrey Shane told attendees "Actually, it's a conference about money."

Although all 31 top officials of Latin and Caribbean carriers in attendance do not embrace open skies agreements, there nevertheless appears to be broad acceptance of the inevitability of liberalisation. There also is a widely held view that the region's dozens of diverse airlines will undergo a consolidation similar to that seen in the USA a decade ago.

Federico Bloch, president and chief executive of Grupo TACA, predicts that the Latin American airline industry will be consolidated radically over the next five to 10 years through large mergers or through the formation of holding companies when national rules and restrictions prevent outright mergers. "I think in 10 years' time, there will be only a handful of carriers in Latin America."

Fastest growing market

Bloch contends that ownership rules are on the way out, and that Latin America is ripe for consolidation. He cites three reasons: this is the fastest growing aviation market in the world, the region is liberalising quicker than other areas, and its airlines are undercapitalised, making it difficult to pay for fleet modernisation, the necessary computer-based systems and carrier expansion. "Even the best-capitalised airline in Latin America is under-capitalised by world standards," says Bloch.

Gustavo Lenis, chief executive of Colombia's Avianca, who also believes a US-style consolidation will take place, expects that some foreign carriers will wind up owning Latin carriers. "All airlines in Latin America need more capital," he says, with some not even able to support strategic alliances. Many partnerships involving codesharing and frequent flier programmes, essential for Latin carriers to compete, will evolve into equity relationships, he predicts. US airlines, in particular, which have concentrated their recent growth on services to Latin America, will try to pick partners with strong domestic networks to increase their dominance in the region.

For that reason, Bloch says, a Latin carrier with a dominant position in its local market, providing feed traffic that is enticing to a partner, will negotiate from a position of strength and stands a better chance of working out a good partnership. "You bring two things to the party - money or market dominance," he says. "You know in Latin America, it's not money, so if you bring more market dominance, you are better off."

A number of officials believe that partnerships with major US carriers will help unlock the world's equity markets by assisting them to become more efficient operators and adapt to the operating standards of publicly owned companies. The aid comes both on the revenue side, by increasing traffic through codesharing flights, and on the cost side by helping them introduce modern systems and financial controls. "We're all going to start behaving more like public companies," Bloch says.

Equity stakes by US carriers in Latin carriers have been limited so far, and the jury is still out. American Airlines has an 8.5% stake in Aerolineas Argentinas; Delta Air Lines once had its 35% stake in now-bankrupt AeroPeru, and Continental Airlines has a 49% equity investment in Panama's COPA.

Pedro Heilbron, COPA's chief executive, sees Continental's participation almost as a lifeline that will help secure its future. "We got a bottom line commitment," he says, with a focus both on costs and revenues. The two carriers, which do not overlap, are beginning codesharing, while COPA has adopted Continental's frequent flier programme as its own and is set to introduce a new corporate image. With the help of some Continental executives seconded to the airline, COPA has begun restructuring to mirror Continental's operation and is phasing in the first of 12 new Boeing 737-700s, aircraft Continental also operates. "It's not good enough to be the best in the region," Heilbron says. "You must be as good as any airline." The next challenge, he adds, is to gain the benefits of Continental's supplier agreements as COPA's agreements come due.

Aerolineas mandate

David Cush, a former American official who became chief operating officer of Aerolineas last November, says he has a threefold mandate: make the company profitable, recapitalise it and sell it. He's been busy. The company has been working with local and New York banks to recapitalise and also is seeking to raise $200 million in equity through sale of non-core assets, such as its stake in Equant, an international data network service provider, and Buenos Aires Catering. A bond offering also is planned.

To upgrade its systems and strengthen financial controls, Aerolineas has contracted with American's sister company, Sabre Group. It also plans to merge wholly owned Austral into its operations to save the expenses of dual codes, brands and workforces. It also is counting on American flights to bring traffic through their codeshare agreement. Cush wants to improve the airline's "nonexistent" traffic in Europe beyond Buenos Aires-Madrid, in which it has a strong market share.

Since its planned aircraft purchases from Airbus are financed, Aerolineas will use funds from the recapitalisation for working capital and to pay off some short-term debt. After the recapitalisation, the company will have an 84% debt to capital ratio which Cush hopes to bring down to 80% in a year.

While Bloch built Grupo TACA, bringing together five Central American airlines into a single operating entity with management control and equity participation, substantial cross-border alliances within the region remain rare. Recently, Aserca of Venezuela has formed a cross-border alliance with Air Aruba and Air ALM of the Netherlands Antilles.

Conrad Aleong, chief executive of BWIA International Airways, has sought to interest other Caribbean carriers in an alliance, with a focus on cargo, but to no avail.

Alliance warning

Although many of the airline executives have partnership agreements with major US airlines and some are considering allowing equity investments, they are warned by both Shane, now an attorney with Wilmer, Cutler & Pickering, and Candace Browning, first vice-president of Merrill Lynch, to be cautious in their selections. "Alliances pose both an opportunity for stable growth, but also a threat," Browning says. The appeal of the Latin American marketplace is such that "stronger global carriers may bully their way in to reap the benefits for themselves".

Browning urges the Latin airlines, some worth 60% of their former value because of the economic woes of the region, to "be extremely careful" about the corporate governance concessions they accept in return for equity stakes, lest they give up their autonomy and hamstring their future growth in favour of the partners' expansion. "Make sure that the alliance is willing to accept that your local market is yours, and that it is in the alliance's best interest to promote your growth in the area," she cautions. "The more your market becomes identified as yours, the less tempted European and US carriers will be to poach in your backyard." It was LanChile's 70% market share in its home country and a unique position in the cargo market that allowed it to negotiate an advantageous alliance structure with American, Browning points out, "avoiding selling an equity stake and suffering any American colonisation."

She also urges carriers, many engaged in fare wars, to address overcapacity in their markets - possibly through mergers followed by fleet and route rationalisation - to produce competitive companies better able to weather economic cycles.

Shane echoes her advice, urging carriers to enter alliances only if the risks and benefits are shared equally. "The terms of the agreement will make or break you," he warns. "If the nature of the alliance is such that your prospects for growth are limited or not subject to your control, you will be relegated to a secondary role. You can't afford to become the tail on the dog."

Source: Airline Business